Keith shorted M in the virtual portfolio on the heels of weak June results and a low volume rally setting lower highs. We remain negative on the intermediate term TREND and long term TAIL.
Macys’ localization & omni-channel initiatives could create margin upside and improved asset turns long term but anyone who owns M needs to understand that it is a zero growth retailer at peak margins. This is all about trusting management to leverage technology and take its existing industry-leading productivity levels even higher. We’re now entering 2H where the expectation for margin upside is predicated on pricing which is all but guaranteed. Department stores have been great plays in economic recoveries of years past. We’re two years in, and are not holding our breath for number three.
Over the past two years, Macy’s has increased its focus on the localization of the business and omni-channel shopping experience. The integration of mobile & online (~7% of sales growing ~40%/year) remains a priority with the e-commerce biz aiming to exceed $2bn in 2012. Macy’s is one of the few retailers that we think ‘gets it’ in this regard. As a result, M has consistently delivered 4%+ comps over the past 8 quarters; comparable growth not seen since 2007. Despite these initiatives driving the top line over the past 24 months, the recent tailwind from JCP/KSS share gains will become incrementally more difficult over the intermediate term which will cost margin dollars, working capital, or both.
Here are some additional factors that we expect will continue to weigh on performance:
- June comps came in +1.2% vs +2.5E (and guidance of slightly below the quarterly +3.5%). This following management reaffirming that Macy’s is gaining share directly from JCP’s inability to execute on its pricing strategy. With June accounting for ~40% of the quarter, July comps need to come in +6% to reach the quarterly guidance of +3.5% and +4.5% to reach the consensus estimate of +3.1%. Each requirement suggests an acceleration in the underlying 2 yr comp trend of 80bps and 150bps respectively. Given a 180bps sequential deterioration sequentially from May to June, this is no slam dunk.
- Sell side sentiment improved on the margin relative to June following the light top line results while short interest remains at a 10 year low creating an opportunity on the short side.
- F12 comp guidance of 3.7% (increased following Q1 from 3.5%) is assuming continued AUR expansion. 2H12 costs may be set at this point however pricing is not guaranteed. While JCP has been unable to properly communicate its pricing strategy, it has yet to roll out its shops in 2H which are arguably the larger piece of the transformation. Additionally, the off price space continues to accelerate its top line momentum as KSS remains unable to capitalize on the JCP attrition. Both the potential for traction at JCP as well as the off price value proposition and now the recently announced EDLP program at KSS will weigh on M’s pricing power in 2H.
- M is currently at peak gross margins with EBITDA margin targets predicated on further expansion. Revitalized competition (mentioned above) creates “strategy audibles”- Macy’s won’t be an exception here.
- Finally, with the M trade range at $32.69-$35.29, it’s bumping up against Keith’s TRADE Resistance and sitting at a point where the fundamentals and price mesh well within Hedgeye’s Risk Management framework