Nearly four months ago, I wrote about Macy's (NYSE:M) and set the target price range to be between $52 and $63 per share for the next twelve months. At that time, the stock's price was about $39 per share, so the expected return was around 30%-60%. You can read the full analysis here.
At the moment, the stock is trading between $41 and $42 per share. This means that, if you invested right after you had read my report, you would have earned:
- More than 5.5% in a stock price appreciation;
- About 2% in dividends ($0.36 on December 11, 2015 and on March 11, 2016).
Hence, the total profit would be about 7.5%, or 33% in annualized terms.
When doing my research, I tend to use both qualitative and quantitative analyses. Today, I would like to make a revision of my first research in order to establish whether the company's fair value has changed or not. I will start with the qualitative analysis.
Key Trends In The Company's Business
During the last four quarters, a few developments have taken place that should be definitely considered in the revision:
- Macy's management announced Q4 and FY 2015 results. The Q4 results were quite positive: the revenue was $70M higher than what the market expected, while the EPS were $0.20 above analysts' expectations. However, the full-year 2015 results were quite depressing: the revenues fell by more than 3.5%, gross profit margin was 92 bp lower than a year before. As a result, the net profit margin started a declining trend and fell by more than 140 bp - to 4% of sales. The free cash flow yield (FCFF/revenue) was nearly two times lower than in fiscal 2014. The management announced that sales are going to fall by 2% in 2016.
- Nevertheless, they project EPS to increase to $3.80-$3.90 due to asset sales and a cost-reduction strategy. Macy's paid dividends per share of $0.36 twice (in December and March) and has completed buybacks of about 29M shares ($1.5B announced).
- Due to a bad year, management's compensation has fallen by 30%.
- In order to make the figures look better, Macy's management has decided to enhance its real estate management strategy. As a result, a new REIT VP was hired.
According to these results, the emerging trends in 2016 are:
- The improving cost efficiency should keep profits above water.
- Earnings are boosted by selling or managing own real estate (i.e. earnings management).
- The company is to continue paying dividends and making share buybacks.
Also, I want to emphasize that the company still has a good cash balance of more than $1B, so there are opportunities for making some positive changes to the existing shareholder-compensating strategy (e.g. paying better dividends/buybacks in the event real estate gets sold).
Comparing to my last report's forecasts, there are several things that have changed since then (see Diagram 1):
- I expected revenues to fall by 3% to $27,262M. However, the actual revenue figures were a little worse - $27,079M ($183M lower than my forecast, or a 1% variance).
- The expected gross profit margin was about 40%, while the actual result was 39%. The gross profit has fallen by more than $321M (a 3% variance) because the cost of revenue has increased by ~$140M.
- The operating expenses have also increased by $40M, compared to my previous estimates. As a result, EBIT was nearly 15% lower (much worse than my expectations), EBITDA was 10% lower (very negative), EBT was 18% lower (terrible).
- Finally, the net profit was 17% lower than the figure I expected to see, while EPS were 14% lower. The net profit margin has been unsatisfactory - down to 4%, which is 70 bp lower than what I expected.
Source: author's estimates
As a result, I have decided to make my Base scenario more conservative.
My new DCF model is presented in Diagram 2. In Diagram 3, you can see how different metrics of Macy's are expected to change during this period. You can see my downgraded revisions in the "Assumptions" tab of my Excel file. The cost of equity is the same in my previous model (10%).
My revised model shows that, after subtracting the market value of debt, minority interest, and adding back cash and investments with the discounted operating working capital balance, the market value of the company's equity is around $15.4B in the Base scenario. Consequently, the fair value per share is around $46.
Compared to my previous report, the estimated fair value per share is more than 16% lower than in the initial model. However, the expected value is still 11%+ higher than the current share price.
My new model
My old model
Source: data - Morningstar.com, DCF model by author
Note: in the new version of my model, I also calculated the discounted value of operating working capital which I did not do in my previous model. If we change the discounted operating working capital to 0 in the new model, the fair value per share becomes $41.6 - much lower than the aforementioned fair value.
The zero-growth analysis has been described in one of my articles. You can read more about it here.
According to this analysis, the current stock price still shows a good margin of safety. The valuation gives a fair market value of equity of $28.3B, which transforms into a fair price of $85.06 per share. This price is around 105% higher than the current market price of the stock. However, if we used only the net income in the numerator, the result would be a share price of $42.7, which is only 3% higher than the market level. This means that cash flow savings arising from depreciation & amortization benefits mean a lot here, but, on average, the fair value per share is 54% higher than the current market price.
My comparative analysis is based on three key ratios: P/E, P/S, and P/BV (see Diagram 4). The P/E and P/S ratios still show that the stock is undervalued by 50%+. However, the P/BV ratio shows that the stock is overvalued by 10%.
The current EV/EBITDA multiple is approximately at 6.6x (the last report's value was ~6x), which is quite a low level for such a company. Comparing it to the updated Damodaran's table, it is still lower than average Retail (General) industry's average of 7.9x.
Source: data - Morningstar.com, infographics by author
Despite the positive results of the comparative and zero-growth analyses, I downgrade Macy's to Hold. The main reasons behind this decision are: low revenue, EBIT, EBITDA, and net profit growth compared to my previous report and poor organic EPS growth (asset sales are mainly expected to drive growth in the bottom line, and I do not like this sort of earnings management strategy).
The updated target price range is $41-$46 per share. Because there is little margin of safety left in the updated fair value per share, I can only suggest risk-loving investors to accumulate Macy's shares.
Disclosure: I am/we are long M.
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.