Retail Values: Kohl's and Wal-Mart

12/17/2013 8:00 am EST

Focus: STOCKS

John Buckingham

Editor, The Prudent Speculator

The stock market, it is often said, climbs a wall of worry. Incredibly, the tremendous advance we've enjoyed in 2013, came amidst the backdrop of dysfunction in Washington and anxiety over Fed tapering, asserts John Buckingham in The Prudent Speculator.

We remain optimistic about the long-term prospects of our broadly-diversified portfolios of undervalued stocks, even as we concede that we are overdue for a pullback and we have a bit more cash than usual.

We have no newfound insight into near-term market moves just because our performance star is shining brighter, but we can say, from our contrarian viewpoint, that recent talk of a bubble in equities has been reassuring. Meanwhile, here's a look at two leading retailers.

Kohl's (KSS)

Kohl's operates family-oriented department stores offering moderately-priced apparel, footwear, accessories, and home goods.

Stores, which number 1,155 (more than a third are company-owned), are heavily-concentrated in the Midwest and East, but Kohl's is aggressively expanding into the South and West.

We like that Kohl's sales mix is well-diversified, and that the retailer has made a lot of progress increasing sales of higher-margin private and exclusive brands.

The shares were hit relatively hard on disappointing guidance, following Q3 earnings. We believe that this latest headwind was just part of the overall turnaround process, as management looks for creative ways to drive new traffic.

Kohl's has a solid balance sheet and generates an attractive level of free cash flow, which provides flexibility for expansion into new markets and the return of capital to shareholders. KSS trades for less than 13 times forward earnings projections and yields 2.5%.

Wal-Mart Stores (WMT)

Wal-Mart is the world's largest retailer, with a presence in 27 countries, operating supercenters and wholesale warehouse clubs.

In addition, the company continues to roll-out smaller store formats, including exclusive grocery stores, in an effort to penetrate historically under-represented urban areas.

While domestic traffic, and overall ticket levels, have been traveling a bumpy road, the company continues to gain overall momentum.

We believe that its Sam's Club business offers solid near-term prospects, while its international unit, with its growing e-commerce business, provides attractive long-term growth opportunities.

Though there are concerns over the growth rates of the domestic business, we like the solid balance sheet and management's willingness to return capital to shareholders via buybacks and dividend increases. We think WMT is a lower-volatility bargain.

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