By Jonathan Chen
Macy's (M) reported third quarter earnings that beat Wall Street estimates Wednesday but shares sold off sharply later as the company cut guidance. (Shares were regaining ground by late morning Thursday.)
Virigina, there might not be a Santa Claus this year, as least judging from the fourth quarter guidance from the department store company. Or is Santa Claus making sure you've been nice, instead of naughty?
The company reported third quarter earnings of 32 cents per share on $5.85 billion in revenue. Wall Street was looking for earnings of 16 cents per share on $5.89 billion. It said that same-store-sales were up 4.0% in the quarter. Aside from the slight revenue miss, the most important thing to note was the substantially weaker guidance for the fourth quarter.
Macy's said it expects fourth quarter earnings of $1.52-$1.57 per share, versus estimates of $1.66 per share. The company said that gross margins in the fourth quarter will be hit by free online shopping, but the company did predict a "spectacular Christmas shopping season."
Terry Lundgren, chairman, president and CEO was very positive on the quarter, stating in the release that, "A number of factors contributed to this excellent third quarter performance. We continue to move forward in the execution of those strategies that have created a culture of growth at Macy's – including My Macy's localization of our assortments and shopping experience; omnichannel integration across stores, online and mobile; and MAGIC Selling and associate coaching programs to strengthen customer engagement."
Macy's, which bought Bloomingdale's years ago, "also enjoyed a strong quarter, both in stores and online," Lundgren said.
Despite the concerns over a potentially weak fourth quarter put forth by the company, Deutsche Bank and J.P. Morgan were particularly bullish, with Deutsche Bank raising its price target to $35.
Why are the banks bullish going forward?
In the note, Deutsche Bank wrote, "We've seen this movie before by Macy's and it's one of the several reasons we like the stock. Simply put, under-promise/over-deliver. Two points: First, 3Q EPS was stronger than expected due to better credit trends (not 1x related) with EPS 2x our est. of $0.16. Second, 4Q EPS guidance of $1.52-$1.57 implies an EBIT flow through of 9.1% (vs. trailing 7 qtr. avg. of 41.2%) on 5.5% SG&A growth, which looks conservative. We think taking a conservative approach is intelligent here, but ultimately we think EPS could exceed $1.65."
So is Macy's under-promising and over delivering here (UPOD), or is this the start of something much worse? Macy's is on the higher end of the middle class, so there could be some concern about the issues ongoing in Europe, equity portfolios, and the job market. Lundgren has historically delivered to shareholders, as shares have returned a whopping 180% in the past three years, compared with a 32.327% return in the S&P 500 (SPY). Over the past year, shares have gained 27.5%, far outpacing the S&P 500 again.
The company has been able to generate strong returns on equity, around 19%, so it could be the fact that Lundgren is indeed doing a UPOD, especially as the company predicts a very strong Christmas season.
Macy's flagship store is at 34th Street in New York City, and if the past is any indication of the future, there may be another "Miracle on 34th Street" this holiday season. Investors just haven't seen the sleigh over their houses yet.
Traders who believe that Macy's is sandbagging guidance might want to consider the following trades:
- Use any haircut to get into a position, or add to an existing one.
Traders who believe that the global economy will take a sharp turn for the worse may consider alternate positions:
- If this happens, middle and lower-end retailers could be hit. Consider shorting names like Target (TGT), Wal-Mart (WMT), Macy's, and J.C. Penney's (JCP).
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