Kohl's: A Retailer(!) Worth a Look

Citigroup has a new favorite.

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Before we start, the answer is yes. We are in a recession, consumer spending is falling, and the shares of retailers have been beaten to a pulp in this downturn. So why take a look at any of them?

Well, contrarian bets are fun, for one. Second, buying up the best names in the most challenged sectors before a market turns can equal outsized returns. And third, for Kohl's specifically, the negative tone among retail analysts toward the stock took a bit of a turn this week.

First off, Citigroup updates its Top Picks Live! list with Kohl's replacing Wal-Mart. (UnitedHealth Group bounces Coventry Health Care off that list, too.) At first glance, it seems a little odd, given outperformance by Wal-Mart against nearly every stock in the sector and the widely held consensus that consumer staples, not consumer discretionary like Kohl's, are the safest place to be in this market.

Here's Citi's case why:

Bottom-line: KSS—We are adding KSS to TPL as the company has a significant opportunity to gain market share from the Mervyns' liquidation over the long term. We also expect it to leverage its real estate experience to pick up valuable square footage at attractive prices as other competitors close their doors.

Kohl's looks like bottom fishing to me in this environment, though the company has been powering through admirably with some pretty aggressive store openings lately. Mervyn's bankruptcy, declared on Friday, could send an extra 2 percent to 4 percent same-store sales growth Kohl's way next year, according to William Blair analysts, who point out that a large chunk of Mervyn's shuttered stores will sit in pretty close proximity to a Kohl's.

To the point about retail's recovery, William Blair also looks back at how investors fare during spending downturns. Turns out, it's not so bad. From its Kohl's note:

More broadly, as it relates to retail stocks overall, we maintain our constructive approach to the sector and recommend that investors add to positions in the highest-quality franchises (such as Kohl's), particularly on pullbacks. While it is counterintuitive, investing in retail stocks during periods when consumer spending is growing solidly has historically produced relative underperformance. Over the past 30 years, virtually all of the outperformance for retailers versus the S&P 500 has been during recessionary periods.

It's time to start thinking about catching some early rebounds.