Kohl's(NYSE: KSS) operates what are, essentially, department stores. This was a good business for many years, leading to meaningful growth. However, consumers have increasingly gravitated away from department stores in recent times, leading this retailer to struggle at growing its business. Revenue, for example, is down nearly 5% from where it was a decade ago. But that's not the only problem.
Concerns about the dividend
Kohl's probably shows up on the dividend short list of many income-focused investors. The reason? It has a huge 11.1% yield today. After a long string of annual increases, the dividend was cut in 2020. That's not too shocking given the impact the early efforts to slow the spread of the coronavirus had on retailers.
Image source: Getty Images.
At this point, however, the dividend has been increased twice and sits at $2 per share per year. That's below the pre-cut dividend, but still enough to leave the stock with a sizable yield. And given the longer-term history, it seems like management sees the dividend as an important tool for returning value to investors.
That statement is buttressed by the fact that a top-level bullet point in the company's first-quarter earnings release said that Kohl's was committed to "maintaining [the] current dividend." You can't get any clearer than that if you are looking to understand management's dividend goals. But there's a problem here -- hinted at by the super-high yield.
Conflicting goals
At the same time that Kohl's announced its support of the dividend, it also said that it was committed to strengthening its balance sheet. In fact, both statements showed up in the same top-level bullet point. It's not that some companies can't support a dividend and reduce debt at the same time. The problem is that Kohl's may not be able to pull it off, a fact that investors are clearly aware of given the elevated yield.
Some numbers should help flesh this out. At present, Kohl's is expecting earnings per share to come in somewhere between $2.10 and $2.70 in 2023. Given the $2-per-share dividend, the low end would produce a dividend payout ratio of 95%. That's extremely high, leaving a very slim margin for error. At the top end of guidance, the payout ratio would be around 75%, which is better but still not exactly great.
KSS Debt-to-Equity Ratio data by YCharts
Adding to the concern is the fact that Kohl's tapped a $680 million credit line in the first quarter, which was a tough one -- comparable-store sales fell 4.3% year over year. Basically, the company isn't really hitting on all cylinders right now, but that's not new; Kohl's has experienced a decade of weakness. The key here, however, is that with so much money going toward the dividend, there may not be much left over for debt reduction. And that potentially puts these two goals at odds with each other.
Cash flow
Dividends actually get paid out of cash flow, so the payout ratio isn't a full picture of a company's dividend-paying ability. And yet one of the quickest ways for a business to free cash up for other purposes, like debt reduction, is to cut the dividend. With the debt-to-equity ratio back near 2020 highs, investors appear to think the dividend is at risk. That's probably not an unreasonable fear when you look at Kohl's financial results and expectations.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.