Looking For Profitability? Macy's Might Be The Right Choice

| About: Macy's Inc. (M)

As the domestic middle-class recovers from the last recession in 2009, many department stores have struggled to maintain or re-establish their positions in the market. Macy's Inc. (NYSE:M), however, took advantage of the crisis to rethink its business model, and this industry player will be one to look out for in 2014.

Although discretionary retailers suffer from non-existent switching costs and a lack of differential factors between department stores, there are some aspects of Macy's that will favor it in the domestic market looking forward. Apart from creating national or exclusive brands, Macy's new localization efforts will propel this company forward over the next few years. With many national retailers like Sears Holdings Corp (NASDAQ:SHLD) or Kohl's Corporation (NYSE:KSS) fighting to gain market share, Macy's tailored and local retail experience enriches its operating structure via a model difficult to copy.

So, in the article below, I will analyze Macy's' past profitability, debt, capital and operating efficiency. In addition, I will take a look at which institutional investors have recently bought this company's shares in the last quarter. Based on this information, we will get an understanding of the company's revenues, operating metrics and quality of earnings.

Profitability Analysis
In this section I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues. By analyzing these four metrics, we will be able to elucidate if the company is really making money.

ROA - Return On Assets = Net Income/Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. It also gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage and in simple terms tells you what earnings were generated from invested capital (assets).

I am encouraged by the fact that Macy's ROA has increased from 4.04% to 6.20% in the past 3 years, indicating that the company is generating more from its assets than it did in 2010.

Quality of Earnings
This metric reflects the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies - such as inflation of inventory. In order to assess the company's quality of earnings we will compare the level of income with operating cash flows.

The company generated profit growth of 66% over the past two years, a figure which surpassed that of the operating cash flow. This implies that earnings could have been created by inventory anomalies instead of high sales.

Working Through the Program
With 840 operating Macy's and Bloomingdale's stores in the U.S. and Puerto Rico, as well as the respective online sites, the company's offering of family apparel, accessories, cosmetics and other consumer goods was available in shopping malls throughout 45 states. However, the new My Macy's program organizes stores in 69 districts, focusing management on local markets and thereby creating a personalized retail experience for customers. This, in addition to an enhancement of the firm's scale, should influence shoppers over the next few seasons, encouraging customer loyalty and sales.

Furthermore, the department store should gain some market share in the medium term as improved flexibility and apprehension of inventory levels continue to improve gross margins. The larger scale will help leverage the company's advertising and marketing presence while boosting its power in vendor and landlord concessions.

Working Capital
Working Capital measures both a company's efficiency and its short-term financial health by indicating whether a company has enough short-term assets to cover its short-term debt. While this ratio can alternate between 0 and 3.0, most believe that a ratio between 1.2 and 2.0 is sufficient.

Macy's' current ratio (working capital measurement) increased from 1.36 in 2010 to 1.55 in 2012, which shows that the company has a strong balance sheet and can pay off its obligations. Looking for companies with current ratios above 1 is a must for long-term investors as it will guarantee a strong balance sheet and low levels of debt.

Gross Margin: Gross Income/Sales
The gross profit margin measures a company's manufacturing and distribution efficiency during the production process. Additionally, it tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. Investors tend to pay more for businesses that offer higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

Over the past three years, the company's gross margin has decreased from 40.7% in 2010 to 40.3% in 2012. A decreasing margin indicates that the company has been becoming slightly less efficient year-after-year.

Asset Turnover
Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue - and in this scenario, the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. The fact that the company's revenue growth (6.6%) has outpaced its assets growth (0.8% growth) on a percentage basis is a positive sign as it indicates that the company is making money on its assets.

Investment gurus

Las quarter, investment gurus Jim Simons and Steven Cohen bought company shares at an average price of $48.01.

Analyst Outlook

Currently, many analysts have a good outlook for Macy's Inc. Analysts at MSN money are predicting that the company will retrieve EPS of $4.44 for FY 2014 and the Bloomberg team is estimating revenue to grow from $28.02B in FY 2013 to $28.78B for FY 2014. The company's target price of $62.15 also demonstrates significant upside potential from this point.


The company's sales dependency on shopping mall locations makes it vulnerable to certain factors like weakness in consumer spending or underperformance due to declining malls in stagnant demographic areas. Furthermore, the company's exclusive brands are subject to consumer preferences, which can vary quickly in the fast paced consumer goods industry.

Nevertheless, management has been focusing on diversifying the firm's operating structure with a particular eye on local retailers in order to establish a differential value from other department stores in shopping malls. And so far, the company's balance sheet has shown positive results, with boosts in ROA, EBITDA growth (18.8%) and returns on capital of 28.7%. Furthermore, with Macy's stock currently trading at a discount price of 15.10x trailing earnings, relative to the industry average of 18.00x, investors looking for a solid and profitable option should consider this industry giant.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.