- 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.
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.
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.
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.
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.
This article was written by
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