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Macy's Needs a Great Holiday Season

Keeping in trend with the disappointing financial news from retail names like Kohl's, Macy's (NYSE: M) reported weak third-quarter results in November that provided further proof that traditional retailers carrying ties to the department-store model aren't finding any relief from the shift in retail to more and more e-commerce. As a result, Macy's is very dependent on the important holiday quarter this year -- more so than usual.

Showing cracks in the third quarter

Macy's managed to maintain a positive financial story throughout the first half of the year. But the third quarter bucked that trend. The retailer reported that:

  • Revenue declined 4.2% year over year to $5.17 billion.
  • Comparable-store sales, including licensed locations, fell 3.5%.
  • Adjusted net income was $21 million vs. $83 million a year ago.
  • Income broke down to $0.07 per diluted share vs. $0.27 per diluted share a year ago.
  • Gross margins were 40% vs. 40.3% a year ago.

Overall, Macy's continues to show cracks. Through the first 39 weeks of the year, operating income represented 2.5% of net sales vs. 4.2% of sales through the first 39 weeks of 2018.

Image source: Getty Images.

I've always rooted for Macy's, but the retailer doesn't seem to be finding any momentum. Management noted that the company was going against a "very strong third quarter" from last year, but I'm not sold on that. It's "thrive or dive" time for many retailers. Macy's is holding up better than many competitors, but this shift to negative comp sales is concerning. Gains from asset sales totaled $13 million after taxes.

There were some hiccups in e-commerce through the third quarter, as management noted the company's website needed some maintenance related to upgrades and preparations for the fourth quarter. Moreover, Macy's noted the delay in cold weather as a source of weakness in its third quarter.

Guidance adjusted to the downside

Due to the weak third quarter, Macy's changed its guidance for the fourth quarter and the full year.

  • Full-year comp sales (including licensed locations) are expected to be down 1.5% to 1%. Previous guidance had called for flat comp sales, up to a 1% gain.
  • Total net sales are expected to decline by 2.5% to 2%.
  • Adjusted earnings per diluted share are expected to be in the range of $2.57 to $2.77. Previous guidance had anticipated adjusted EPS of $2.85 to $3.05.
  • Macy's is relying on more asset sales to create some cash. Gains on assets sales are expected to be $150 million, representing $0.37 per share. Previous guidance had called for $100 million in gains from asset sales.

The main saving grace for Macy's has been its valuation. The stock carries a market capitalization of $4.7 billion, well below the company's shareholder's equity of $6.05 billion. Based on the liberal end of guidance for adjusted earnings, the stock is trading at 5.57 times full-year adjusted earnings. That's pretty cheap.

These valuations are keeping the stock from overreacting to the disappointing news. Couple this with the dividend yield of nearly 10%, and you can see how Macy's retains some appeal to certain types of investors.

Looking forward, I think the top line really has to improve for that "appeal" to be retained.

The holiday spirit

Good holiday cheer is going to be important for Macy's. The fourth quarter creates a lot of its cash flow for the year -- cash flow the company desperately needs.

Strong sales performances by Walmart and Target in the third quarter demonstrate that overall consumer confidence remains strong. Indeed, retail seems primed for a good fourth quarter. Whether or not that potential will be reflected in Macy's financials is a different story.

Whereas diversified names like Target are drawing in considerable comp-sales growth, Macy's has been less inspiring. This may imply that consumers are shifting away from Macy's to other options.

I view the fourth quarter as the stock's final shot to create some strong near-term momentum. So far, 2019 hasn't been good. Total revenues are down, operating income as a percentage of sales are down, and earnings are down. The holiday season is so important in terms of annual sales, and a disappointment would set a bad tone for 2020.

I don't consider Macy's a great investment, but the low valuation and a dividend yield of nearly 10% has helped keep the stock price in the current range. But holiday cash flow is going to be very important to provide Macy's with the ammunition to drive a turnaround in its business.

Macy's isn't dead yet, but the trends it's exhibiting are eerily similar to how troubled competitors like Sears or J.C. Penney have faired in recent years.

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David Butler has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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