Do my research conclusions hold up to snuff?

I enjoy investing. Growing up, I played fantasy baseball to prove my chops at finding underappreciated assets. As a grown up, I turned to investing to fulfill that same drive profitably!

I’ve chosen to share this investment choice because I like testing their merits against wise ears. What do you think? Let me know in the comments section or reach out to me directly.

Note: this article was last updated on 8/19/18. This article will be updated to the best of my ability to account for news affecting the stock valuation.

MACY’S ($M)
Price (8/19): $36.03
Market Cap: $11B
Revenue: $25B
Dividend: 4.19%
P/E Ratio: 10.14 
My price target: $60.00 by December 2021
Trading plan: I accumulated shares this past week at $35.80 and hold a full position in my diversified portfolio. I would consider buying more shares at the expense of portfolio diversification at $32 or below.

Conventional wisdom of the department store space is gloomy. Market share for department stores has been lost for years to specialty retailers and Amazon.com, stores are outdated and tied to out-of-style suburban shopping malls, and many industry players are closing stores and/or heading towards bankruptcy. While I do not challenge these headwinds for department stores, several factors about Macy’s have led to my conviction in their ability to endure through the calamity with rewards for shareholders.

Here’s my investment thesis:

Some fundamentals

  1. Macy’s trailing P/E ratio is 10.14, well below the mean S&P 500 ratio of 24.69. Thus, keep in mind that Macy’s needs to outperform low expectations, not high ones, to make money for shareholders. Source.
  2. The dividend of 4.19% is high for the retail space and helps ease volatility risk.
  3. Same store sales, a critical metric, is improving. It was -2.9% in 2016, -1.9% in 2017 and is forecasted at +2.3% in 2018 (Source: Credit Suisse subscription via Charles Schwab). CEO Jeff Gennette took over in March 2017. My investment thesis largely credits his leadership with this momentum as his results have consistently beat analysts’ expectations.
  4. The balance sheet is healthy. Cash flows are allowing the company to reduce a managable debt load.

Experiential Retailing

I believe Macy’s will endure in the long run because its investing aggressively in experiential retailing, meaning that Macy’s is developing a unique value proposition that is making its stores worth visiting. Here’s what they’re doing:

Macy’s new experiential concept: The Market @ Macy’s. Credit: Rebecca Fitts via RetailWire
  1. In fifty stores, Macy’s has launched an initiative called the Market @ Macy’s. These pop-up stores leverage a business model pioneered by b8ta. If you’re a boutique designer without the capital to have your own storefront, you can rent space at the Market @ Macy’s. You’d keep all the sales, while Macy’s is guaranteed the income of the ‘rent’ of the space and isn’t responsible for inventory. For the consumer, this space rapidly turns over with fresh merchandise regularly. Seemingly every time you enter a Macy’s location, you’ll see something new and unique at this space. To support this business model, Macy’s invested in b8ta in June to accelerate the rollout of this strategy.
  2. In May, Macy’s acquired a single location NYC retailer called Story. In its current form, Story is a retailer whose space gets entirely remodeled every four-to-eight weeks to a different theme. One past theme, called the “Future of Work”, saw the store laid out like a hip office and work-from-home space with everything in the store available for sale, including furniture, apparel and books. Story partners with designers for each exhibit to make the ‘story’ work for visiting customers. It’s unclear how this concept gets scaled up to a department store. The CEO of Story is now the Chief Experience Officer at Macy’s. My hypothesis is that this concept will get rolled out first at flagship stores, like New York, to draw tourists on top of traditional retail shoppers.

Both initiatives are long term. Their order of magnitude is too small to immediately impact earnings, so more needs to be brought to the table.

An example of Story, the experiential retailer Macy’s acquired in May. This exhibit was designed to a “Remember When” theme that was nostalgic to the 1990’s. Source

Real Estate

Macy’s in downtown Philadelphia. Credit: Ray Stubblebine/Reuters

Macy’s owns a lot of real estate, including premier real estate in major metropolitan areas. Management’s current strategy is to strategically sell this real estate, raising cash in support of debt repayment and growth investments. In Macy’s most recent 10K, the company cited real estate sales totaling $411 million in 2017. The most recent Q2 earnings call cited a goal of $300-$325 million in additional sales this year. Of the company’s 852 stores, 370 were owned and an additional 118 were owned with additional space to lease to other tenants.

Will so many stores still under ownership, including the Herald Square property in New York, a lot of runway remains on this strategy. How much it’s worth in valuing the stock isn’t quite clear. One analyst pegs the portfolio at $16 billion, well exceeding the value of the entire company. The Herald Square building may be worth over $3 billion alone.

The Macy’s Herald Square location in the early 1900’s. Credit: Library of Congress

I’m not sure how to value this into the potential for the stock, however I do believe these assets stabilize the downside risk. These assets certainly help to ensure a stable and controllable source of free cash flow.

Backstage — Macy’s Outlet Strategy

Macy’s is rapidly outfitting existing stores with space allocated to Backstage. The most recent Q2 earnings call specified that 120 Backstage locations will open this year, up from 52 entering the year. The 10K published in February cited a goal of 100 new locations, so this initiative is moving faster than expected.

In the Q1 earnings call, Gennette cited an average 7% sales lift for an entire store when a Backstage opens inside of it. This message assuaged some of my concerns about Macy’s less flashy locations in smaller metropolitan areas.

It is also inferred in Macy’s investment materials that Backstage is very helpful to managing its inventory costs, a major KPI for department stores.

Other Good News

  1. Gennette and his management team have established credibility, beating earnings expectations each of the last four quarters.
  2. Macy’s owns a fast-growing cosmetics and spa retailer called bluemercury. It’s not big enough yet to be a needle mover, but it’s a hip brand that could potentially have the impact that Sephora had on J.C Penney. While Penney’s is on the path to bankruptcy, the Sephora store-within-a-store concept was one of their successful moves. The marriage of bluemercury with Macy’s is good. I’m just not sure how good.
  3. The destruction of competition creates share gain opportunities for Macy’s. Sears still generates $15.3B a year. Penney’s makes $12B on their top line every year. The failure of competitors like these generates conversion opportunities for Macy’s. Management seems to be grasping on the opportunity with recent initiatives to improve their rewards program. No longer is a credit card required to become a ‘Bronze’ rewards member and ‘Platinum’ members are receiving more customized benefits incentivizing their shopping experience. Gennette cited that 1 million new Bronze reward members have been added so far through this initiative. Revenue generated by the Macy’s credit card program is significant at a run rate of $720–735 million and management guided up this forecast in the Q2 earnings call.
  4. Macy’s recently improved employee incentives and it was noted as a successful initiative in the Q1 earnings call.
  5. Macy’s has market power. Their size and brand entitle it to exclusive offerings in their stores, helping it gain and sustain preference among consumers. The annual Thanksgiving Day parade helps raise brand awareness right before the critical holiday shopping season.

Devil’s Advocate — Risks to my Assessment

The bear case for Macy’s stock looks more like this. Credit: Andrew Mangum for The New York Times

Let’s look at the other side of the equation.

  1. Macy’s may be doing some exciting things at their premier locations, but many Macy’s locations are in smaller metros and struggling mall properties. The current initiatives may not be enough to beat the downward momentum of department store retail. When we look back, the current acceleration in Macy’s same store sales may just be a blip on the radar.
  2. The consumer economy is enormously strong right now. Historically speaking, we are due for a recession. I believe that the U.S. government’s deficit spending, particularly from recent tax cuts, has been fueling the recent surge. I don’t believe these effects are sustainable and that near-term events could ‘shock’ the market into bear territory. What kinds of events? Perhaps the November elections will signal that the deficit spending ‘party’ is over if Democrats take the House. Similarly, a scathing report in the Russian collusion investigation could trigger the same effect.

If the consumer economy weakens, Macy’s will go down with the rest of the market. I believe, however, that those circumstances will create buying opportunities. The company’s solid balance sheet, high dividend, low valuation, and its real estate assets provide downside stability for the stock to endure such challenges.

Other Supporting Exhibits

Macy’s store locations. (1) Macy’s closed a lot of stores between 2015 and 2016, but that pace stabilized in 2017. (2) Macy’s also owns Bloomingdale’s and is rapidly growing its bluemercury brand. Source: 10K
In recent history, sales were declining. Macy’s turned the tide back to growth with improvements to the balance sheet (see Long-term debt), earnings per share, and the dividend. Source: 10K

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Non-legalese disclaimer: (1) I’m an amateur investor. I have no credentials to be an investment advisor and I am not receiving, nor am I requesting, any compensation for this material. (2) It’s possible that I have mistakenly stated or interpreted the information presented in this article. (3) This article will be updated as new or better information is discovered to advise my investment thesis. If you are using this article as a source for your investment decisions, please send me a message and I will let you inform you of any updates to my research.



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