Macy's: It Is Profitable To Buy 'Off The Rack'

| About: Macy's Inc. (M)

The purpose of this article is to determine the attractiveness of Macy's, Inc (NYSE:M) as an investment option. I will look at M's recent performance, review the company's latest annual and quarterly reports, and consider current trends to attempt to determine where the stock may be headed from here.

First, a little about Macy's. Macy's is a retail organization operating both physical stores and Internet sites under the two brands of Macy's and Bloomingdale's. The company sells a range of merchandise, including apparel and accessories, cosmetics, home furnishings and other consumer goods. M operates in 45 states, the District of Columbia, Guam and Puerto Rico. Some of M's main competitors include J.C. Penney, Nordstrom, Target, and Wal-Mart. The stock is currently trading at $49.13/share and is up almost 26% year to date and over 35% over the last 52 weeks. M pays a quarterly dividend of $.25/share, which translates to an annual yield of 2.04%.

Clearly, M shareholders have been rewarded recently. The stock has participated in the bull rally and has rebounded seven-fold since the depths of the recession. However, M operates in an increasingly competitive retail space as consumers continue to seek value and stores seek to meet this demand by lowering prices. M has attempted to remain competitive by closing stores and implementing new pricing strategies designed to lure in customers. Since 2010, M has closed 27 outlets while opening only 18 new ones, netting the chain with nine fewer stores to work with. Since the company is contracting, albeit slowly, rather than expanding, same-stores sales are going to become an increasingly important metric for the company. Luckily, this is currently a positive area as M grew comparable sales by 3.8%, besting the competition from Kohl's and Nordstrom, which saw comparable sales at -1.9% and 2.7%, respectively. However, these sales have come at an increased cost. While total sales at M are up 4.8% year over year from 2011 to 2012, the cost of sales was up 5.1% during the same period. This means that M is spending more money on each new dollar of sales, a trend that is not surprising given the retail environment, but still is nonetheless a negative trend. This is a metric I watch closely on all companies because sales growth can be negated if the company is offering drastically reduced prices to obtain those sales, or if costs are disproportionately rising. For M, this is a number I will look at over the next few quarters to see if the company can reverse that trend.

There are some other areas in the annual report I feel particularly optimistic about. While the company faced steep loses in terms of operating income, net income, and earnings per share in 2008 (during the height of the crisis), all three have rebounded swiftly since then. M has seen all three of these figures rise consistently since 2008, every year, including a 6.3% rise in net income from 2011-12. The company has managed to turn things around by closing unprofitable stores, extending store hours and offering exciting deals during the '12 holiday season, and relentlessly focusing on offering quality goods to consumers. Another positive driver for the stock has been J.C. Penney's shortcomings. As the chain has struggled with its pricing policies, gone through CEO turnover, and seen customers leave in droves, Macy's has benefited. I personally feel that M will continue to retain these customers and will likely continue to extract new ones from J.C. Penny as that chain's troubles are far from over. While this is not a long-term growth strategy, this reality should continue to help M throughout this fiscal year.

While M has been increasing profit and growing sales, the company is not without risks. M is heavily reliant on the U.S. market and is operating in an extremely competitive retail environment. While J.C. Penney has been struggling, the company will surely announce sales and promotions designed to bring its customers back, and M also competes with firms like Kohl's and Wal-Mart that operate with extremely low margins. Macy's will need to continue to demonstrate its value to consumers by staying relevant and acting ahead of consumer trends. Additionally, if consumer spending drops, or unemployment picks back up, Macy's will be severely affected (as we saw in 2008) because the company is not able to make up lost U.S. sales with growth overseas, like other major U.S. companies. Finally, Macy's is involved with some legal battles over the Martha Stewart label with J.C. Penney. A long drawn out legal battle could put a pressure on margins.

Bottomline: Macy's does not operate in an ideal retail environment, yet the company continues to post strong numbers and improving performance. By focusing on its most profitable stores and areas, and closing under performing branches, Macy's has been able to walk away from the '08 recession more profitable than ever. I am optimistic about the company's future, and, as a dividend investor, am heartened by the company's dividend history. While a yield of just over 2% is not in and of itself enticing, M has doubled its dividend payout the past two fiscal years. Commitment to dividend growth can be more important than current yield, and I would expect to see Macy's dividend climb along with its increasing income. While Macy's does not operate in a historically safe industry, and its beta of 1.66 gives me some concern, I expect Macy's to continue to outpace its competition for the foreseeable future.

Disclosure: I am long WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.