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M (15.15) - Barron's article

Outside the massive Macy’s flagship store at Manhattan’s Herald Square, a Christmastime sign reads “Believe in the Wonder.” But with the retailer’s shares down by nearly half this year, investors might be wondering what to believe.

Profits are tumbling. This fiscal year through January, operating income is expected to fall by a third, to $1.25 billion. That’s less than Federated Department Stores earned on its own before 2005, when it paid $11 billion for May Department Stores to create today’s Macy’s. At this point, the company’s credit-card business earns more than its stores. Further operating-income declines are expected next year, and the year after.

The shares (ticker: M) recently fetched $15, after topping $70 less than five years ago. Who would want to own them? Perhaps an investor eyeing that Herald Square real estate, which Macy’s owns, and which could be worth $3 billion to $4 billion, versus a stock market value for the company of $4.6 billion. Or an income seeker enticed by the 10% dividend. Or a bargain hunter following the turnaround efforts of another department store, Nordstrom (JWM), whose shares have slumped for years, but jumped 10% after the company’s latest quarterly financial report, and 16% the report before.

Count us among the Macy’s skeptics, as bustling as we found the flagship store during a midday visit this past week.

Outside the main entrance, a crowd gathered as a Salvation Army collector danced to Michael Jackson’s “Billie Jean.” Inside, tourists wielded selfie sticks. Many carried bags with purchases. One local, Shawn Kennedy, 50, from the Bronx, called the clothing prices he found “all right—they could have been better.” He has been coming to this store since his mother took him there to see Santa Claus as a boy, and doesn’t like shopping online. “I’m kind of old school,” he says. Next to his Macy’s bag was one from Old Navy.

Here are three things investors should know about the Herald Square store:

First, those who visit should skip the elevators and instead ride the remarkable wooden escalators found between higher floors. Some have treads made from solid ash, a hardwood, and are approaching 100 years old.

Second, this particular store, with vast spaces devoted to thriving luxury brands such as Louis Vuitton and Gucci, gives a false sense of the challenges facing the broader company. Macy’s operates more than 600 of its namesake stores, and an analysis by UBS last year of per capita incomes near these stores found that Macy’s customers more closely resemble those of TJX’s (TJX) T.J. Maxx and Marshalls chains than those of Nordstrom. TJX specializes in so-called off-price goods—including those bought opportunistically from overstocked department stores and sold at deep discounts. An analysis of off-price store openings, including for Ross Stores (ROST) and Burlington Stores (BURL), suggests that these merchants view Macy’s neighborhoods as plum targets.

Macy’s takes its own high-low approach to retailing, with its upscale Bloomingdale’s chain and its off-price Backstage stores. But Bloomingdale’s has only several dozen stores, and sells many of the same brands found at Macy’s. And Backstage largely operates within Macy’s stores, where it can’t avoid competing with them.

The third thing to know about the Herald Square flagship is that Macy’s says it’s exploring its real estate options, but is committed to the store there. According to Morgan Stanley, a sale and leaseback of the property would result in long-term lease payments with a present value of perhaps $4 billion—a near-term cash freer-upper, but hardly a big moneymaker over time.

There are reports that Macy’s plans to build up from its store, perhaps adding residential or office space. The company says that it will give more details on its real estate strategy in a Feb. 5 investor presentation. According to Morgan Stanley, after years of Macy’s cashing in on its real estate, the Herald Square location is the last flagship of significant value. Macy’s declined a request to speak with its CEO of two years, Jeffrey Gennette.


Credit-card revenue, which comes from a venture with Citigroup (C), declined 1%, year over year, last quarter. But Morgan Stanley, extrapolating from management guidance, reckons that it could fall 9% during the fourth quarter. Such financing operations can be a boon when consumers are feeling flush, but a burden if conditions worsen.

The dividend will cost about $465 million this year, and Macy’s generates enough cash to cover it, but if cash flow continues shrinking at its present pace, management could come under pressure to cut payouts within two years.

Long-term debt is $4.7 billion, and long-term lease liabilities are $2.8 billion.

Every stock has a bull case. The one for Macy’s probably involves a smaller store base and a clever real estate plan. A price of under six times this year’s projected earnings covers a lot of flaws. The stock could gain quickly on good news. J.C. Penney (JCP), a much weaker operator, has seen brief windows in which its shares jumped 50% or even doubled in value over the past five years. But those stretches of strength have come amid a long slide to just over $1 a share recently.

Macy’s has time to avoid that fate. But with consumer spending strong now, this is a moment of no excuses for retailers. Believe in the wonder at Macy’s, sure, but doubt the turnaround until management offers much more evidence.

Write to Jack Hough at [e-mail]

https://www.barrons.com/articles/miracle-on-34th-street-not-anytime-soon-for-macys-51575633601?mod=past_editions