Macy's Looks Like A Shoe-In To Plunge On Earnings

| About: Macy's Inc. (M)

Macy's is an upscale department store. It operates Macy's and Bloomingdale's stores and Websites in the US, Guam, and Puerto Rico. It sells apparel and accessories for men, women, and children; cosmetics; home furnishings; and other consumer goods. It is basically an upscale JC Penney (NYSE:JCP). However, it is not a Nordstrom, which tends to cater more exclusively to yuppies and the well-to-do.

Since late in 2008, its chart has gone straight upward in the strongest of uptrends. Part of this was probably due to the Fed "juicing" the market; but it has also been due to what can only be described as a great recovery by Macy's (NYSE:M). See the Macy's five year chart below.

Why then would I say that it is a shoe-in to plunge on earnings? First it is essentially still a financially weak company. It has a total debt to total equity ratio (mrq) of 53.8%. This is high compared to the industry average of 41.98%. It has a quick ratio of 0.47x, which means it doesn't have much short term liquidity. Still it does have good interest coverage (mrq) of 4.48x. This means the company's operating profits for the most recent quarter were 4.48 times greater than its interest payments. Essentially it is much like other apparel retailers in this case.

The problem is that big retailers are in general losing customers to hip specialty shops. According to one scholarly article, older big retailers such as J.C. Penney, Macy's, Bloomingdales, Saks Fifth Avenue (NYSE:SKS), and Kohl's (NYSE:KSS) are the most at risk to the new, "hip" shops. When the net profit margin (TTM) is only 4.91%, any substantial loss of business is a big problem, especially when the usual solution is to offer discounts to attract more customers.

When Hearing Mosaic says Macy's comps are running negative for July 2013 compared to original estimates, one has to worry. When the Yahoo Finance EPS estimates for Macy's show a slight rise over the last 90 days, one has to think the market's expectations are likely too high. When "hip" American Eagle Outfitters (NYSE:AEO) lowers its Q2 earnings outlook (presumably so it won't disappoint) due to weaker than expected sales and margin results, one is inclined to think that "stodgy" Macy's may do significantly worse than its estimates.

For reference purposes, AEO now expects EPS to be $0.10 per share compared to prior guidance of $0.19 to $0.21. That's a 50% cut. AEO said total net revenue decreased about 2% in Q2 2013. Consolidated comparable sales, including AEO direct, decreased 7%. On top of this, results were exacerbated by a highly promotional environment, which intensified over the course of July. AEO stock price fell approximately 15% on this news. This agrees strongly with the report of bad comps from Hearing Mosaic; and it seems sure to mean a disappointment from Macy's on earnings.

When you look at a few other apparel stores, you see similar disappointments. At Ralph Lauren (NYSE:RL) -- a store with comparable customers to Macy's, whose Q1 ended June 29, 2013, sales at stores open at least a year slipped -1% for the quarter. This was significantly below the +4% growth of the previous quarter. The stock price fell -6.1% on the news.

J.C. Penney has been a dead duck for years now. It has predicted many rebounds; but it has made none. It is essentially a Macy's that caters to a slightly less affluent clientele. It is losing money -- a lot of money. JCP does not make one think that Macy's will do well in the near future. Even online retailer, (NASDAQ:AMZN), lost money in Q2 2013. Plus it guided lower -- for a loss in Q3 2013. This would seem to indicate that Macy's online sales are unlikely to save its quarter.

I could go on; but it looks like retail sales may be slowing in most apparel categories. At the beginning of 2013, many thought this was a strong possibility after the payroll tax cuts were re-instated at the beginning of January 2013. These amounted to an approximate 2.9% tax increase on the average American. If you posit that the average American only has about 20% of his/her income to spend after taxes, housing, food, transportation, and education expenses, then that 2.9% tax increase amounts to almost 15% of discretionary income. It is not surprising that a 15% cut to discretionary income and by extension discretionary spending might hurt apparel store sales.

One could ask why this tax increase didn't hurt same store sales in Q1 2013 very much if at all? My explanation is that it took people a while to realize that they had a tighter budget to deal with. I also believe that Obama enacting the sequester on March 1, 2013 finally brought home to people that they might have to conserve more in 2013. Also these two actions are expected to cut US GDP growth in 2013 by at least -1%. That in itself is a problem for the US economy. It means less money to spend.

Further some have estimated that a cancellation of the sequester could have added 1.6 million jobs to the US economy by itself. Those additional 1.6 million people who are not now working have cost retailers significant business. Of course, it took a while for the sequester to be felt by the overall economy. We may finally be feeling it now. If the comments about the worsening of the retail picture in July are generally applicable, retailers are in for a tough back to school season. They seem likely be in for a disappointing holiday season.

Don't forget that interest rates have risen roughly 1% (the US Treasury 10 year note yield) in the last one to two months. This is just in time for the big Christmas season borrowing by many retailers. This extra 1% rise in Treasury rates amounts to a 10% to 25% increase in interest rates (for example 4% to 5%) for the Christmas borrowing by US retailers. A lot of stores do finance their inventories, especially their Christmas inventories. Since they often have 75% or so of their total yearly sales in Q4, the amount they have to borrow to fund their Christmas inventory is not a small amount to many stores. The higher interest rate will hurt margins for the Christmas season. It should lead to slightly lower EPS guidance for Q3 and Q4 2013 on an interest rate basis alone (cost of goods basis). A smaller subset of retail companies may not even be able to afford the new, higher cost of their planned Christmas season inventory. Cutbacks in orders will mean less overall sales.

Further with 393 of the S&P500 companies having reported, the blended earnings growth rate is only 1.7% for Q2 2013. This falls to a -3.4% growth rate without the financials. 61 companies of the 77 that issued guidance revisions made negative revisions for Q3 2013. Currently the Consumer Discretionary sector is projected to see a +10% increase for Q3. Given the above data and fundamentals, this seems highly unlikely. This means Consumer Discretionary EPS estimates will have to be adjusted downward over time. This is doubly true when revenue growth is supposed to be relatively flat. It is more true when the sequester will be more fully felt by then. It is still more true when taxpayers will have fully realized they are getting 2.9% less in take home pay due to the re-instatement of the payroll taxes.

Don't forget that at least some of the Affordable Care Act new costs are scheduled to go into effect in 2014. Cintas said that it expects fiscal 2014 medical expenses to be higher as a percentage of revenue by 10 to 30 bps. Darden Restaurants says it will be adversely affected by $0.06 per diluted common share in 2014. The Affordable Care Act costs will work their way into estimates over time. They should lead to slightly lower guidance. Macy's has a lot of relatively lowly paid salespeople. They are likely to have the same effect on Macy's earnings that Darden's Restaurants employees are projected to have on it. I don't believe this has been factored into Macy's future estimates yet.

Technically the slow stochastic sub chart (far above) shows that Macy's is neither overbought nor oversold. The main chart indicates Macy's is in a strong uptrend. The many fundamental factors mentioned in this article add up to excellent reasons for the uptrend to reverse. The results of similar stocks that many thought highly of indicate that Macy's is likely in for a fall too. It has been a good grower; but it isn't a great grower. If its profits are 50% below estimates as AEO's were, it should get hit hard. Even if it has a lesser miss, the fundamentals mentioned above should mean it will get re-evaluated lower. Macy's is a sell on fundamentals.

Logically all uptrends end eventually. This four year old uptrend is overdue for a major correction. The huge number of negative fundamentals likely argue that this earnings season will be at least the start of such a correction. It is time to take profits. If you are an aggressive trader, you can consider shorting it. Yes it has a relatively low PE of 14.13 and an FPE of 10.70. However, its net profit margin can turn negative easily. Even if the net profit margin (4.91% TTM) only narrows a bit, Macy's is still a sell. With the large number of negative fundamentals, it is likely that the net profit margin (and guidance for future net profit margins) will move down substantially.

Macy's currently has an average analysts' recommendation of 2.1 (a buy). This leaves a lot of room for downgrades. CAPS by contrast gives Macy's a two star rating (a sell). CAPS tends to act in advance of the brokerage analysts. This could well mean that many of the brokerage analysts' recommendations will soon be revised lower.

For those considering shorting Macy's, remember that it pays an approximate 2% dividend annually. This may be enough to make some consider using options or option spreads.

NOTE: Some of the above fundamental financial information is from Yahoo Finance.

Good Luck Trading.

Disclosure: I am short 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.

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