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Turnaround Letter
Out-of-Favor Stocks with Real Value

Macy’s 3Q: Weak, but Working Hard for Better Holiday Season

Turnaround Letter Buy-rated Macy’s (M) reported weak results compared to a year ago, although earnings were higher than consensus expectations. Revenues fell 4.3% compared to last year. Comparable store sales on an owned/licensed basis fell 3.5%. These declines were worse than consensus and management’s expectations and disappointing to us as well. Some of the causes included weather, tourism and weak results in lower-tier malls, as well as lower prices from discounting to clear out excess inventory. Based on management’s comments on the post-release conference call, Bloomingdales, BlueMercury and the top 150 Macy’s stores (out of 636 total) had decent performance. However, that implies that the 486 other Macy’s stores are struggling more than it appears.

Adjusted per-share earnings of $0.07 were sharply lower than $0.27 a year ago, reflecting the lower revenues and slightly lower gross margin. Selling, General and Admin expenses were lower than a year ago, as were interest costs. Adjusted EPS was somewhat higher than the consensus estimate for a 1-cent loss.

Steady credit card revenues of $183 million (at very high margins) fell only 1% from a year ago. Macy’s outsources its credit operations to Citigroup but still participates in its profits. This income remains a large portion of Macy’s overall profits and needs to stay healthy as it helps fund Macy’s operating transition and debt paydown. While we expect profits to remain robust, they are vulnerable to the economic cycle.

Macy’s reduced their full-year guidance across the board. Adjusted earnings per share, excluding asset sale gains, are now expected to be about $2.30, about 15% below their prior guidance.

Macy’s appears well-positioned for the fourth quarter. Inventory apparently is in great shape, their store upgrades (esp the Growth 150 stores) and website/mobile improvements are ready for customers, and other initiatives stand ready to capture holiday revenues and profits. The company makes nearly all of its annual profits in the fourth quarter, so the pressure is on for solid operating performance. While the fate of Macy’s doesn’t reside in the fourth quarter, it will anchor investor expectations for the pace and success of their on-going transition.

In 2020 and beyond, the company’s challenge remains unchanged: balance the declining relevance and economics of their presence in lower-tier malls with the murkiness of transitioning to a more relevant merchandising and distribution mix, while maintaining sufficiently profitable. Consumers still buy a remarkable amount of “stuff” every year (as Target’s and Walmart’s recent results clearly illustrate), but what is sold (needs to be relevant), where it is sold (geographic location, on-line presence) and at what profit margin it is sold have become much more critical to get right. Macy’s is spending aggressively to get it right, as seen in their operating expenses and capital spending.

The company’s balance sheet and cash flow are healthy-enough, with, again, some pressure to produce decent 4Q results. Macy’s continues to chip away at its debt, with more paydowns coming from 4Q holiday profits.

With the stock trading at 4.3x EBITDA, and paying a ~$0.38/share quarterly dividend that appears maintainable and offers a 10.3% yield, Macy’s offers real appeal. While fundamental concerns have driven much of the recent selling, tax loss selling likely is contributing. While our $48 price target remains aggressive, we will retain it pending 4Q results.

We retain our Buy rating on Macy’s (M) with a $48 price target.

Disclosure Note: One or more employees of the Publisher own shares of all Turnaround Letter recommended stocks including M shares.