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Turnaround Letter
Out-of-Favor Stocks with Real Value

August 20, 2021

Today’s note includes earnings updates on Macy’s (M) and the podcast. There were no ratings changes this past week. Also, a few scheduling changes as the CTL is on vacation next week.

Clear

Today’s note includes earnings updates on Macy’s (M) and the podcast. There were no ratings changes this past week. Also, a few scheduling changes as the CTL is on vacation next week:

  • There will be no Friday update or podcast next Friday, August 27.
  • We will be publishing the September letter on Wednesday, September 1, with the Catalyst Report on Friday, September 3.

We appreciate your understanding as we re-charge our batteries for what will likely be a very interesting September and fourth quarter in the markets.

Ratings Changes:
None

Earnings updates:
Most of our companies have reported. Only two remain: Signet Jewelers (SIG) and Duluth Holdings (DLTH), both on September 2.

Macy’s (M) With a capable new CEO since February 2018, Macy’s is aggressively overhauling its store base, cost structure and ecommerce strategy to adapt to the secular shift away from mall-based stores. Its sizeable debt is not crippling the company but remains an overhang. Macy’s was hit hard by the pandemic, setting back its turnaround from a financial perspective, but the company’s acceleration of its overhaul shows considerable promise.

Macy’s uncorked a stunningly strong quarter, raised its full-year revenue and profit guidance, initiated a dividend and share repurchase program and suggested that it is on the path to an investment grade bond rating. The shares surged nearly 20% yesterday. With the stronger outlook, the shares now appear to have upside into the $25 range, implying about 15% upside from here. But, we are keeping the HOLD rating as this upside isn’t enough to justify a return to Buy.

Revenues of $5.6 billion rose 2%, and same-store sales rose about 5.9%, from two years ago (one-year-ago comps are not meaningful due to the pandemic). Macy’s had 10% fewer stores compared to two years ago, so showing any amount of sales increase was impressive. Revenues were 13% above the consensus estimate.

Adjusted earnings of $1.29/share were 4.6x earnings of $0.28 two years ago and 6x the consensus estimate of $0.18. Adjusted EBITDA of $836 million was more than double the comparable 2019 earnings and the consensus estimate.

Revenues were surprisingly strong as the company’s online and in-store marketing and merchandising benefitted from broad customer demand trends as well as Macy’s-specific improvements. All three names (Macy’s, Bloomingdales, Blue Mercury) showed good results, although suburban locations were healthier than urban locations. Better merchandising and inventory productivity (faster turns, lower mark-downs) helped boost gross margins even as delivery expenses rose sharply. Operating expenses fell 13% despite the higher sales – an impressive accomplishment. Their Polaris strategy is clearly working.

We like their plan to carve out space for ToysRUs mini-stores. This is still a highly recognized brand, and shows that Macy’s is flexible enough to try new ideas. Given the huge draw of toys, especially as the holidays approach, this initiative looks promising.

Also, while many believe that department stores are becoming irrelevant, Amazon has decided to launch its own department stores. This is a fascinating reversal that suggests that Macy’s may not be on the wrong side of consumer shopping.

Credit card revenues rose 12% from two years ago, illustrating some surprising customer loyalty (and low credit losses) although the penetration was about 5 percentage points lower than two years ago. In reviewing the cardholder benefits on the Macy’s website, we can see why loyalty is high – their rewards program is very attractive to regular shoppers and appears well designed to entice and retain the customers they are targeting. Interestingly, the company spoke about negotiating better terms with Citi or changing to another financial institution. Either would be a positive.

Macy’s capital strength got a major boost: the company generated $769 million in free cash flow and looks well positioned to generate more. In response, it repaid $1.3 billion of debt (after quarter-end) yet still have $800 million in cash, reinstated a $0.15/quarter dividend, announced a $500 million share repurchase plan and is on its way to an investment grade credit rating in a year or two. This is a remarkable turnaround from a year ago when Macy’s very existence was in doubt. Interestingly, the implied 2.9% dividend yield raises the costs for short-sellers, thus removing one barrier to a higher share price.

The company raised its full-year 2021 revenue and earnings guidance sharply. Based on this guidance and stronger prospects, we think the shares are now worth around $25, but retain our HOLD rating as the upside from here isn’t sufficient to warrant renewing our Buy rating. Also, we are wary of the risk that this quarter and the summer period in general may be an unsustainable surge, particularly as Covid variations threaten the return to normal.

Friday, August 20th, 2021 Subscribers-Only Podcast
Covering recent news and analysis for our portfolio companies and other topics relevant to value investors.

Today’s podcast is about 13½ minutes and covers:

  • Brief updates on:
    • Macy’s (M) – blowout earnings but keeping our Hold rating

  • Comments on other recommended stocks:
    • Credit Suisse (CS) – two new board members.
    • General Motors (GM) – pressing ahead with production re-start even as competitors slow down.
    • Baker Hughes (BKR) – drilling activity continues to tick upward.
    • Xerox (XRX) – Carl Icahn raises his stake.
    • Organon (OGN) – Berkshire Hathaway buys some OGN shares.

  • Final Note

Please feel free to share your ideas and suggestions for the podcast with an email to either me at bruce@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time limit we may not be able to cover every topic each week, but we will work to cover as much as possible or respond by email.