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This Overlooked Stock May Acquire Kohl’s — Is It a Buy?

Kohl’s (NYSE: KSS) has been a hot topic of conversation lately as investors ponder whether the department store chain is a buy amid the ongoing talks that it could be taken private if the right deal is struck. But what about shares of the company that may end up being the acquirer — Franchise Group (NASDAQ: FRG)

The Ohio-based holding company is now in an exclusive negotiation window with Kohl’s after talks with several other potential acquirers fizzled out. Deal or no deal, shares of Franchise Group look like a sound long-term investment as the shrewd operator continues to build its empire of franchised businesses. 

Image source: Getty Images.

What is Franchise Group?

Franchise Group is the owner and operator of a variety of franchised and franchisable businesses across an array of industries . It seeks to acquire businesses in consumer-facing, economically resilient sectors with low maintenance and capital expenditures and little chance of being disrupted by e-commerce.

The company was formed when Buddy’s Home Furnishings merged with Liberty Tax Centers in 2019 . It has since divested from Liberty Tax Centers and assumed its current form by steadily acquiring a stable of new businesses. .

You may be familiar with some of the company’s best-known holdings, such as The Vitamin Shoppe and Sylvan Learning Centers. The company also owns furniture and appliance chain American Freight, and Badcock Furniture, a home furniture retailer in the southeastern United States. It also owns companies in the pet care inudustry like Pet Supplies Plus and Wag N’ Wash . And it still has rent-to-own furniture seller Buddy’s in its portfolio.

I like the fact that Franchise Group’s mix of businesses seems to fit this criteria it has outlined — in the event of an economic downturn, businesses like pet care supplies and low-cost options for furniture should remain fairly resilient, whereas business for a rent-to-earn franchise like Buddy’s may even pick up. The company has increased revenue and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) over the past three years — and a large backlog of 367 locations between the businesses indicates that the strategy is working so far . 

The company is led by CEO Brian Kahn, who has an impressive background in the private equity space  and has so far done an exemplary job of acquiring businesses that have enhanced the value of Franchise Group, such as Vitamin Shoppe and Sylvan. The shares have gained over 300% since 2019 although they’ve had a tough go of it this year — down 32% year to date.

How could Franchise Group Make Kohl’s Work? 

If Franchise Group completes its acquisition of Kohl’s, it would be by far its largest acquisition to date . But the company’s success with previous acquisitions and the management team’s track record inspire confidence.

Kohl’s has struggled over the last few years, leading some major shareholders to call for change. Macellum Capital Management, one of Kohl’s top shareholders with ownership of almost 5% of shares outstanding , has bemoaned the fact that Kohl’s has lost market share and rewarded executives despite subpar results . They point out that had an individual invested $100 in Kohl’s ten years ago, it would still be worth the same amount today, meaning the shares have vastly underperformed the broader market . Macellum also says that management has “failed at capital allocation and balance optimization, leaving billions of owned real estate idling.” 

We don’t yet know how Franchise Group will seek to improve Kohl’s operationally, but the part about billions of dollars worth of real estate left idling fits right into Franchise Group’s playbook. After the recent Badcock acquisition, Franchise Group engaged in a sale and leaseback of $94 million worth of real estate that Badcock owned . A similar strategy with Kohl’s-owned real estate seems like it would be well-received by shareholders as this is one of the ideas Macellum has been pushing for and would make Kohl’s more of a less capital-intensive business .

By monetizing the real estate on the balance sheet, Franchise Group could immediately put it to work to improve the business and reward shareholders. Other possible advantages of the deal include increased pricing power for the group by adding Kohl’s into its current mix of companies and finding synergies between Kohl’s, American Freight, and Badcock, for example. 

Attractive valuation and growing dividend  

An investment in Franchise Group has more than doubled over the last five years, but the shares still look relatively cheap compared to the broader market, trading at just under eight times earnings . Franchise Group uses the recurring royalty payments from its franchises to create a steady stream of dividends for its shareholders. The company’s significant dividend yield of over 6.5%  is well above that of the S&P 500. Franchise Group has been growing this dividend, from $1.00 per share in 2020 to the current $2.50 per share annually, representing a 250% increase in just two years .

Franchise Group states that its goal is to pay a “growing and dependable dividend to shareholders.”  Additionally, the company will also be returning capital to shareholders via share repurchase as it announced a massive $500 million share-buyback authorization in May, which equals almost a third of the current market capitalization . 

Is Franchise Group a buy?

All in all, if Franchise Group is successful in acquiring Kohl’s, it could revitalize the company with a fresh talent and perspective coming in to turn things around. On the other hand, even if Franchise Group doesn’t acquire Kohl’s, its shares still look attractive as a long-term investment, trading at a modest valuation with an solid dividend and a skilled management team at the helm that can keep scouring the market for other accretive acquisitions while continuing to improve its current holdings.

Either way, Franchise Group has the hallmarks of a solid long-term investment.

Michael Byrne has positions in Franchise Group, Inc. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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