By Brian Sozzi
Very rarely do I blow my own horn when a stock recommendation works out swimmingly. A while back the readings from author Deepak Chopra instilled in me the need to stay humble and laser-focused on the moment at hand. I would like to think that helpful guidance, coupled with a good upbringing, has planted my behind firmly in the ground in an industry chock full of interesting characters.
Every so often, however, I am compelled to give myself a little high five when a call on a stock, made months earlier, enriches the accounts of clients. Sometimes containing the enthusiasm is just too trying because I thoroughly love studying the markets, companies, and meeting with management teams that shape the world.
So my horn blowing today is on Macy's (M), which in case you didn't know blew through 1Q earnings estimates by $0.11, raised FY guidance, and doubled its dividend payout. Macy's was an open recommendation on our Hotline service from February 18, and since then there have been bumps along the road in terms of the stock price. Each time there was a rough patch for the stock, I circled back to my ordinal thesis from February.
As an investor, it's vital to continuously review the original reasons why a stock is placed in the portfolio, especially with a never-ending news cycle that makes each event seem incredibly instrumental.
Consider the macro-related events that transpired from February 18 to May 10:
- Cautious 1Q guidance ranges by retailers issued on 4Q conference calls.
- Gasoline price spike.
- Ramp in inflation in a basket of goods.
- Unseasonable start to spring.
- Japan devastation.
- Below consensus 1Q GDP print and ensuing downward revisions for the year.
- Ben Bernanke's heralded press conference, where he revised down growth expectations.
Through all of the noise, I adhered to the notion that Macy's shares were mispriced by the market for a number of reasons. There was tremendous results being posted monthly online, Bloomingdales is capturing those equity account rich upper-income households, and initiatives at Macy have to more productively manage the store fleet continued. Moreover, debt reduction was coming into focus, and therefore was likely to free up capital to be deployed to shareholders (such as in the dividend hike yesterday).
Do the fundamental homework on a company and maintain the conviction to stay the course.
Macy's review from February 18:
Without question, Macy's had a strong 2010. Same-store sales surpassed management's initial forecasts as a result of solid execution by major market and online. Moreover, the performance was not solely relegated to Macy's, as Bloomingdales basked in the glow that was the returning high-end shopper. Nordstrom's (JWN) outlook at the core was encouraging, and given Macy's having a much more efficient business model than peers we believe the risk reward is favorable. The stock is valued at a mere 10x forward earnings on a P/E basis, and 5.6x on a TTM EV/EBITDA basis. On both accounts, the stock appears attractively valued as the high-end consumer spends even more freely at Bloomingdales, online remains strong, the Macy's store base benefits from a middle-income consumer that has a bit more cash in the wallet, and debt reduction continues to be a high priority of management. The stock trades at a noticeable discount to its department store operator peers, which we believe is a disparity.
Is 1Q the High Water Mark for Retailers?
Let me play devil's advocate for a brief second. The market is cheering the much better than expected 1Q reports from the likes of Macy's and lingerie purveyor Maidenform (MFB). Both reports fit snugly with the EPS beats from the initial wave of apparel and footwear manufacturers in late April.
Que pasa? Weren't we supposed to receive dour news on the earnings front from companies selling promoted items to the consumer as inflation crept into the financial statements? I think 1Q could represent the medium-term high water mark for retailers, with rejuvenation in results as we head into the holiday season.
To me, it looks as if retailers and vendors were able to manage input costs in 1Q through product reengineering and movement of production to lower cost countries, "test" product price increases with a certain degree of success, and hold the line on operating expenses despite a pickup in investments (store technology, central technology, online technology, international openings, and associate training). The market fully anticipated these reports in my estimation; if one subscribes to the adage that the market prices in events six months in advance, then it's worth noting the S&P Retail Index is up 12% from November 11, 2010.
The stress on the profit margin line is surfacing, however. Broadly speaking, the stress is not being captured in the 2Q EPS guidance ranges, but investors could extrapolate it on the conference calls (hearing reservation on the future earnings potential of businesses due to higher transportation, cotton, leather, steel, and resin costs) and within 1Q gross profit margins.
1Q gross margin rundown for those consumer discretionary names that have announced:
- Bebe (BEBE): -340 bps y/y
- Crocs (CROX): +80 bps y/y
- Under Armour (UA): -50 bps y/y
- Ethan Allen (ETH): +210 bps y/y
- Furniture Brands (FBN): flat y/y
- Bed, Bath & Beyond (BBBY): +42 bps y/y
- Coach (COH): -131 bps y/y
- Columbia Sportswear (COLM): +250 bps y/y
- Timberland (TBL): -280 bps y/y
- Macy's: -30 bps y/y
- Nike (NKE): -110 bps y/y
- Decker's Outdoor (DECK): +40 bps y/y
- Wolverine Worldwide (WWW): +40 bps y/y
- Sherwin Williams (SHW): -120 bps y/y
- Maidenform: -220 bps y/y