Getting 10%+ Yield From These 3 Retailers

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Includes: AEO, KSS, LB, M
by: Napoleon Capital
Summary

A solid Bull Case can be made for Macy's, Kohl's, and American Eagle.

Where it really becomes interesting is the impressive yield that can be generated by selling covered calls.

To top it off, the strike prices I'm suggesting leave ~15% upside so you can still capture price appreciation.

Macy's (M), Kohl's (KSS), and American Eagle (AEO) are in my opinion some of the better stock opportunities in traditional retail. The icing on the cake, however, is that we can write calls to generate significant premium while only moderately limiting upside potential.

Here's a summary of these three trades, with more details on each below.

Stock (Price) Before Selling Call After

Macy's (21.91)

Annual Div. Yield: 6.8%

Price Upside: Unlimited

Yield (Dividend + Premium): 13%

Price Upside: 18%

Kohl's (48.71)

Annual Div. Yield: 5.5%

Price Upside: Unlimited

Yield (Dividend + Premium): 11.7%

Price Upside: 18%

AE (16.8)

Annual Div. Yield: 3.3%

Price Upside: Unlimited

Yield (Dividend + Premium): 12.5%

Price Upside: 19%

Macy's

macy

Source: Macysinc.com

Macy's has experienced a drop in revenue, EBITDA, and share price over the past 5 years as competition in the retail space has been intensifying. However, management has been making many strides towards returning Macy's to growth. They have improved utilization of square footage inside their store, adding an off-price section called Macy's Backstage to take advantage of the growth in off-price retail in the past several years. They are also testing an experiential retail section called STORY, which changes every few months to help bring traffic into stores.

In addition, Macy's has partnered with Brookfield Asset Management to redevelop some of the property it owns, such as excess parking lot space, into new retail and office spaces to be leased out. This will help them turn some of their underutilized real estate into stable cash flow.

Finally, the most encouraging development is the growth of the standalone Bluemercury stores that Macy's operates. They are luxury beauty stores similar to those of Ulta Beauty (ULTA). Bluemercury has been growing quickly, going from 100 at the end of FY 2016, to 164 as of Q1 2019.

So far the turnaround seems to be taking shape and comp sales have stabilized, with FY 2019 guidance of flat to 1%. With a 7% yield and sustainable payout ratio of 42%, investors can win even if it takes time to materialize. With options, this payout can get even richer. If you sell the 1/17/2020 $26 calls for 0.72/share you can boost this yield to 13% (annualized). It comes with the cost of limiting your upside to 18.7%. This covered call strategy could generate a significant return even if all of the operating improvements generate underwhelming results. If the turnaround has more impressive results, there is still significant upside potential from an increase in share price.

Kohl's

Kohl

Source: Kohls.com

Kohl's is a department store similar to Macy's, but there are significant differences between them. First, Kohl's has had better operating results in recent times. They achieved slightly positive revenue growth in the past 5 years, and only suffered a third of the drop in operating income that Macy's has suffered. While Macy's has been filling much of their underutilized space in their stores with their own concepts, Kohl's has made partnerships with outside companies such as Planet Fitness to lease out unneeded space in many of their stores. They have also partnered with Amazon to accept returns of Amazon items in their stores and sell Amazon products such as Alexa.

Kohl's has no presence in off-price retail, recently announcing plans to close the few locations they have in the space. This leaves them vulnerable to being undercut by both online and brick & mortar retailers who offer discount price goods. They are much more of a pure play in the department store space than Macy's due to not having any significant operations outside of their primary stores. Their risk profile is also different in that they have less exposure to malls than other department stores, meaning that they could outperform peers if mall traffic suffers.

If a 5.5% dividend yield isn't enough to get you into the stock, perhaps selling the 1/17/20 $57.5 call for 1.55/share to boost that yield to 11.7% annualized while leaving 18% upside will tempt you.

American Eagle

American Eagle Store Source: aeo-inc.com

When you hear the phrase "Mall-based retailer", growth is probably not the first thing that you expect. Despite an environment of declining mall traffic, American Eagle has been doing just that. A comparable store sales increase of 6% in the most recent quarter suggests that growth seems to be continuing at a steady pace.

Chart Data by YCharts

One of the highlights of the company is the lingerie and active wear chain called Aerie. It's body positive brand is well positioned and continues to take market share from older brands such as Victoria's Secret (LB). Combined with the fact that a third of revenue is from it's growing online sales, AEO has proven itself to be making the right moves to succeed going forward.

Given that it is growing steadily, it is not surprising that the dividend yield is much lower than M or KSS at 3.3%. But, you guessed it, we can sell the 1/17/2020 $20 calls for 0.80/share to increase the yield to 12.5% annualized and leave 19% upside to benefit from the growth.

If the growth trajectory of these three retail stocks don't excite you, hopefully the potential for double digit yields do.

Disclosure: I am/we are long 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.

Additional disclosure: All of the yields mentioned are annualized, and based on the price of the calls at time of writing. Both the price of the stock and call options are subject to change, which could affect the yields quotes in this article.