Macy's Still Not Screaming Value

| About: Macy's Inc. (M)
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Falling revenues and income underscore challenges in the retail environment.

Economic backdrop not supportive of more spending over the near-term.

Valuable real estate portfolio has not translated to value for shareholders.

Even though value investors have been touting the merits of renowned retailer Macy's (NYSE:M), the troublesome environment for brick and mortar retail outlets has only accelerated the company's plunge over time. The irreversible problem for Macy's has been the internet, which is increasingly capturing more market share from more traditional big box retailers, raising serious questions about the viability of the old. As the company struggles to remain relevant in the 21st century, an upcoming earnings report is likely to underline these challenges amid a troublesome economic environment and weak consumption backdrop. With revenues falling and earnings expected to show the core business under pressure, the absence of a turnaround strategy or more fleshed out tactics to deliver returns from the substantial real estate portfolio indicates further room for shares to fall.

Unconvincing Backdrop

A disappointing holiday season and falling revenues should be a flashing warning sign to potential Macy's investors. Aside from the fact that revenues fell by -3.65% over the course of fiscal 2016, at $27.079 billion, the top line figure was lower than the values reported for the prior three fiscal years. While the company has tried to keep earnings buoyed by employing substantial financial alchemy, a 52-week return of -38.25% highlights the abject failure of management to restore confidence among shareholders. However, one of the key factors behind the underperformance is the fundamental environment for retailers. Even though job creation should be looked upon favorably, average hourly wages have not risen for the vast majority of wage earners while Americans in aggregate are seeing disposable incomes shrink thanks to an increasingly large allocation to healthcare.

According to the latest available figures from the University of Michigan Consumer Sentiment survey, confidence is at the lowest levels since last September. The fact that retail sales have been flat or negative for the prior three readings does not instill a great degree of confidence in Macy's ability to outperform expectations over the near-to-medium term. Although the Federal Reserve believes the economy is going through a bit of softness, citing "growth in household spending has moderated," it remains positive on the outlook even with the multitude of factors dragging down growth. Despite general consumer spending rising, much of this can be attributed to healthcare and has not translated to growth in retail, with the Thomson Reuters Same Store Sales index contracting by -0.10% in March. Forecasts anticipating 1.40% growth for the quarter ending in April could be missed by a wide margin, highlighting the ongoing tepid environment for retailers.

Buybacks Backfire

Although year-to-date the company has performed admirably, climbing back 10.58%, the sustainability of these gains is questionable at best. One of the key drivers of momentum has been share buybacks, with the program given an additional $1.50 billion lease on life for the fiscal year. However, in spite of spending tremendously over the last few years to repurchase shares, dropping the amount from 425 million outstanding at the end of fiscal 2012 to just barely over 310 million at present, Macy's shares are not far off of levels last seen in 2012. This is all the empirical evidence needed to show that the strategy to bolster shareholder returns has fallen well-short of expectations with expanded purchases announced in February unlikely to translate to value for shareholders. With the buyback blackout period currently upon Macy's, there is technically no upside in shares to be captured from repurchases at present.

The Real Estate Component

On the whole, Macy's is currently sitting on an exceptionally valuable real estate portfolio which is not providing any measurable shareholder value at the moment. Although key hires in the space have given the indication that additional resources are being allocated to unlock the value, the prevailing issue is how to provide long-term returns from these assets instead of a one-off benefit from selling the assets. Furthermore, the process for generating heightened revenues from these properties will undoubtedly be a longer-term strategy that will take substantial time to implement. While activist investors like Starboard believe that the real estate portfolio is currently worth in excess of $21 billion, the company's valuation of $12.31 billion is well below the value of the property it occupies if Starboard's assertion is correct. However, any value in the real estate portfolio is contingent on a buyer presenting themselves.

Financially Speaking

The holiday season in particular was a harbinger of times to come for Macy's after sales tumbled by -5.29% in the fourth quarter versus the same period a year prior. Besides the top line losses, the bottom line has also suffered tremendously over the last year, with fiscal 2016 income falling by -29.75% to $1.072 billion. This is the weakest print for the company since fiscal year 2010, underscoring the fact that management has fallen flat when it comes to energizing top and bottom line results. The growing debt burden is also raising costs for the company which saw interest expenses climb 17.50%, likely owed to the company financing ineffective buybacks. Moreover, capital expenditures are also climbing, with spending on fixed assets rising to $1.113 billion. Unfortunately for Macy's, spending more on assets that are already underperforming is not going to unlock the potential value investors are anticipating.

Even though the valuation may seem cheap considering the market capitalization relative to the balance sheet valuation of total assets at $20.576 billion, until Macy's can restore top and bottom line growth, there will be limited upside to capture in shares. Value investors might be keen to point out that a price to earnings multiple of 11.76 versus 23.70 for the aggregate S&P 500 is evidence of upside potential, Macy's is generally keeping pace with developments in the retail sector. While the dividend might be appealing for income investors considering the 3.72% yield, there could be better value, especially if shares fall further after the upcoming earnings announcement. Right now consensus is anticipating earnings per share of $0.38, revised substantially lower from $0.46 three months ago. Despite the revision, a downside surprise is possible considering the company's sustained underperformance and weak fundamental backdrop.

Risks Remain to the Downside

While Macy's management may take the upcoming earnings announcement as an opportunity to reveal new strategic initiatives to unlock shareholder value, the timing is not ideal. A weak spending backdrop for the US economy combined with a troubling outlook for the brick and mortar business means that value investors are unlikely to be rewarded at current levels even if they hold out over a long-term horizon. Income investors may see some value by parking money in Macy's over the near-term, but acting before the earnings report is unwise, especially considering the probability of another round of disappointing results. With little in the way of optimism outside of the burgeoning real estate portfolio, share prices are anticipated to continue retreating, retesting February lows of $34.05 per share with any break paving the way towards $32.00. Even at these levels however, value investors might be facing more downside risks at the expense of minimal upside potential.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.