Is Kohl's Coming Unbuttoned?

Slovenly stores and shrewd competition have hurt sales

Shopping recently at a Kohl's (KSS ) store in Niles, Ill., Kimberly Rellinger can't find any boys' shorts as she digs through a jumble of misplaced items. And she gives up on the shorts idea altogether when she sees the five-person checkout line. Instead, she heads to a nearby Old Navy (GPS ) where she finds what she wants with no wait. "Now I will go there first," says the 36-year-old mother of two boys.

Plenty of Kohl's shoppers seem to be making the same call these days. On July 10, the apparel discounter reported a 2.4% decline in June sales at stores open at least a year. Worse, it warned that for the first time since going public in 1992, second-quarter earnings would decline. In part, the disappointing numbers reflect growing competition from department and specialty-apparel stores. But Kohl's Corp. execs may also have lost their Midas touch: Distracted by a big expansion into California, they have misjudged inventories and relaxed once-tight control of existing operations.

It's quite a reversal for this '90s retail star. Until recently, it seemed the Menomonee Falls (Wis.) chain could do no wrong. Kohl's has posted 35% compounded annual earnings growth over the past five years. It did so with the simplest of strategies: selling casual brands at low prices. By locating its stores in strip centers, Kohl's draws shoppers who find malls inconvenient. Now, having missed sales targets for 7 of the past 9 months, Kohl's heady days may be over. "It's the first crack in the growth story," says Deutsche Bank Securities Inc. analyst Bill Dreher.

Nonsense, says Kohl's CEO R. Lawrence Montgomery. He attributes the weak sales to a sluggish market for apparel, which affects Kohl's more than department-store rivals because clothing makes up a higher percentage of its sales. But, he admits, the competition has "narrowed a little bit."

Indeed, rivals ranging from J.C. Penney (JCP ) and Sears, Roebuck to Federated Department Stores (FD ) Macy's unit have borrowed from Kohl's playbook. Like Kohl's, they made their stores easier to navigate and beefed up casual brands. Most of all, they have cut prices to counter the advantage of Kohl's locations, says Marshall Cohen, chief analyst at market-research firm NPD Group Inc. As a result, Penney, Sears, and Federated all posted better sales results than Kohl's in June. "The consumer is going back to the mall because they can get a better price with a wider variety," Cohen says.

Department stores aren't the only ones playing better defense. Gap (GPS ) Inc.'s Old Navy unit, whose shops are often based in strip centers with Kohl's, has recently shifted from trendy teenage fashion toward clothing that appeals to mothers with children, one of Kohl's targets. On the low end, Kohl's is facing more pressure from Wal-Mart (WMT ) Stores Inc., which is upping the quality of its apparel and adding national brands like Levi's. "Wal-Mart is also after the same middle-level shopper," says Patrick McKeever, an analyst at SunTrust Robinson Humphrey Capital Markets.

Meanwhile, Kohl's expansion into California seems to be distracting management. The chain has opened 28 stores this year in the greater Los Angeles area, where it is encountering fierce resistance from entrenched players such as Mervyn's and Macy's West. Some analysts say the challenging expansion helps explain recent stumbles at Kohl's existing stores. While the retailer has always loaded up on inventory, this year it misjudged demand and wound up having to discount heavily, which dented profits. Shoppers also complain that stores are less well-kept and check-out lines longer than they were.

Most troubling, perhaps, is that sales have slipped at Kohl's most mature outlets. That raises questions about the chain's growth prospects as older stores become a larger percentage of Kohl's locations. Deutsche Bank estimates that same-store sales at outlets five years old or more have declined for the past three years. In June, Kohl's worst-performing stores were in the Midwest, home to the bulk of its older shops. Montgomery blames a weak Midwest economy and lousy weather. If he's wrong, Kohl's days of rapid growth may be behind it.

By Robert Berner in Chicago

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