Kohl's now plans to open Sephora shops within all its more than 1,100 stores, expanding a partnership that the struggling company said has boosted its sales in a difficult retail environment by attracting new customers and driving foot traffic.

The Menominee Falls, Wisconsin-based firm will have Sephora store-in-store beauty sites at about 600 locations by year-end, with 400 of those opening this year. Kohl's is slated to increase that number by 250, to a total of 850, next year. And now the department-store chain is working with Sephora to design a smaller-footprint concept for the beauty shops for the retailer's remaining 300 stores, to cover its entire brick-and-mortar footprint, CEO Michelle Gass said during a second-quarter earnings call on Thursday. The Sephora in-store shops currently open are 2,500 square feet.

"Sephora at Kohl's provides our customers with easier access to prestige beauty, and the partnership has brought in new, younger and more diverse customers to Kohl's," Gass said in a statement.

Kohl's made the announcement as it also reported a second-quarter sales decline, with net sales falling 8.5% and comparable sales down 7.7% compared with last year. And it lowered its full-year guidance. Like other retailers such as Walmart and Target, Kohl's has seen shoppers — in its case middle-income customers — pull back on nondiscretionary spending for items such as apparel because of record inflation. The bright spot for Kohl's has been San Francisco-based Sephora, according to Gass.

Kohl's isn't the only chain that has partnered with other retailers to let them open stores-within-stores, but its deal with Sephora is now turning out to be one of the most expansive of such arrangements. For example, Macy's is debuting Toys R Us shops within all its roughly 500 brick-and-mortar locations. Ulta Beauty opened shops within 100 Target stores last year, with 250 more coming this year and a total of 800 planned over time. The partnerships aim to bring new customers to the host retailer as well as the satellite retailer. They also allow a company such as Sephora to expand its footprint beyond malls, and for a retailer such as Kohl's to enjoy more foot traffic generated by loyal Sephora customers.

The Sephora at Kohl’s shops mimic the look of a freestanding Sephora, with that chain's distinctive branding, and feature a curated assortment of so-called prestige makeup brands such as Fenty, Nars and Charlotte Tilbury, and skincare, hair and fragrance brands. Sephora-trained beauty advisers offer personalized beauty consultations and help shoppers find products. The shops also have testing and discovery zones where customers can experiment with a rotating assortment of new or trending products. Men’s grooming will also be receiving dedicated space.

Regarding its partnership, Kohl's is projecting that Sephora at Kohl’s will grow to hit $2 billion in annual sales by 2025. It's been a year since the first Sephora shop opened at Kohl's, and Gass said the partnership has been a success.

"We have acquired more than 1 million new customers since launching last August, which is encouraging given that this occurred in less than half of our fleet, many of which have just been opened for a very short period of time," Gass said.

Kohl’s stores with Sephora continue to outperform the balance of the chain. The 200 Kohl’s stores with Sephoras in them that opened in 2021 have maintained a high-single-digit percent sales lift, relative to the rest of the chain, according to Kohl's. And in the nearly 400 stores opened this year, there's been a mid-single-digit percent sales increase, consistent with the initial performance in the first 200 stores.

In addition to attracting new and younger customers, people that shop at Sephora at Kohl's visit more frequently than its average customers, Gass said. And Sephora at Kohl's customers are shopping across the entire store, according to Kohl's. Roughly half of all the customers buying Sephora items are acquiring at least one other nonbeauty item with their purchase, Kohl's said.

Neil Saunders, managing director of GlobalData, said he doesn't view Sephora as a solution to Kohl's woes in the long term.

"The addition of Sephora does not fix the wider issues with Kohl’s proposition," Saunders said in an email to CoStar News. "I am not surprised that Sephora has done well at Kohl’s, because Sephora is a compelling brand that people will make purposeful visits to. As for helping Kohl’s, I am sure there is some benefit but the stores they opened Sephora in first tend to be better more robust locations. It will be interesting to see the impact on the rest of the chain as this is rolled out. Indeed, if the Sephora locations are outperforming, given Kohl’s currently dismal results the rest of the chain must have really, really bad comparables. The bottom line is that Kohl’s needs to grow the Sephora partnership and improve its own offer."

Kohl's merchandising strategy, a focus on active wear and casual clothing, and lagging performance has come under fire from a number of activist shareholder groups. Earlier this year Franchise Group, headquartered in Dublin, Ohio, bid to acquire the chain. But both parties couldn't come to final terms, and on July 1 the sale was called off.

When it bid, Franchise Group said it would finance the acquisition by monetizing Kohl's real estate, presumably with sale-leaseback deals for its stores and distribution centers. Kohl's Chief Financial Officer Jill Timm addressed that issue on Thursday.

"We are assessing the current retail environment and leveraging a competitive process to determine potential opportunities to monetize a select portion of our real estate assets," she said. "As we have done in the past, we will focus on opportunities that will enhance our financial flexibility and maintain our healthy balance sheet."

Asked for more detail about the real estate's potential, Timm said, "So when we talk about looking at potential opportunities to monetize the real estate assets, I mean, obviously the market is quite volatile right now. So we're doing a competitive analysis of that, really helping understand what we can get I would say right now with the industrials. In terms of the [distribution centers], [e-commerce fulfillment centers] have a better rate than what we're seeing from a store perspective. But also key to that is understanding what that means from lease terms and the long-term components of those contracts."

The retailer also plans to move forward on plans to open 100 small-format stores, but the timetable on that has slowed down because of the economic environment according to company officials.

"So we're looking for those markets that make sense," Timm said. "We're also taking into consideration the current market conditions. I would say we are still planning to open 100 stores over the next several years, but it will be paced and I think more of a ramp up toward those latter years versus in the beginning part as we kind of learn more and how to merchandise them, putting a fulfillment store, which is going to look very different than any store that we've opened, much more locally relevant. So you're going to walk in and it's going to feel different than when you walk into a Kohl's store."

Kohl's also plans to debut a new concept in Tacoma, Washington, in November. It is being designed to offer "a more localized, modernized and inspiring shopping experience" to customers, according to the retailer, which is using data to create a Kohl's unique to the Tacoma market.

“We are going to use the new store as an opportunity to test, learn and inform as we continue to scale and drive long-term real estate growth,” Mark Griepentrog, Kohl’s chief property officer, said in a statement.

In addition to localized assortments, the Tacoma location will have a different look than traditional Kohl's stores, with touches such as polished concrete replacing carpet.

“We’re leaning into inspiration and storytelling with lifestyle-led curations across brands and categories for an outdoor, active lifestyle,” Nancy Carruth, Kohl’s executive vice president, brand strategy, creative and experience design, said in a statement. “Our goal is to provide a solution-oriented layout that guides customers through the store and helps them find what they are looking for.”