Macy's Inc - Department Store Chain for a Value Investor

Stocks
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Macy’s Inc is a traditional American department store chain whose market value has plummeted amid the current coronavirus panic. The company sells fashion apparel and cosmetics in its department stores, online, and via mobile app. Last year’s reported earnings per share (EPS) was $1.81. The company has launched a three-year cost-saving program to overhaul its organizational structure. Past performance can be tracked through this link to the Macrotrends website. As a side note, Macy’s generated a pre-tax profit of 444 million (receiving a tax refund) during the fiscal year ending January 31, 2009, in the midst of the financial crisis, excluding goodwill write-downs. With a share price of $9.5 and 309 million shares outstanding, the current market capitalization of the equity is $2,935.5 million.

Let’s address the elephant in the room right away. This company is very similar to Stockmann, with the distinction that Macy’s is profitable, whereas Stockmann’s entire business collapsed and its investors lost their money permanently. To make contrarian investing sensible, one must know whether the markets are right and efficient. We must answer the question: is Macy’s path the same as Stockmann’s? The balance sheets of both companies are frighteningly similar due to large amounts of goodwill. Macy’s equity, minus goodwill and intangible assets, is 2,030 million.

An essential factor is the demand for the company’s products, on which all business is based. Demand normally depends on the quantity of the company’s assets—meaning if you open or close locations, your revenue naturally grows or shrinks. Revenue growth is not an end in itself; the purpose of an investment is to generate profit for its owners. This development is well illustrated by the Asset Turnover ratio, where the fiscal year’s revenue is divided by the average total assets at the beginning and end of the fiscal year. The resulting figure depends heavily on the industry and the company, so a sensible benchmark is the company’s internal development over time.

The following table shows Macy’s Asset Turnover values, which I have calculated from the company’s reports:

Macy's asset turnover

In some companies, demand truly changes with the business cycles. Demand for Stockmann’s products has withered throughout the 2010s (see Stockmann’s company page, PDF), making it difficult to cover fixed costs.

Macy’s equity ratio is 30.1%, and its liquidity, measured by the Current Ratio, is 1.18.

For 2020, Macy’s provides guidance for an adjusted result of $2.20 - $2.40, excluding gains from real estate sales. This guidance was issued on February 25, 2020, while the coronavirus situation was ongoing, but it does not account for the effects of the virus. According to the latest data, 95% of the company’s factories in China have already resumed operations. The company generates the majority of its profits in the fourth quarter, from November to the end of January. According to management, the first quarter and the first half of the year will be weak, with earnings improving toward the end of the year.

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Good summary! I was already looking at this company a week ago when the dividend yield and P/E were attractive. I decided not to buy, as the company’s trend is downwards. It has come down 25% in a week. The dividend yield is already almost 15% and the P/E is under 4. Is that correct?

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Institutions own 94.75% of Macy’s shares, meaning the stock’s movements largely depend on how EFT and other fund investors want to buy and sell their stakes labelled “retail” or “department store”. These companies are not cut from the same cloth; Macy’s is a strong competitor and its stock is more affordable than, for example, J C Penney or Nordstrom. Funds generally cannot take strong views on individual companies. This makes the stock price formation inefficient, and I considered this ownership specifically from the perspective of a value investor picking individual stocks. In a technical sense, it is probably wise not to go against the trend. I myself have been at the edge of this excitement since $17.5. Stocks can behave unpredictably and move tens of percentage points in either direction in a day when mispricing is noticed. The market expects nothing from this company.

P/E can be calculated in many ways. As a result of this transformation process, extraordinary items affect the earnings. The adjustment is intended to give an indication of the company’s earning power, which is something entirely different from what the current stock price suggests.

Macy's EPS
Macy's EPS905×264 14.3 KB

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Just as a note for those interested in Macy’s, according to Morningstar data, over a quarter (26%) of the stock is currently sold short. That’s by quite a large margin the highest figure among SP500 index companies, along with The Macerich Company.

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This is definitely an interesting company, but it’s coming down so fast that I don’t think the decline is over yet. From the bottom of the financial crisis, you could get this for around $5, and I’ll wait until then. The dividend yield here is already close to 20%, but the sustainability of the dividend is not a very credible claim in this market situation. The plans to turn the tide seem good to me, and the value of the properties owned by the company seems to be already significantly higher than the market value, even if they had to be sold off at half price.

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Information about Macy’s development project for the coming years can be found from the capital markets day:
https://livestream.com/icenyse/macysinvestorday2020/videos/201559522
(put anything in the complaint fields)

The video is four and a half hours long, but if you don’t have time for everything, I recommend watching at least the CEO’s part and CFO Paula Price’s presentation (2:52:00 - 3:24:05). At the end there is a Q&A session where the management is challenged (3:27:30 -).

It takes a certain courage to guide declining revenue in a market that values increasing revenue above all else. However, the company acknowledges the industry challenges and has decided to respond to them by improving profitability. Small, poorly performing locations are being closed, and logistics and customer focus are being improved. When the numbers are presented, 100 million is 5% of the current market cap.

The guidance for 2022 is a revenue of $23.2 - $23.9 billion (Owned & licensed 1% geometric decline in 2019-2022).
$2.50 - $3.00 adjusted EPS including asset sales. (~772.5 - 927 million)
$2.25 - $2.75 adjusted EPS excluding sales. (~700 - 850 million)
$1 billion in free cash flow.
Growth continues after 2022.

The figures look realistic considering Macy’s history, and if they materialize, a profitable company like this at this price can only be found perhaps once every 10 years during crisis times. I also looked at the financial statements for the last 20 years, and the company has never made an operating loss (goodwill write-down in 2008 and an internet company bought during the tech bubble was written down in 2001, neither had cash flow effects). Of course, this does not guarantee that a loss could not be possible. The Helsinki stock exchange offers at best a 10% return, but this 30% return is three times better. The coronavirus will be a mere memory by summer.

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A very concise summary. I’ve also been following M for a while now. However, this involves big issues related to brick-and-mortar stores in the US, so a lot now depends on how that “reconstruction” will succeed. There are plenty of ifs and buts to ponder.

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Then, if you look at it through TA (sorry for the spam if you’re not interested), on a monthly basis, there’s only one actual support level left, practically $5. After that, it’s about a “Black Dirt Breakdown.” Traditionally, these have been situations where the threat of bankruptcy, among other threats, has been considered.

The virus threat and fear come at a bad time for brick-and-mortar stores. People’s movement will change significantly, and it’s still difficult to predict how quickly this can be contained in that regard. In the short term, this will certainly show in M’s results and, above all, its cash flow.

Dividend income is not a decisive factor for me in long-term investments if volatility is high. Changes in stock value can eliminate dividend benefits in the short term, and in the long term, a company’s ability to stay alive is the most significant thing. I’m waiting to see a daily trend reversal in TA before I start buying into M.

The chart still shows the level at which I was actively following it, and a break from there caused a free fall.

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I see two main reasons for Macy’s undervaluation:

  1. Funds own almost all shares, and the company has no anchor owner (source). This makes funds the marginal investor determining the market price of the stock. I can imagine that Macy’s is found in the holdings of many ETFs focused on value investing, retail, or department stores. These have not been popular in recent years. Fund investors do not like underperforming funds; instead, they bet on winners and sell losers. Shorting is a good indication of this.
  2. The effects of the coronavirus hit almost everywhere, and Macy’s is not immune. The S&P 500 index has been historically high, and a general sell-off combined with Macy’s already favorable valuation creates a historic opportunity specifically for a long-term “buy and hold” value investor. If this drops to five, I think there’s a risk that some Berkshire might buy the store out. I don’t know enough about the logic of corporate acquisitions to assess the probability of this risk.

A drop in share price as an indication of bankruptcy risk probably holds as a rule of thumb, but bankruptcy usually results from long-term losses. Another, rarer option is a lack of liquidity in a financial crisis situation when lending ceases. Macy’s is a profitable company with exceptionally strong cash flows due to depreciation (1608 million operating cash flow last year vs. 3475 million net debt). The company’s credit rating is investment grade, which the company’s management wants to maintain. I consider the company’s bankruptcy threat to be low.

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According to the link, funds own about 25.5% (top 10), maybe a little more if smaller ones are included. Not all seem to be ETFs. You can also see the latest big moves from there.

I need to research M myself a bit more closely, I’ve mainly been following it because such a big drop is always a warning sign for me. Institutions are smart owners. Similarly, a large number of shorts is a signal that such a large number of shares have been found for lending. That also has its own purposes.

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10 minutes after the US stock market opened, it was -9.8%. Quite wild when you look at the original $17.5 dollar investment at a -60% loss. But here, one has to act and not just say, after sitting on a pile of money for four years hoping something to buy would come along, watching all possible videos, reading books, and getting to know the investment. I tripled the number of shares at a price of $7.5, P/B 7.5 / (20.26 - 0.38) = 0.38, market cap 2317 million. This was not even this cheap at the bottom of the financial crisis. At the lower end of the 2022 guidance, the return is 30%. If these numbers cannot be trusted, then the whole thing is pointless. Price is what you pay, value is what you get.

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We’ve received early preliminary data on U.S. retail sales for February:

For Macy’s, the relevant segment is clothing & clothing accessories, and the relevant comparison point is the corresponding period last year. The reported sales figures are higher this year. I believe that this does not take into account the fact that February this year had 29 days, which would weaken comparability.

So, if we calculate the decline in sales in this segment, it was 22,411 * (28/29) / 22,100 - 1 = -2.08%.

Macy’s gross profit last year was 9,389 million, and if we roughly assume that this decline would reflect a decrease in revenue for the entire year, gross profit would decrease by -196 million. Macy’s made an adjusted profit of 906 million last year. This calculation is certainly wrong, but it gives some indication of how strong a company it ultimately is.

It is clear that the gross domestic product will decrease in the United States and Europe amidst this corona panic, and many weakly profitable companies will suffer. However, company revenues will not drop to zero, and life will continue when the number of active disease cases turns to a decline.

Regarding valuation, the market capitalization milestone of 2,000 million was surpassed at a share price of $6.47. I think I will continue the buying program at 1,500 million ($4.85). Then half of the investment assets would be in shares. What on earth am I missing here?

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Your target price is rapidly falling. The last support level in TA is at 5.07, which is the lowest figure in stock market history so far. Someone is missing something, but who?
Are department stores about to close due to the virus, or why is the decline continuing?

I wouldn’t have believed a year ago that BA’s price would touch $100.

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Here’s a list of businesses that are closing or reducing their opening hours: Ihre Datenschutzeinstellungen

Macy’s isn’t on the list, but there are quite a few big players and the list will probably get longer.

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Macy’s also announced it would close all stores from March 18-31 (or until opening is permitted) and serve customers online. Employees will be compensated for the period.

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This seems like an interesting company, and I’m particularly interested in its real estate assets. Are these properties currently not valued at fair value on the balance sheet? I haven’t had time to do an in-depth analysis yet, but from what I quickly read, the real estate portfolio should be worth well over 10 billion, even though some of it has been sold?

As it currently sits, the Herald Square building’s value was pegged at $3-4 billion in 2015, according to the Wall Street Journal. It has about 1.1 million square feet in floor space for retail and 1.1 million square feet for office and storage space.24.4.2019

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Good question. However, it’s worth remembering that many department stores are old properties and there may not be demand for them if Macy’s wants to get rid of them (for example, there are already empty department store properties left by Sears). This is a broader problem in the US, meaning not all retail space is particularly good or modern. (cf. Stockmann’s properties, for example). Of course, they could try to sell them to a real estate investor and simultaneously commit to a sale-leaseback, if there’s an acute need for cash.

This comment is made quite generally; I have no idea which properties are on the balance sheet and which are not, or what condition they are actually in. But the fair value estimates from 2015 may not have grown by any large multiple.

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Thanks for the comment, I need to investigate this a bit further. The estimates are old, of course, and one has to assume some kind of decrease from the old values. At least the value of Herald Square could be imagined to be close to the current one, as I don’t believe there has been a major collapse in values in Manhattan. In addition, a skyscraper is planned there, which in this situation could certainly be postponed.

“In early 2016, hedge fund Starboard Value argued that Macy’s real estate was worth more than $20 billion. A late-2017 study by investment bank Cowen put the value at $16 billion (which seems like a more realistic figure).”

https://www.fool.com/investing/2019/05/29/macys-real-estate-value-matters-more-than-ever.aspx

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This is a good point! I checked the 2018 annual report, as Macy’s has not yet released last year’s annual report. It says this:

So, the company depreciates its real estate assets on a straight-line basis annually, apparently based on the acquisition cost, and the properties have not been valued at fair market value. Also, the income statements do not include a “fair value changes” line item for changes in the market value of properties, as real estate investment companies do. If the fair value of these properties is 16 billion, it would add ~10 billion to equity, or +$32.36 per share. However, fair values depend on economic cycles, and that estimate was given at the hottest market moment.

I recommend that all interested parties watch the capital markets day video that I linked earlier. It details the company’s near-term plans. Property assets are discussed from 1:59:00 onwards. Personally, I believe that improving profitability is precisely the right strategy in a weakening economic situation. The company’s management expected weakening growth even before the coronavirus.

Funds continue to offload shares. According to my notes, Macy’s had 308,965,297 shares outstanding on November 30, 2019 (rounded to 309 million). At a share price of $6.20, the market value would be 1915.58 million. The company’s operating cash flow last year was 1608 million. If you want to consider that a lucky number, you can get it at a share price of $5.20. Normally, these price/cash flow values are something like 10, 15, 20 times.

However, it is not worth focusing on the dividend. I would be surprised if the company continues to pay a quarterly dividend of 116 million in such an uncertain situation. The company’s cash flows have traditionally been very strong, but now it would be important to secure working capital for certainty. The coronavirus epidemic may end in 3-6 months, according to some estimates.

I am very much looking forward to the Q1 report, which may be released on May 15. It will be bad, but how bad?

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Macy’s is making adjustments:
https://www.businesswire.com/news/home/20200320005560/en/

Dividend payments will be suspended and a $1.5 billion revolving credit facility was put in place as a proactive measure. Unnecessary expenses are being cut and this year’s investments are being reduced. This year’s guidance was withdrawn. February went as expected, but the closure of stores from March 18 onwards makes forecasting difficult.

Sounds reasonable.

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Even five days later, it’s still being tested:

Consumer loans can quickly destroy a balance sheet. At the turn of the year, Macy’s had a tangible book value of approximately 2030 million, from which a paid dividend of 116 million can be subtracted. That credit facility is 1500 million. Q1 2019 expenses totaled 5570 million, of which SG&A accounted for 2112 million.

Now we need some monthly sales reports. It’s quite a sad situation when department stores are closed and there’s no end in sight to the pandemic. This could also lead to bankruptcy.

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