Do Macy's Troubles Mean The End Of The Department Store?

| About: Macy's Inc. (M)

By Jharonne Martis

Every year, retailers look toward the make-or-break holiday season with fingers crossed and hope in their hearts. At the beginning of Q4, Macy's Inc. (NYSE:M) CEO Terry J. Lundgren said the retailer would shift into overdrive to focus on adapting to changing consumer shopping preferences in order to restore comp sales growth. What's more, the retailer opened off-price stores offering merchandise attractively priced (StreetEvents, 11/11/15).

Then, reality arrived. In January, the retailer reported weak holiday sales, thousands of job cuts and several store closings. What happened? Warmer-than-usual weather, for one thing. Macy's said, "about 80 percent of our company's year-over-year declines in comparable sales can be attributed to shortfalls in cold-weather goods such as coats, sweaters, boots, hats, gloves and scarves" (StreetEvents, 1/6/2016).

In addition, the strong U.S. dollar means foreign tourists aren't spending as freely when they visit the U.S.

With about 800 brick-and-mortar stores, the company is losing ground to online retailers, although its own online sales are up. According to a report by Cowen and Company, Amazon (NASDAQ:AMZN) could surpass Macy's by next year to become the largest retailer of clothing. Are we seeing the end of the department store concept?

Credit Worries

To determine which department stores are most likely to default in 2016, we looked at our StarMine Combined Credit Risk model, the most comprehensive StarMine credit model. Several department stores, including J.C. Penney (NYSE:JCP) and Sears (NASDAQ:SHLD), had been in the riskiest 15% of all retailers likely to default in the United States for some time now. However, one fairly newly entry to this list of weak performers is Macy's, with a score of 13. Six out of nine stores score in the bottom of the StarMine Combined Credit Risk (CCR) model score, the most comprehensive StarMine credit model. These scores correspond to implied credit ratings of B or worse, suggesting these stores are not financially stable.

Exhibit 1: StarMine Combined Credit Risk

Click to enlarge

(Source: Thomson Reuters Eikon)

Currently, S&P gives Macy's a BBB+ credit rating, but StarMine implies a weaker rating of BB-.

Exhibit 2: StarMine Combined Credit Risk Model Rating - Macy's

(Source: Thomson Reuters Eikon)

Real Estate

With more than 800 stores, the company is sitting on some prime real estate in the U.S. In view of its financial troubles, Macy's has recently announced it will consider spinning off some of its property. It has already sold part of its downtown Brooklyn real estate. Maybe the most valuable thing about department stores is the space they occupy.

Three years ago, Canada's Hudson's Bay Co. (OTC:HBAYF) acquired Saks Fifth Avenue. HBC also owns Canadian department stores and Lord & Taylor. Is Macy's now a takeover target? The company is now on track to post four quarters of negative same-store sales (SSS). It has a Q4 2015 estimate of -4.5% SSS, well below last year's 2.0% result.

Exhibit 3: Macy's Same-Store Sales

Click to enlarge

(Source: Thomson Reuters Eikon)

Cheap, But a Value Trap?

Macy's is in the top percentile of both the StarMine Intrinsic and Relative valuation models, suggesting that its stock looks cheap. The stock is currently trading at $40.36, with a negative market implied growth rate of -7.6%. However, StarMine's Intrinsic Valuation model thinks it should be trading closer to $80.39.

Exhibit 4: StarMine Model Scores - Macy's

Click to enlarge

(Source: Thomson Reuters Eikon)

Warning Signs

However, beware - analysts are bearish and have been lowering earnings estimates. As a result, earnings and revenue estimates show a contraction over the next four quarters. Thus, we may be seeing a potential value trap.

Exhibit 5: Macy's Earnings and Revenue Growth

(Source: Thomson Reuters Eikon)