Introduction
The department store Macy’s, Inc. (NYSE:M) management may be beginning to regret their decision to call off takeover talks with Arkhouse Management, who offered to buy all outstanding shares for $24.80. With the shares now trading over 35% below the offer value, having fallen another 9% following earnings, the missed opportunity is glaring.
Although the earnings headline numbers appeared all right, with earnings per share coming in ahead of expectations, revenue below consensus and a cut in guidance drove the shares lower. Back in April, I rated Macy’s shares a sell, on worries that rising credit card delinquencies would harm Macy’s prospects. So far, it has been correct to avoid, with the shares down 19% since then, significantly underperforming the S&P 500 (SPY) that has returned 11%.
Despite the decline, I still rate the shares a sell. In this article, I would like to provide an update on the stock, cover the latest results, and explain the reasons why I think Macy’s shares could fall further.
Q2 Results
Macy’s released its second-quarter results on August 21st, which showed a mixed performance. Net sales came in at $4.9 billion, down 3.7% year-on-year, missing expectations by $110 million. This decline was driven by ongoing weakness in the sales of men’s clothing, handbags, and home goods, which was only slightly offset by stronger sales in fragrances. On a comparable store basis, sales were down 4% for owned stores.
Despite the revenue fall, the company reported adjusted EBITDA of $438 million, and non-GAAP earnings per share of $0.53, beating estimates by $0.24. This came following a 2.4% increase in gross margins year-on-year to 40.5%.
Across the three main brands Macy’s operates, the namesake department store chain saw net sales fall 4.4%. This came as Macy’s continued closing stores, with the targeted number of closures this year rising from 50 to 55. Despite Macy’s aim to grow its Luxury sales through the expansion of its Bloomingdale chain, net sales in this segment were down 0.4% year-on-year, and -1.4% on a comparable store basis.
Credit card revenue came in at $125 million for the quarter, a small 4.2% increase against last year. I have previously written about the importance of this revenue to Macy’s given it forms part of a profit-sharing agreement.
Despite this only accounting for 2.7% of net sales, this is almost all profit given it’s a profit-sharing agreement with its partner bank. This represents 46% of the year to February 2024’s EBIT of $1.34 billion. Any fall in this revenue, whether from a cap on late fees or rising delinquencies, translates to a significant fall in revenue for Macy’s and I believe this risk to profits is currently overlooked by markets.
Although credit card revenue was up in the quarter, looking ahead, Macy’s expects credit card revenue to fall to $110 million in the third quarter, down over 22% year-over-year. With credit card debt reaching record highs and consumer sentiment ebbing, combined with rising credit card delinquencies and, although currently on hold, the potential for a cap on late fees, this particularly lucrative source of revenue may be at threat. Falling consumer sentiment and rising delinquencies do not just point to lower credit card revenue, but a weaker consumer in general, which could lead to a fall in Macy’s sales in coming quarters.
In response to the weaker consumer outlook, Macy’s cut its guidance for the rest of the financial year. Net sales are now expected in the range of $22.1 billion to $22.4 billion, down from the previously guided $22.3 to $22.9 billion. Adjusted diluted earnings per share remain guided at $2.55 to $2.90.
Overall, Macy’s Q2 results show the challenges facing the business. While the quarter showed operational improvements with growth in gross margins and earnings per share beating expectations, ongoing sales declines and signs of a weaker consumer show the difficulties Macy’s faces.
Turnaround Plan
As with any business facing headwinds, Macy’s has put in place a turnaround plan tagged “A Bold New Chapter.” The plan will see Macy’s close over 150 of its stores while focusing on expanding its more upmarket Bloomingdale and Blue Mercury chains. Combined with investing in smaller locations, and freeing up capital by selling off parts of its real estate portfolio, it is almost the standard retailer restructuring plan.
It will not succeed. Over the past 5 years, Macy’s sales have fallen from $28.1 billion for the year ending January 2015 to $23.9 billion in the year ending 2023. Current expectations are for this to fall even further over the coming years. Earnings have fallen as well, with net income of $110 million in 2023, the lowest since 2010, except for 2020 when sales were impacted by the pandemic.
The problem is that Macy’s faces the issues of running a flagging department store business combined with the challenges facing any other retailer. Fierce online competition from the likes of Amazon.com, Inc. (AMZN) and Wayfair Inc. (W), and newer, fast fashion rivals such as Shein and Temu. These fast fashion brands offer ultra-low prices and respond rapidly to changes in consumer preferences. They are not just targeting lower income earners, but Macy’s traditionally higher earning clientele, with individuals earning over $130k a year making up around 44% of Temu’s sales. Combined with challenges from traditional brick-and-mortar stores such as department stores Nordstrom, Inc. (JWN) and Kohl’s Corporation (KSS), and other retailers like The TJX Companies, Inc. (TJX), Macy’s operates in a highly competitive landscape. At the end of the day, why would consumers buy from Macy’s if they can get it cheaper elsewhere.
Additionally, Macy’s physical stores remain dated, failing to attract younger consumers. While the company wants to expand its luxury sales, particularly through its Bloomingdale chain, the same luxury goods businesses would like to sell direct to consumers themselves. With shoppers searching for a luxury experience when shopping, would they rather buy from Macy’s or inside the brand’s own store.
Although I appreciate Macy’s attempts to leverage its real estate portfolio, selling stores is no panacea. Although it may free up capital in the short term, it leaves Macy’s exposed to rising rental payments, which may limit its investment ability in the future.
Valuation
Macy’s currently trades on a price-to-earnings ratio of 5.5, well below the broader market and a bit below its historical five-year average. This pricing suggests the market is skeptical about Macy’s ability to execute its turnaround plan and grow earnings in the face of declining sales and intense competition. Analysts are currently predicting a continued contraction in revenue and earnings over the next two years, with rising risks from competition, a weaker consumer, and a fall in lucrative earnings from credit cards. However, I believe there is potential for earnings to fall even further than anticipated. Given the anticipated fall in earnings and negative outlook, I assign the shares a sell rating. Unless Macy’s can demonstrate a clear path to stabilizing and turning around its business, the stock’s valuation is likely to remain under pressure.
Risks
While I maintain a bearish outlook on Macy’s, as with any thesis, there are risks that could drive the shares to the upside.
One risk is that despite the company’s struggles, Macy’s remains a potential acquisition target. The takeover offer from Arkhouse Management at $24.80 per share, highlights the potential institutional investors believe Macy’s and its assets may have. With interest rates set to begin falling, financing a deal may become easier, making a buyout more likely.
Another risk to my thesis is the potential for Macy’s to begin leveraging its real estate portfolio, which includes flagship locations such as the Macy’s Herald Square. If the company pursues a strategy to unlock value through sales, leasebacks, or redevelopment, it could generate substantial cash flow. This could be used to strengthen the company’s financial position, and shareholder returns, or reinvest in the business. With current commercial real estate values far below their peak, and many of Macy’s buildings uniquely located, the true value of the real estate is uncertain, yet it could be a valuable asset for the company.
Conclusion
In conclusion, Macy’s faces several challenges in a rapidly changing retail landscape. Despite some improvements in gross margins and earnings, ongoing store closures, weak sales, and risks to credit card revenue highlight the difficulties ahead.
Although Macy’s has a turnaround plan in place, I do not believe it is sufficient to overcome the challenges the business faces and the fierce competition in the retail sector. While potential upside exists through realizing the company’s real estate value or renewed buyout interest, these remain speculative. Given the challenges facing the business, I assign Macy’s shares a sell rating and suggest potential investors wait for clearer signs of a turnaround before considering investing.
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