Macy's: Not Bad, But I'm Not Buying

About: Macy's, Inc. (M)
by: Leo Nelissen

Macy's just released its first quarter earnings.

The company beat EPS estimates but failed to deliver on sales expectations.

The turnaround is starting to show promising results which unfortunately is not yet leading to a rewarding bull case.

Macy's (M) continues to be one of the more depressing stocks on my radar. The company has been in a steady downtrend which could not be stopped after the company reported strong Q4 sales a while ago. The pressure on the US consumer continues to be a huge headwind for brick and mortar retailers as I discussed in my previous article. In this article, I will discuss the just released Q1 earnings and tell you why the bigger picture is not yet sending a buy signal.

Source: Macy's

The Bigger Picture Matters

I don't know a lot of stocks that are surrounded by emotions the way Macy's is. I know plenty of people who aggressively bought the stock over the past few years and some who made it their biggest retail short. Both sides are (obviously) equally convinced they will be right. In this article, I will give you both the good news and the news that is keeping the stock down and tell you what I consider to be a good entry.

First of all, adjusted EPS easily beat expectations. EPS reached $0.44 in the first quarter which is $0.08 above expectations. It is also 5% higher compared to Q1 of 2018 when EPS totaled $0.42 at a growth rate of 75%. Overall, the bigger picture remains fragile as EPS growth rates have dropped significantly after showing some promising results in 2018. Total sales came in at $5.50 billion versus expectations of $5.53 billion with a growth rate of -1% after contracting by 2% in Q4 of 2018.

Source: Estimize

Nonetheless, there are plenty of numbers that are promising. First of all, the company reported its sixth consecutive quarter with positive comps growth. In this case, comps were up 0.6% (owned) and 0.7% (owned and licensed). Macy's is also happy with the performance of Macy's, Bloomingdale's, and Bluemercury and confirmed its full-year guidance.

One of the reasons why the company is optimistic is the performance of its Growth150 program. This program is based on the upgrade of facilities, fixtures, staffing, assortment, and customer service to build a better scalable model for brick and mortar growth. The number of companies that try to reinvent the brick and mortar experience is growing steadily as the changing consumer environment is pressuring, but not eliminating, the need for brick and mortar stores.

According to Macy's, the Growth50 (first stores of the program) outperformed other fleet stores and achieved higher customer satisfaction. This momentum is expected to last going forward. Almost needless to say, the company is scaling to another 100 locations in 2019 (Growth50 becomes Growth150) which will result in 50% of brick and mortar sales coming from the Growth150 program.

Adding to that, the success from the Vendor Direct program continues as well with SKUs almost doubling since the expansion in early 2018. At this point, roughly 10% of all sales are coming from the Vendor Direct program which allows customers to choose from additional new brands and categories. In 2019, the company is expecting to add 1 million new SKUs and more than 1,000 new vendors.

And speaking of fast growth, the mobile sales channel continues to be a real outperformer. In 2018, mobile sales contributed $1 billion with higher growth expected in 2019.

With that said, full-year comps (owned and licensed) are expected to be flat to up by 1% with gross margins down moderately in both H1 and H2 with SG&A slightly up. In Q1 of this year, SG&A expenses rose to 38.4% of total sales from 37.6% in the prior-year quarter. Operating margins declined from 4.3% to 3.7%.

And speaking of margins, it is very obvious that investors want to see higher profitability ratios before buying this stock The stock price has declined along with profitability as you can see below. And this is not a problem only Macy's has as the entire brick and mortar business is suffering from lower margins since 2015.

Chart Data by YCharts

Additionally, we are still witnessing declining consumer confidence as 7 of the past 10 University of Michigan consumer confidence readings were negative. This confirms earlier worries I had with regards to the bigger consumer confidence trend which continues to point in the wrong direction.

Source: Author's Spreadsheets (Raw Data: U. of Michigan)

Almost needless to say, investors ignored the company's turnaround as stocks are currently close to their 2017 lows. Note that the stock is trading at 7.5x next year's earnings with a dividend yield of almost 7%.

Source: FINVIZ

I am still not buying the stock and hate to once again mention the company's size which makes the turnaround hard. The company's current growth measures are promising, but they need time to gain significance within the bigger picture. And speaking of the bigger picture, consumer confidence continues to decline which makes it unlikely that retail stocks (in general) are going to be go-to stocks on the mid-term.

I am buying Macy's once the current business cycle bottoms. I am talking both about general economic indicators as well as consumer confidence. At that point, stocks like Macy's that are working on a turnaround start to become interesting because unlike some competitors, they have proved to be able to find ways to grow in a challenging retail environment.

In other words, I am neither a convinced short seller nor an aggressive deep value buyer. I am on the sidelines until the bull case starts to gain some momentum.

Thank you very much for reading my article. Feel free to click on the "Like" button and don't forget to share your opinion in the comment section down below!

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.

Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.