Unusual Options Activity in Kohl's Corp Stock Highlights Its Value

Large unusual options volume today in Kohl's Corp (KSS) puts and calls topped the list in today's Barchart's Unusual Stock Options Activity Report. These options trades highlight the underlying value of KSS stock. That also depends on whether the investor believes a recession will occur.

In midday trading, KSS stock is at $20.18 per share, up slightly since Kohl's released its Q2 earnings on Aug. 28. The stock was at $19.65 on Aug. 28, so it's now up 2.7% in the last month.

This could also be because KSS Corp is a high dividend yield stock. Its annual $2.00 dividend gives investors almost a 10% dividend yield (i.e., $2.00/$20.18 = 9.91%).

Unusual Options Activity

That could also be why there is a large volume of options activity today. However, the ex-dividend date was Sept. 11, so, since this period has passed, it does not account for this activity.

According to the Barchart Unusual Stock Options Activity Report today KSS tops the list of options contract volume. For example, the $17.50 strike price put option that expires in 16 days on Oct. 11 has traded over 20,000 put contracts. That is over 147 times the prior number of put options outstanding (i.e., see the Vol/OI column in the table below). These are deep out-of-the-money (OTM) puts - since the $17.50 strike price is over 13% below the spot price at $20.18.

In addition, the same expiry period shows over 21,000 calls traded, or 82x the prior volume outstanding. The strike price is slightly higher (i.e., 4.0% out-of-the-money, since $21.00 is 4% over $20.18).

So, what is going on here? Options investors are making big bets that either KSS will fall in the next two weeks or rise slightly higher. In both cases the premiums are not that high, so it's likely that these are initiated by directional investors. 

On the other hand, some of the traders may be selling covered calls for 45 cents and buying long puts for 9 cents, for a net credit of 36 cents. That provides a net yield of 1.78% over the next two weeks to the covered call investors.

In addition, they could potentially sell their shares at $21.00, so their net gain would be 5.845% (i.e., ($5.45-.09)/$20.18.

Long-put investors might be betting on hopes that KSS stock will fall, even though the yield is high. They might be hoping that the market no longer believes that the dividend is sustainable. After all, it's not uncommon for high-yield stocks like this to end up cutting their dividend.

Let's look at that point more carefully.

Kohl's Dividend - Is It Secure?

First of all, Kohl's management made a point of insisting in their latest earnings report that the dividend is secure. For example, one of the six bullet points in the Q2 earnings release was this: “Committed to returning capital to shareholders through the dividend and further strengthening balance sheet.”

Moreover, the cash flow statement seems to support this. For example, in the first half of 2024, the operating cash flow was $247 million and the dividend cost was $111 million. 

However, capex spending was $239 million. So, its free cash flow (FCF) was not sufficient, at $247m-$239m or $8 million. There is not enough “free” cash flow to cover the $111 million in first-half dividend payments.

But that is not how you should analyze this company. Since Christmas revenue is such a large part of the whole year financials, it's better to look back on the last 12 months (LTM). 

For example, the LTM free cash flow, based on data from Seeking Alpha, as of Aug. 3, was $709 million (i.e., $1.187 billion operating cash flow - $478m in capex spending). That FCF more than covers the annualized $222 million dividend cost at a $2.00 dividend per share (DPS).

In fact, this covers the expected debt paydown amount of $226 million. This is based on the $113 million in debt reduction in the first half of 2024. It also leaves room for share buybacks.

In other words, the dividend is covered by cash flow if you take a full-year approach. Here is another way to look at this.

Next year analysts expect to see revenue of $16.1 billion. Since its $709 million LTM FCF represented a FCF margin of 4.14% on $17.124 billion in LTM revenue, we can use that to estimate its future FCF. So, taking 4.1% of the 2025 $16.1 billion (even though lower than its LTM figure), results in an FCF estimate of $660 million.

That is still ample FCF to cover the $222 million in dividends, $226 million in debt reduction, and over $2212 million in share buybacks. The point here again is that the 10% yield looks secure.

Target Price for KSS Stock

The average dividend yield for KSS stock in the past 5 years has been 6.60%on a forward dividend yield basis, according to Seeking Alpha. That implies that at today's 9.91% yield, KSS stock is undervalued.

For example, assuming the $2.00 DPS is secure, we can divide it by 6.60% to derive a price target of $30.30 per share (i.e., $2.00/0.066 = $30.30). That is 50% higher than today's price.

Similarly, Morningstar reports that the five-year dividend yield average has been 7.47%. So, dividing $2.00 by 0.0747 results in a price target of $26.77 per share. That is 33% higher than today's price.

This also coincides with the average analyst price target of $26.54 as shown by AnaCharts survey of 14 analysts who cover KSS stock.

The bottom line is that KSS stock looks undervalued here. That could be why there is huge out-of-the-money (OTM) options activity in the stock seen in today's Barchart's Unusual Stock Options Activity Report.

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On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.