Michael M Santiago
2023 started strong for value stocks, but suffered a significant downturn following the demise of SVB Financial, and other banks failing with their liability management activities. While the markets in general performed well On the back of the largest technology-oriented companies, many stocks are weakening far worse than the companies’ overall fundamentals would suggest. While retail is not my favorite area of investment, sometimes you find really attractive opportunities with a solid margin of safety, and I think such an opportunity exists in the general stock of Macy’s (New York Stock Exchange: M), after falling 31.5% over the past three months. At a recent price valuation of about 5.7 times the lower end of potential low EPS guidance, I think the stock is up about 50% from current levels.
Missy has it It reinvigorated itself by becoming an effective multi-channel retailer. The company uses its stores for pickup and delivery and has significantly expanded its brands with BlueMercury and Backstage. Macy’s has made strong progress investing its value real estate over the years, while also investing in locations outside of malls to diversify. The company was hit hard by shutdowns in 2020, as it was forced to ramp up its debt, but it has been cutting that in the past few years, while benefiting from the collapse of competitors like JC Penney. Diluted earnings per share in 2022 and 2023 were $4.55 and $4.19 respectively, which together is over 50% of the current share price. It sounds very cheap to me, which is why we’ve recently increased our exposure in the stock through various strategies.
On June 1, Macy’s reported adjusted diluted earnings per share of $0.56, down from $0.98 a year ago. Total revenue of $5.173 billion decreased from $5.565 billion. Net sales of approximately $5 billion were down 6.8% year-on-year. Credit card revenue decreased by $29 million to $162 million in the first quarter, dragged down by higher intra-portfolio bad debts. Operating income was $244 million, down from $463 million. Gross margin actually improved to 40%, up from 39.6%, as inventories were in a very good place during the quarter. Delivery expenses improved 40 basis points and inventory decreased 7% year-over-year, in line with lower net sales. SG&A rose $45 million, or 2.4%, to $1.95 billion. Macy’s raised the minimum wage on May 1 of last year, which was the main reason for the increase.
As April progressed, Macy’s saw sales decline, particularly among lower- and middle-income consumers. By name, Macy’s net sales were down 7.7% and comparable sales were down 7.9% based on ownership licensed, compared to an increase of 10.1% last year. Bloomingdale’s held up better with net sales down 2.3% and similar sales down 4.3% on an owned and licensed basis, compared to a gain of 26.9% a year ago. Beauty, contemporary clothing for men and women, and household items fared relatively well. Blue Mercury continues its climb with net sales growth of 4.4% and comparable sales increase of 4.3%, versus a 25.2% increase last year, buoyed strongly by medical and medical skin care, as well as hair color.
Macy’s lowered guidance significantly with the premium assumption of increased macro pressures occurring mid-March through April, while the low forecasts a potential deterioration as the year begins. The company expects comparable sales to decline 6-7.5% year-over-year, and a gross margin rate of 38-38.5%, as the company anticipates deeper writedowns. Adjusted EBITDA as a percentage of revenue is expected to be around 8.8-9.4%, or 9.1-9.7% as a percentage of net sales. Annual adjusted EPS is expected to come in between $2.70 and $3.20, down from a previous forecast of $3.67 – $4.11. For the second quarter, Macy’s expects net sales of $5-5.1 billion and diluted earnings per share of $0.1 to $15. The company takes the right steps to reduce slow-moving inventory through promotions, so that it can move quickly to the appropriate areas when demand picks up. Macy’s has announced that it will bring back Nike in the fall, which should be a great addition to the floor plan.
Macy’s has done a good job over the past five years improving its cost efficiency, recently scheduling $200 million in cost savings for this year and about $300 to $350 million in 2024. The company also reduced its capital spending by about $50 million. Longtime CEO Jeff Genette will step down from Tony Spring in February of next year. The company intends to continue revitalizing its own brands, expanding into smaller locations outside of malls, and focusing on more personalized offerings by leveraging technology. Brands like Bloomingdales, Backstage, and BlueMercury have boosted revenue for the company as a whole, and there remains a strong runway for ongoing investments. The store within the store concept helps make better returns on Macy’s valuable real estate, and nearly every store is turning a profit after pruning out weaker locations over the past few years. Management’s goal for 2024 is single-digit sales growth and a sustainable low double-digit adjusted EBITDA margin.
Macy’s current valuation of 4.1x after-earnings and 3.8x excess EV/EBITDA is not required. The current dividend yield is a healthy 4.14% and the market value is about $4.2 billion. Macy’s carries approximately $3 billion in long-term debt, while it also has approximately $3 billion in long-term lease liabilities, so I think the company should continue to prudently reduce debt with free cash flow. Although I believe Macy’s is undervalued, investors looking for a more conservative strategy to invest in the stock may use selling collateralized puts for cash. For example, one could sell a $12 quote on January 24 that expires in 229 days for $1.04. This equates to a return of approximately 9.5%, or 15.3% per annum on maximum risk. Your worst case scenario is because of Macy’s at $10.96 breakeven price per share, which I think will put you at potential vulnerability on the next strong rebound in retail spending. I realize that this investment is not as exciting as Nvidia or AI in general, but a successful investment capitalizes on opportunities when they present themselves. Macy’s could drop about 29% from its current share price of $15.42 to break even, which I think, combined with the current attractive valuation, provides a very strong margin of safety.
