Macy's: A High-Yielding Dividend Stock On Sale

Summary

• Changing consumer preferences (i.e., e-commerce) has hurt Macy's performance and crushed its stock price, but there now appears to be considerable upside potential.
• Macy's dividend (5.50% yield) is conservatively supported by free cash flow and is not at risk of being cut any time soon.
• Macy's trades at a discount relative to historical valuation multiples and peers.

Source: Stock photo

Brick and mortar consumer retail companies have struggled over the last decade. Competitive pressure from e-commerce giants like Amazon (AMZN) has certainly taken its toll. However, Macy's (NYSE:M) is one stock in particular that's weathered the transition particularly well and has a lot of upside potential given the following reasons:

• At worst, Macy's projects revenue performance for fiscal year 2018 to be flat year-over-year, so it appears that the damage from e-commerce competitors has possibly stabilized.
• Macy's real estate portfolio has considerable value that enhances cash flow as needed. This has helped Macy's reduce debt and buy back common shares over the last couple of years.
• Macy's huge dividend (5.50% annual yield) is supported by free cash flow and should continue growing.
• Macy's trades at an attractive valuation when compared to historical multiples and peers.

As I look at Macy's stock performance over the last 5 years, you can easily see the damage. The stock trades at less than half the price it did back in 2015. Some of this performance is warranted given shifting market dynamics, but I believe the stock now is in deep discount territory given the reasons I'll continue discussing throughout this post.

M data by YCharts

Macy's Financial Snapshot

Macy's sales have definitely struggled over the last couple of years (gross margins too). With that being said, profit margins, earnings per share, and free cash flow were all good during 2017. Macy's has been using excess free cash flow and asset sales (real estate portfolio) to repurchase shares, which has helped. Macy's has also been able to reduce debt and improve its net cash position, which is impressive considering the large dividend and shifting market dynamics.

Macy's real estate portfolio is one thing that needs to be highlighted. I believe investors just don't give any credit for this. This portfolio includes stores as well as non-store real estate such as warehouses, outparcels and parking garages. Over the last three fiscal years, Macy's has completed transactions totaling approximately $1.3 billion. Macy's net property and equipment is currently recognized at $6.7 billion on its balance sheet, but the true value of those holdings is likely understated. Also consider that Macy's enterprise value is only approximately $14 billion, which is why I don't believe investors don't give much credit to this real estate portfolio.

Data Source: Google Finance. Note - Macy's fiscal year end is February 2018, but is presented as 2017 in all tables (consistent with how Macy's presents its filings).

Macy's 2018 projections look good, especially sales expectations. The consumer transition from brick and mortar to e-commerce is a risk that could be shrinking. According to Macy's most recent earnings release:

For fiscal 2018, the company expects comparable sales on both an owned and an owned plus licensed basis to be flat to up 1 percent. Total sales are expected to be down between 0.5 percent and 2 percent in fiscal 2018. Adjusted earnings per diluted share of $3.55 to $3.75 are expected in fiscal 2018, excluding anticipated settlement charges related to the company's defined benefit plans. Adjusted earnings per diluted share include anticipated asset sale gains of $300 million to $325 million in fiscal 2018, compared to $544 million in asset sale gains for fiscal 2017. The company anticipates an effective annual tax rate of 23.25 percent for fiscal 2018.

Dividend Analysis - 5.50% Annual Yield

One of the best reasons to own Macy's is its large dividend, which currently provides a 5.50% annual yield. That puts the stock in the top 20 out of all the companies on the S&P 500. Given the difficulties the retail industry has faced over the last 10 years, it's surprising to see that Macy's dividend is quite safe. As you can see from the table below, Macy's has been a strong producer of free cash flow and had a payout ratio of only 39% during its last full fiscal year. Over the last 4 fiscal years, the dividend payout ratio has also averaged 39%. What this means is that if Macy's has a dip in performance, the current dividend should be able to be maintained. Macy's also has room to continue growing the dividend.

Gains from asset sales are not included in the table above.

In terms of Macy's dividend history, dividends have been provided since 2003. The last financial crisis caused Macy's to cut its dividend, which is understandable. Macy's has consistently increased dividend payments annually since 2011.

M Dividends Paid (ttm) data by YCharts

Macy's Historical Valuation Multiples

Macy's historical valuation multiples are attractive across the board. Macy's trades well below 5-year averages for Price/Sales, Enterprise Value/Free Cash Flow, and Trailing P/E. You really need to go back to the last financial crisis to find a time with worse multiples. Macy's historical performance does need to be considered, but I think everything still looks attractive, even when the risks are considered.

M PS Ratio (ttm) data by YCharts

M EV to Free Cash Flow (ttm) data by YCharts

M Normalized PE Ratio (Annual) data by YCharts

Comparables Analysis

With a forward P/E of 9.34x, Macy's compares favorably to peers as well. I also like that Macy's has a good price/sales multiple and also has the best gross margins. Only J. C. Penney (JCP) has a better price/sales multiple, but that company is struggling and on a negative trajectory.

Enterprise Value, Forward P/E, PEG Ratio, Price/Sales and Yield provided by Yahoo Finance. LT Growth is derived from Forward P/E and PEG ratio. I didn't calculate average PEG ratio or LT Growth given the negative percentages skew that presentation.

Conclusion

With a forward P/E of only 9.34x and stabilizing sales, I believe Macy's stock is in deep bargain territory. Macy's stock price really hasn't responded much to what is looking like an improving market, so I believe there is considerable value. Downside risk is further reduced, given the stock trades cheap based on both historical multiples and relative to peers. I also like Macy's huge dividend that should continue increasing over the next couple of years from strong free cash flow and Macy's large real estate portfolio.

Analyst’s 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.

Comments

[jay_kay]

Going nowhere near M and KSS. Their stores are half empty all the time. It’s only a matter of time before the stocks tank

[AlieGee]

Finding the Bargain Stocks Among Department Stores -- Barrons.com
9:37 pm ET March 2, 2018 (Dow Jones)

By Avi Salzman

Investors in department stores finally got to unwrap some presents from Christmas. Several of the big chains last week reported surprisingly strong results for the fourth quarter, and their stocks popped.

The late-arriving holiday cheer shows that as a sector, department stores aren't dead. Still, investors need to pick carefully through the bargain bin.

The stores are benefiting from a consumer-driven economic recovery in the U.S., which led to a particularly strong holiday season. In past years, inventory has piled up during the holidays, forcing fire sales even before Santa showed up.

This year, however, the companies resisted the markdowns and still moved merchandise. Kohl's (ticker: KSS) reported 6.3% growth in same-store sales -- or sales at stores open at least a year -- its best quarterly result since 2010. Macy's (M) had its first positive same-store sales result in 12 quarters.

The recent pickup follows a long slump for most of the chains, which have lost customers to online retailers and fast-fashion chains like H&M Hennes & Mauritz's (HMB.Sweden). Retailers announced more than 6,000 store closings in the U.S. last year, and mall traffic has been in a steady decline.

Many of the department-store stocks have fallen by 30% or more over the last three years, leaving them trading at price-to-earnings valuations that trail the broader market. They appear tantalizingly cheap.

Buyer beware, industry experts say.

A real rebound in the sector, says Brian Tunick, an analyst at RBC Capital Markets, "will take at least a few more quarters of positive same-store sales and stable store traffic results."

Indeed, most department stores trade at total market values that lag their annual sales, a sign that Wall Street sees little growth ahead.

To investors encouraged by the recent news, it's worth being choosy now. Nordstrom (JWN) and TJX (TJX) appear to have the most staying power, with Nordstrom the more attractive choice in terms of valuation.

Kohl's and Macy's are showing new life, but both need to prove they can repeat their stellar fourth-quarter performances before the stocks become attractive. And J.C. Penney (JCP) and Dillard's (DDS) remain tricky -- volatile small-cap stocks in a declining industry.

Still, economic forces are giving department stores a lift. Consumer sentiment has improved, and the recent tax cuts have put money into the pockets of most Americans. Corporate tax cuts will increase the bottom line for department stores, which had paid particularly high effective rates.

At TJX, which owns the T.J. Maxx and Marshalls discount chains, the new tax law could lift next year's earnings per share by 18%, allowing the company to raise its dividend by 25%, ramp up stock buybacks, and give workers bonuses and other benefits.

Economic growth and tax cuts won't solve the larger issues plaguing the sector.

The chains have responded by launching elaborate turnaround plans, often with grandiose names. Macy's has its North Star Strategy, and Kohl's executives follow "the key pillars of the Greatness Agenda."

In short, they're looking for ways to generate excitement -- exclusive products, stores within stores -- and to cut costs, often by closing underperforming locations or sub-leasing extra space. Online sales matter too, of course. But brick-and-mortar stores remain an important part of the mix.

Although internet sales get all the headlines, e-commerce remains just 9.1% of total retail sales in the U.S. Even after excluding auto dealers, gas stations, food and beverage stores, and restaurants, e-commerce will account for about 18% of retail sales by the end of this year, according to IHS Markit.

TJX, the discount chain, has been the most successful of the bunch, even though e-commerce is "a relatively small part" of the business, its chief financial officer, Scott Goldenberg, said on the company's conference call on Wednesday.

TJX has benefited from some of the same trends as dollar stores in recent years, attracting consumers looking for bargains. After a rocky start to 2017, a 4% same-store sales jump in the fourth quarter should give investors "a sigh of relief," argues Tunick, who thinks the shares can rise to $91 from a recent $83 and change.

Nordstrom, a premium chain that owns the discount brand Nordstrom Rack, has succeeded with a different strategy. E-commerce accounted for 32% of its sales in the fourth quarter, among the best if not the best of the department stores. (Not all break out online sales.) Nordstrom Rack struggled earlier this year, leading the stock to fall, but it rebounded over the holidays. And its full-price mall stores are relatively safe, with 95% in so-called A malls that are filled with top-quality tenants.

The Nordstrom family, the company's largest shareholder, has also reportedly been looking to buy the entire company with help from a private-equity firm. Nordstrom didn't address the buyout rumors on its earnings call and did not respond to a request for comment from Barron's. Cowen analyst Oliver Chen thinks there's a better than 50% chance the company goes private, and sees shares rising to $60 from a recent $53.

Macy's presents a conundrum. A storied brand with iconic stores, its sales have mostly been falling over the past three years. Bullish investors have argued that the company's real estate is worth more than its enterprise value of $14 billion.

Activist investor Starboard Value pushed Macy's to spin it off from the operating company, but the company has been reluctant to do so. Last year, it sold $411 million in real estate assets.

The recent sales improvement has brought Macy's stock back to its level of a year ago. But without sustained growth, the stock could return to the doldrums.

At Kohl's, same-store sales jumped 6.3% on the back of high demand for athletic apparel and sneakers. Kohl's has experimented with several strategies to drive more traffic, even setting up Amazon return centers in some of its stores. But the company's sneaker bonanza could reverse, as it has for stores like Foot Locker (FL). Kohl's guidance for zero to 2% growth in 2018 looks "too aggressive," argues Morgan Stanley analyst Kimberly Greenberger.

Department stores may have returned to growth for now, but most still don't belong in investors' portfolios.

[GB70]

I've been buying over the past year and have an average cost of about $25 - thinking of taking some profits in a couple weeks after the x-div date. i still think there is some upward movement in the stock price, but would like to lock in some gains.

[Vandooman]

Macys is a mess. The only reason they survive is their real estate whereby either they pay no rent or they signed leases for nominal rents when they were the anchor tenants of new mall. Not sure you can say they can capitalize on real estate when in fact they already are. Interesting timing in that a Macys' clerk told my wife only yesterday that all the employees of the store were in fear of losing their jobs. She also felt that on-line sales were taking sales away from the stores and the store had to take returns while getting no credit for the on-line sales.

I have to admit a bias against the company because I once tried to help finance a redevelopment, only to be thwarted continually by the bureaucracy and arrogance of Macys. Their store in the mall was a disaster and hadn't been renovated since inception. The redevelopment was benefitting Macys without them putting up a dime, including money for them to renovate. They still proceeded with glacial speed.

If you want to assess the retail operations, change the cost of occupancy to a market level of rent, and see if they would be making any money without the legacy real estate and leases. I doubt it. Seems to me the article just encourages yield shopping on a damaged company, which is usually the reason for a high yield because the stock price is where it deserves to be. I will continue to follow the advice of Mr Buffet (not Jimmy Buffet) and buy great companies at a fair price. Those who bargain hunt may end up following Jimmy Buffet to Margaritaville.

[TK8500]

So buying all that real estate was a smart business move

[mahaloco]

Was your experience with Macy’s before or after California did away with redevelopment agencies and incremental tax financing? I observed the exact same issues with Macy’s when the City of Pasadena was going through redevelopment. They held on to an outdated structure in a prime location while everything around them was being torn down and rebuilt top notch - attached to the Paseo Colorado. They remained an eye sore for 15+ years. They are finally being replaced by a Hyatt.

[Exile of the Mainstream]

Macy's stock price really hasn't responded much to what is looking like an improving market

Err it's nearly doubled.

[matandnat3]

the market is also responding to Trumps comments on Tarrifs at the same time.

[mattm38]

Hope to see a dividend increase this year! that would be awesome

[ckarabin]

They will pay down the high interest debt as a first priority over increasing the dividend

[Joseph Oppenheim Investing]

I didn’t see any mention of bluemercury in the earnings meeting transcript. How is it doing?

I recently got into M, average cost 19.6.

[lew69sd]

M stock is going to 35.

[team Gabe]

thumbs up emoji !!

[ckarabin]

They now apparently have a good plan in place to monetize much of their considerable excess real estate, proving you can make nice cash flow when a firm retrenches as it frees up a lot of assets for sale. They signed a deal to redevelop and rent out the top 7 floors of their State Street Chicago store which should provide them a long term continuous cash flow for many years to come with similar deals likely on 40 other properties too.

Not to mention that the retail operation is highly profitable and produces considerable cash flow too. The excess cash flow will enable them to pay down lots of 6%+ debt too, still another source of increased profit for them.

This stock is SUCH a no brainer! Worth at least $40.

[rodolfoavalos1]

I agree with the premise that Macy’s is still undervalued given its potential with the recent adjustments and initiatives to lure people into their stores, but I think this might not be a good entry price, as many investors look at it still with a “show me some sustainability” view.. we might get a chance of buying Macy’s at a lower price at some point prior to the next ER, where they will have to continue showing improvements in the operating numbers and increased revenue growth. I will wait for that pull back before buying some more..