Macy's (M) appears to have been one of the biggest winners of the holiday season thus far. In reality, Macy's has been winning for the last five years. The company has been resilient against a weak economy and appears to be setting itself up for continued success in a rebounding economy.
This holiday season is shaping up to be the best in a long-time for Macy's
All in all, it appears that the holiday season is shaping up to be quite competitive this year, with deep discounts leading the way. It's worth noting that Macy's appeared to have a very successful Thanksgiving holiday, including early store opening; Macy's opened at 8 p.m. on Thanksgiving, compared to midnight last year. Macy's CEO Terry Lundgren said that there were some 15,000 shoppers lined up outside its Flagship Herald Square store on Thanksgiving, 4,000 more than last year. He also noted that the weather was set up perfectly for selling outerwear.
The other aspect of strong outerwear sales is that since Black Friday, the weather across the U.S. has remained cold. A normal winter (compared to the unseasonably warm winters of the last couple of years) is a big positive for Macy's; where its Bloomingdale's (10% of Macy's business) customer is shopping months in advance of their need, its Macy's customers is shopping for the weekend. Thus, if it's going to be cold that week, they'll be buying a coat.
One of the big moves the company made to increase Thanksgiving holiday sales was to offer doorbusters and deals of the day, compared to morning specials. This included a refreshing the products it was promoting. Its heaviest trafficked areas were home and kitchen appliances, men's and women's shoes, outerwear, and handbags.
Millennials is one of the other big growth opportunities for Macy's. They are attacking both ends of the Millennial market, with Impulse areas of Macy's for older Millennials and Mstylelab for younger Millennials. Macy's is looking to add 13 new Millennial brands by the end of 2013
Another move to target Millennials includes its Finish Line (FINL) partnership. Macy's now has Finish Line in-store shops, with a plan to bring Finish Line to 450 Macy's stores. This new partnership should help Macy's sell additional activewear. This should also help bring in additional millennials.
MOM initiative sets Macy's up for the long-term
Macy's 3Q results were quite impressive, with the retailer beating EPS estimates by 20.5%. This marketed the fifteenth consecutive quarter the retailer posted Y/Y growth in EPS.
For 3Q, Macy's bought back some 10.1 million shares for $447 million. It still has $1.75 billion remaining at its disposal under its share repurchase authorization. But it's more than just the fact that the company is killing it with earnings and the holiday season sales; it has in its arsenal a number of initiatives that it has put in place for the long-term.
Its first initiative is My Macy's, which includes tailoring its merchandise by store. This has improved store productivity and helped boost same store sales. The beauty of what Macy's has built with its My Macy's over the last five years is that it's an organizational structure that's unrivaled in the industry.
Part of what My Macy's does is look across markets and place items and sizes that will better sell in those areas. For example, the same Ralph Lauren (RL) plant might supply a wide array of stores, but it's how Macy's distributes those items that makes it special; there could be a shorter inseam required on a large Hispanic market, or there could be larger sizes in the Midwest, or there could be smaller sizes in San Francisco.
What makes this work, and affordable for Macy's, is that its vendors work with the company to customize purchasing decisions. That's because Macy's is generally the largest purchaser for major manufacturers.
As a tangential point, there are a lot of benefits that come with being a major purchaser. Firstly, Macy's has a lot of exclusive merchandise, with over 45% of sales coming from its exclusive distribution. The other point is that Macy's is able to avoid a pile up of apparel supply thanks to exclusivity. One such example is Michael Kors (KORS); Macy's is their largest customer.
Its second initiative is Omnichannel. This includes attacking the market from all angles, including stores, website and mobile. Basically, this allows Macy's customers to shop seamlessly from store to device. One example is that associates can sell products that might be unavailable in their current store by selecting merchandise from other stores or online fulfillment centers for shipment to the customer's door. On the other hand, part of the omnichannel includes using inventories in stores, not just fulfillment centers, to fill orders that originate on the Internet or mobile devices.
Third is MAGIC, a sales program to help employees improve their customer engagement skills. MAGIC stands for Meet and make a connection, Ask questions and listen, Give options, give advice, Inspire to buy and sell more, and Celebrate the purchase. The move is a big positive, one that will help differentiate Macy's from the competitors. This comes as customers are equipped with more knowledge than ever, thanks to the web, thus, associates must be knowledgeable.
It's five years in, and Macy's MOMO initiatives continue to yield results. The reason that Macy's is staying ahead of the curve is that it's adapting and embracing tech. Macy's has shifted its capital investment spending over the last five years toward infrastructure and tech, and that continues to yield results via its ability to tailor merchandise and sell to customers via various avenues. One of Macy's latest tech innovations is to track customers in store, being able to tell where they are standing and how long they've been standing in front of an item, for example, and if they haven't purchased it, Macy's will send the customer a note to give them encouragement to do so.
A quick look at price suggests Macy's is still heavily undervalued
Macy's trades at less than 12x forward earnings, which is on the low-end of its historical average and well below some of its major peers. However, Macy's is expected to grow in line, or above, the industry.
We believe that Macy's is in a league above both high end retailer Nordstrom (JWN) and top discount department store TJX Companies (TJX). Even on a EV/EBITDA basis, Macy's trades at only 6.7x, while TJX is at 11.1x.
Using a p/e multiple of 17.5x, which still keeps Macy's PEG ratio below 1.5, suggests that Macy's is grossly undervalued today. Using 2014E EPS, which is fiscal year ending in January, suggests fair value should be close to $68.
The expansion to a 17.5x multiple assumes we get back to 2010 multiples for Macy's, and before that, it'll be the pre -2007 levels. Yet, we don't see a problem with Macy's trading at 17.5x, where it's currently generating FCFPS, churning out a net margin and posting a ROIC that's either at or above decade highs.
Looking at the valuation another way, putting a 17.5x multiple on 2015E EPS suggests that Macy's should be trading over $75 in just over a year's time.
The risk/reward is very compelling at 2.3x. Where we see the upside to $75, we believe the downside could be to just under $42. At $42 per share, Macy's would have no multiple expansion (still trading at 12x in 2015) and EPS would have to come in 20% below expectations.
Macy's FCF yield and earnings yield are both over 7%. Compare that to the 30-year T-Bond that's sub 4%. Couple Macy's 0.6 beta with its 1.8% dividend yield (that's only a 25% earnings payout), and you have a solid investment on an absolute basis too.
While the retail shoppers can often be fickle, especially when it comes to apparel, Macy's shoppers are tried and true. The company knows how to get shoppers in the door and keeps them coming back. It's tough to find something wrong with Macy's. It's doing a lot right, from inventory management to merchandise planning, and embracing technology.
The company has outlined its own plan for 5% top line growth, 15% net income growth and 20% earnings growth. While the market has slightly lower longer-term EPS growth expectations, the company is still greatly undervalued. If the company hits its growth targets, it'll only further outperform the market. In any case, we see over 45% upside over the next year or so.
Granted, there is the risk that this holiday season won't be as robust as last year's, which might lead to year over year negative comps, and ultimately send some investors scampering out of the stock. Thus, current Macy's owners might consider buying some protection in the event that investors have a negative reaction to holiday sales results (an income oriented strategy).