How Kohl's figured out the Amazon era

Kohl's has connected with mid-aged, middle-income women through a mix of stylish clothing brands and a knack for quickly reacting to the latest fashion trends.

Wall Street has taken notice. Kohl's (KSS) is one of the hottest retail stocks over the past year, outperforming peers like Macy's (M), Nordstrom (JWN), JCPenney (JCP), and Gap (GPS).

Much of Kohl's recent success can be attributed to the department store's improved tactics in its top business: Women's clothes.

Doubling down on women's clothes

Kohl's women's apparel division accounts for about a third of the company's roughly $19 billion in annual sales.

Kohl's stands out against competitors because it makes a big chunk of the clothes it sells, under three $1 billion private-label brands — Sonoma Goods for Life, Apt. 9 and Croft & Barrow. It also has relationships with designers for exclusive lines, such as LC Lauren Conrad and Simply Vera Vera Wang.

Private-label and exclusive brands make up 70% of Kohl's women's business and 42% of the company overall. By comparison, private labels represent 20% of Macy's total sales.

Exclusive brands, like one with fashion designer Vera Wang, help Kohl's stand out against rivals.

Controlling the supply chain for those clothes is a big advantage for Kohl's. It can nimbly respond to shoppers' style preferences and minimize inventory mistakes, such as ordering too many heavy jackets during a warm winter.

In recent years, Kohl's has focused on mastering the basics to strengthen its shopping experience.

For example, its has narrowed choices on the shelves to reduce clutter. It has also sped up the manufacturing timeline by 30% to move clothes from initial drawing stages to the shelves.

The approach is paying off. Last quarter, Kohl's own brands had their best performance in five years. Inventory fell 8% per store, signaling that shoppers grabbed up just about everything they could find off store shelves.

"Kohl's has done an admirable job by investing in desirable products customers want," said Oliver Chen, a retail analyst at Cowen.

Next year, Kohl's will start selling Nine West shoes, handbags, and an exclusive clothing line. It's adding a new private-label plus-size clothing brand, EVRI, and heightening the label around the stores with more racks and larger mannequins. The company sees an opportunity to appeal to women searching for fashion in extended sizes. Those mannequins will help Kohl's showcase EVRI in stores.

Retailers wake up to opportunity in plus-size clothing

Kohl's is also chasing more Millennial women.

It recently started selling PopSugar at Kohl's — a collection of tees, tops, skirts and shorts curated by the digital media company.

"We see an opportunity to draw more Millennial customers and young families to Kohl's," Greg Revelle, Kohl's chief marketing officer, said about the tie-up with PopSugar.

Running with athleisure brands

Kohl's has made an expanded push into selling more athletic brands, too. The strategy has driven sales and helped the company attract new, younger shoppers.

Nike has become Kohl's largest national brand partner, and Adidas products are a top seller at its stores. Last year, Kohl's began offering Under Armour merchandise for the first time.

"Active and wellness is a permanent part of the American landscape. And we want to be the destination," CEO Kevin Mansell said earlier this year. Michele Gass, Starbucks' former marketing guru, took over for Mansell in May.

The active and wellness division has grown to more than 15% of Kohl's overall sales.

Kohl's is making a big bet on athletic brands like Under Armour and Nike.

As part of Kohl's efforts to become a go-to athleisure retailer, it is testing expanded floor space for top athletic brands, an increase to 40% at 30 stores.

Tie-ups with Amazon and Aldi

Investors believe that Kohl's is well prepared for the future.

Kohl's mastery of retail fundamentals gives it flexibility to rethink its store layouts and take risks.

Over the last few years, Kohl's has reduced the size of 500 stores — close to half of its fleet — from 90,000 square-feet to 65,000 and 35,000 square-feet. The company makes the same amount of sales at those stores, but it saves money by carrying less inventory and employing fewer workers. For shoppers, Kohl's says the smaller format is easier to navigate. Most of its stores are located away from struggling malls.

Reorganizing store space creates opportunities for outside-the-box thinking, too.

While many retailers are fighting against Amazon, Kohl's has joined with the online seller. It offers free returns for Amazon.com purchases at more than 100 stores in Los Angeles, Chicago, and Milwaukee. Kohl's is also experimenting selling Amazon Echo and smart home devices at designated stations within 20 stores.

More recently, executives announced a test with grocery chain Aldi to lease out 5 to 10 stores next to Kohl's beginning next year.

Kohl's is looking to fill the spaces with other retailers and grocers that can help stores attract traffic. Chen believes Planet Fitness could be an attractive partner for Kohl's or even Amazon Go cashier-less stores.

Bringing on complementary retailers' customers is a crucial part of Kohl's attempt to future-proof its business.

Kohl's has had trouble growing sales since it doesn't offer a ton of must-have brands. Its shoppers are less fashion-driven than Macy's or Nordstrom's customers and likelier to stay home when the weather is rough, Chen said.

Plus, TJX Companies (TJX) and Ross Stores (ROST) have undercut Kohl's in recent years with rock-bottom prices and a treasure hunt-like shopping experience.

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