Kohl’s Corp. (NYSE: KSS) had a rough Thursday after earnings. Then, in what may feel like adding insult on top of injury, a key analyst downgrade took Kohl’s rating down to Neutral from Buy after the drop. Sterne Agee CRT’s Charles Grom, Renato Basanta and John Parke were the analysts, and they cited earnings risk and an uncertainty over the earnings multiple as well.

The argument is that there is clearly a more challenged retail and consumer backdrop, and the path for same-store sales growth for 2015 and 2016 is less visible for Kohl’s. The research team said:

While we remain proponents of the Greatness Agenda, it is becoming increasingly unclear how quickly sustainable sales benefits can materialize. Complicating matters, with Kohl’s P/E valuation (and others) still above historical levels (about 15 times), we now find it difficult to justify stock upside as the “E” (earnings) comes under more scrutiny. Net, with stock still up 24% since February of 2014 (versus S&P up 14%), we think it makes sense to move to the sidelines until greater clarity develops.

Sterne Agee CRT’s team showed that Kohl’s reported $0.63 in earnings per share (EPS) for the first quarter, up from the firm’s $0.53 estimate and above the consensus of $0.56 EPS. Gross margins and lower expenses helped, as did a lower tax rate. Those gains were partly offset by softer sales and by a higher share count. Still, the gain of comparable sales being up 1.4% was under the firm’s 2.5% estimate.

The revenue was short of estimates despite the EPS looking good, and the three analysts said:

Beyond the top line disappointment, the other key line items were very favorable with: (a) gross margins up 18 bps vs. our expected decline of 30 bps and (b) SG&A up only 7 bps vs. our modeled 40 bps increase. Net, EBIT margins were 80 bps better than our model at 6.8% leading to a $30 million EBIT level beat (~$0.10 in EPS) in the quarter. Below the EBIT line, the benefit of a lower 35.2% tax rate was partly offset by fewer repurchases vs. our model ($147 million vs. SA @ $280 million). All told, we like the strong operating level beat in the quarter, but the disappointing 1.4% comp is, rightfully so, the focus of this print with Kohl’s seemingly another victim of today’s choppy retail sales environment.

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24/7 Wall St. did not edit out the abbreviations and the wording from the research report below, in which Sterne Agee CRT’s team gave eight key takes from the Kohl’s call:

1) the company noted that February comps were slightly negative and the March/April combined period came in consistent with the company’s expectations at ~2%;
2) traffic was “flat” in the quarter, a slowdown vs. the 4Q +2.0% gain;
3) non-credit sales outperformed credit in 1Q as the company focused more of its efforts on loyalty – a favorable development;
4) the company commented on the potential for a “massive” impact in 4Q from its personalization initiatives and also a 4Q boost from the continued ramp of loyalty (will have 35 million members by year-end vs. 29 million today) with potential benefits from new “mystery point offers” and “loyalty days” now in test;
5) about half of 1Q transactions were on the Yes2You loyalty platform and KSS is seeing consistent results across the ‘12/’13/’14 classes of sign-ups;
6) national brand penetration continued to increase at up 200 bps higher YOY in 1Q;
7) the localization strategy continues to develop with tiered localized assortments expected to be in half of the chain by the end of next year;
8) Juniors/Jewelry were meaningful comp drags of 90 bps and 30 bps, respectively, while the active and wellness business was up in the “high teens.”

They also have four points to consider on the good news side of the coin:

1) same-store sales accelerated sequentially during the quarter, with a combined March/April period finishing ahead of a softer February;
2) KSS beat our quarterly estimate by $0.10, with majority of the variance coming above the EBIT line (see quality discussion above);
3) Gross Profit Margins improved 18 bps YOY to 36.8%, with the improvement driven mainly by higher merchandise margin rates from more strategic direct mail/promotions and in despite of an 18 bps hit from the mix shift toward national brands;
4) SG&A expenses were also controlled very well, leading to only 7 bps of year-over-year deleverage.

Sterne Agee’s team lowered the old buy target of $85 down to $70 with the new Neutral rating. The firm’s 2015 EPS estimate went to $4.55 from $4.65 and the 2015 estimate went to $5.00 from $5.25. That new $70 target is now based on 14 times the Sterne Agee CRT fiscal 2016 estimate.

Kohl’s shares were down 11.6% at $65.87 on more than 18 million shares as of 2 p.m. Eastern Time on Thursday. Its 52-week range is $50.90 to $79.60. This stock was at $74.51 just a day before.

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