Macy's: A Much Improved Balance Sheet Will Lead to Good Things for Equity

| About: Macy's Inc. (M)

Macy’s Inc. (NYSE:M) has approximately 850 stores in 45 states, the District of Columbia, Guam and Puerto Rico under the names Macy’s and Bloomingdale’s. The company also sells via the internet through and In addition, Macy’s also operates four Bloomingdale’s Outlet stores with three additional outlet stores scheduled to open in the fall of 2011.

Current Valuation
Macy’s stock is trading at approximately $24.00 per share, which equates to a market capitalization of $10.2 billion. As of December 31, 2011, the company had $1.5 billion of cash and $7.6 billion of debt on its balance sheet. This implies an enterprise value of $16.2 billion.
In 2010 the company generated $3.1 billion of EBITDA from $25.0 billion of revenue. The company is levered at 2.4x trailing EBITDA.
Macy’s is trading at a discount to its peer group (see Table 1 below).
Table 1: Trading Multiples – Macy’s versus Comparable Companies
Price to Trailing Earnings
Trailing EBITDA Multiple
Macy’s (M)
Nordstrom (NYSE:JWN)
Dillards (NYSE:DDS)
JC Penney (NYSE:JCP)
Limited Brands (LTD)
Source: Bloomberg
Long-term Investment Thesis
First Quarter 2011
Macy’s will report first quarter earnings on May 12, and while I expect earnings to be good (note that the company has not had an earnings disappointment since Q1 2008) my investment thesis is based on the next 18-24 months, not the “binary” outcome of exceeding (or missing) consensus analyst estimates for the first quarter of 2011.
Nonetheless here are a few factoids that speak positively about the potential for the first quarter:
  • Same-store-sales grew in January, February, and March at 2.6%, 5.8% and 0.9%, respectively
  • The same store sales number for March was positive 0.9% despite Easter moving into April (when the company announced February same-store-sales numbers they anticipated a negative March number)
  • Redbook’s month-to-date same-store-sales numbers for the first 3 weeks of April were up 5.0% versus 2010 and up 5.3% versus March 2011
While there are real risks associated with rising commodity prices, including the impact of increased gas prices on the American consumer, I believe Macy’s is a good long-term investment.
My long-term investment thesis is based on the confluence of i) continued operational execution including cost containment and ii) cash flow generation and the use of that cash.
2010 Cash Flow Generation
In the year ended January 29, 2011, Macy’s generated $1.5 billion in cash flow from operations and approximately $1.0 billion in free cash flow. The company repaid $1.2 billion of debt reducing leverage from 3.6x to 2.4x. Further, Macy’s contributed $825 million to the pension plan in 2010 reducing its underfunded status from $1 billion in 2009 to only $220 million at the end of 2010.
2011 Guidance
Macy’s has guided to 3% same-store-sales growth in 2011, and has also announced the opening of 3 additional Bloomingdale’s outlet stores in the fall.
Using the 2011 company guidance provided in the fourth quarter and 2010 earnings release on February 2, it is possible to back into Macy’s sales growth assumptions.
The company provided EPS guidance of $2.25 to $2.30 for 2011 based on flat gross margins, SG&A dollars increasing by 2 to 2.5%, 2011 pension contribution of $225 million, and the $450 million of 2011 debt maturation. This implies top line growth of 3.5 to 4%.
And What About 2012?
Macy’s has an additional $800 million of debt maturing in 2012, at a blended rate of close to 6% (see page F-21 of the 10-K for a breakdown of debt by maturity). Assuming a 35% tax rate this would add approximately $0.07 to EPS.
Excess Capital, Dividends?
Like many companies Macy’s reduced the dividend during the financial crisis to conserve cash. The company may soon find itself in a position to begin returning excess cash to shareholders either via dividends or a share repurchase. By the end of 2011, the pension will be fully funded, debt will be down to approximately 2.0x, and balance sheet cash will be building. If it pays down the debt that matures in 2012 rather than refinancing it, the credit profile will be further enhanced and could lead to a credit ratings upgrade. If it refinances the 2012 maturities it can think about other uses for the balance sheet cash. Presumably its decision on pay down versus refinancing depends on the state of the business, capital markets, and other factors in 2012. Said another way, the company has some flexibility because of the improvements it has made to the balance sheet in 2010.
Internet Strategy
It is worth noting that Macy’s has embraced the internet. With an increasing amount of consumer-direct retail sales going on-line Macy’s has utilized both and to make sure it is not losing sales because of the online trend. In fact, through March Macy’s reported that online sales were up 33% year-over-year.
Macy’s has rebounded from the recession with gusto. The company is executing as evidenced by growing sales and contained costs, the balance sheet is much improved and should continue to improve over the coming quarters, and the future looks bright. Further, given its strong cash flow generation it will soon be in a position to return capital to shareholders. All of this while trading a material discount to its peers.
I am long Macy’s.

Disclosure: I am long M.