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We’re still cautious on Macy’s, and even more so after this quarter. Don’t forget how quickly estimates can change on a zero-square footage growth apparel retailer with financial leverage.

If there’s only one thing I had to look at this quarter for Macy’s, it is the triangulation of sales, inventories and margins. The SIGMA chart below for M shows all… It has been in the sweet spot for 8 consecutive quarters. That’s pretty huge for any retailer. This is when inventories are being managed down, the pipe is clean, prices are generally higher, and closeouts are a smaller part of the mix.

Through history, there have been a few companies who have had a multi-year run in this quadrant – such as Coach, Lulu and Abercrombie.  But most would probably agree with us when we say that M is not of the same caliber. (Conversely, we’ve had companies like Sears, K Mart, and Foot Locker spend the better part of a decade in the opposite quadrant – inventories up margins down).

But to see Macy’s finally take a decidedly negative turn South on this chart is not good. We call this The Denial Quadrant. “Yeah, inventories might be getting a little heavy, but our margins are up, and we’re optimistic about our business,  so everything is cool.”  History proves that higher inventories are manageable, until they’re not.

We still think that Macy’s is one of the most consensus longs in retail. The most common point of pushback I get on a short is that “if you believe the numbers, it’s really cheap.”

Well, let’s run some alternate math. Let’s take comps down 3% next year, GM down 50bp, and SG&A up 1%.  That gets us closer to $2 in earnings. In instances where estimates are being downwardly revised, M will have no problem trading at 8x.

Looking at EBITDA – which we think is more fair – we’ve got 6.5x these numbers. If M trades at 4x – which it has in the past when estimates come down, you get to a $15 stock.

We’re not making that call – yet. But we have a heck of a lot more confidence in a -3% than a +3%.

The risk/reward here doesn’t look good.

M: Bad Risk/Reward - M SIGMA

Brian P. McGough
Managing Director