Takeaway: The stock still isn’t cheap despite today’s shellacking. Don’t get heroic buying it here.

Macy’s picked the wrong market environment to be Macy’s. The irony with this sell-off is that relative to historical trough valuations for this business, it’s not even that cheap at 5.5x EBITDA. I know a sub 6x p/e looks appetizing, but the reality is that the earnings base is shrinking in perpetuity, credit rolled over this quarter, excluding both credit and asset sales EBIT for M this quarter was -$26mm. That tells me that you throw the p/e out the door, and value it on the credit book and real estate portfolio. The latter is a black hole – particularly given that an illiquid portfolio of ~670 mall anchor stores is hardly monetizable, and estimated values of the flagships carry an ocean-wide range – so value is theoretical if anything. And in Macro Quad 4 while we’re smack dab in the middle of a trade war --- the same one that Macy’s management acknowledges that it can’t take up prices in – it’s not the time to get heroic buying a name like Macy’s. We took this name off our Best Ideas Short list about $8 higher – a mistake. Granted that was before the trade war or Quad 4 broke out. But a good lesson as to how these names can always get cheaper. At 4x EBITDA (it’s traded below there in the past when numbers were actually real) Macy’s is an $11 stock.  M sits at a 10% dividend and has about a year and a half until it starts to hit some big debt maturities in 2021-2024 of $2.8bn.  The prudent move is a dividend cut in 2H.


Key Fundamentals

  • Macy’s was able to squeeze out a positive comp of 0.2%. Transactions drove the comp, up 5.3%, with UPT down 1.8% and AUR down 3%.  The AUR reflects promotion and inventory clearance that hit the gross margin line hard (down 160bps) as the slow start to 2Q meant spring clearance later in the quarter.
  • Credit inflected negatively, down $10mm or 5.4% this Q, as the company cited higher fraud and bad debt expense.  Management stated is has strategies in place to mitigate the 2H exposure.  Though I’m not sure how easily you can strategize away fraud and bad debt beyond over-reserving.  3Q compare in credit is much harder.
  • SG&A delevered 40bps as M likely sees the wage pressures of the overall retail industry.


Management Tone and the Plan
Management sounded surprisingly bullish despite the weak quarter.  The CEO is trying to shift focus to the “Growth 150” plan and citing “destination businesses” comped up MSD.  The Growth 150 stores are 50% of B&M sales, and the destination business are 40% of sales. It begs the question, what about the other ~60% of sales and how much of profits is that?  And you have to love the rapid growth of the innovative "Backstage" store concept now up to ~200 locations within a Macy’s store, otherwise known to most retailers as the clearance section.  Should we really fault management here though?  Is there any way to steer US B&M retailers that let their store concepts become tired and stale, and that started investing in ecommerce a decade too late, away from their ultimate destiny?  What more can you do than focus on the good, try to invest in stores that might succeed, and let the struggling ones slowly go away. Still what you have today is a company at a 10% dividend yield, at about 2x levered with $4.6bn in debt, and a credit book tracking toward 60% of EBIT (ex asset sales) that is inflecting to decline at the cycle peak. 

Tourism & Tariffs
M comments on the tourist consumer are likely weighing on some other retail names today, as sales slowed to -9% from -3.1% last Q.
On tariffs, the company noted a 4th tranche of tariffs is not in its guidance, though stating the impact of 10% on list #4 would likely only be about a nickel on 2019 earnings.
Management thinks it can deal with a 10% tariff on list #4 with not overly significant earnings impacts or price increases, but 25% would be much worse.