Macy's Is Still Running In Quicksand

Summary

• M's quarterly revenue declined slightly, while gross margin eroded.
• SG&A costs as a percentage of revenue increased. M has to invest in its digital platform to keep pace with larger competitors.
• The company expects a decline in comparable sales again in 2020.
• M is running in quicksand. Sell the stock.
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Source: Barron's

Macy's (NYSE:M) reported quarterly revenue of $8.34 billion, non-GAAP EPS of $2.12 and GAAP EPS of $1.09. Macy's beat on revenue and non-GAAP EPS, yet missed on GAAP EPS. The stock is off over 10% post-earnings. I had the following takeaways on the quarter.

Falling Revenue

Heading into the quarter, the company's sales were falling in the low-single-digit percentage range. This quarter the company's net sales fell 1% Y/Y. This was an improvement over last quarter, yet the net sales decline was still a cause for concern. Comparable sales for owned plus licensed were down 0.5% for the quarter and down 0.7% for the year. Until Macy's arrests the comparable sales decline, the company's stock could remain challenged. On a product basis, Macy's saw strong performances from dresses, fragrances and fine jewelry. Sales for men's tailored and mattresses were also solid. The company experienced weakness in watches and housewares.

Items per transaction fell 1%. Average unit retail ("AUR") was up 1.1% on the strength of the company's Destination businesses. The increase in AUR came amid lower AUR from Backstage, the company's on-mall, off-price business. Backstage grew comps in the mid-single-digit percentage range. Off-price retailers are winning in the current retail environment, so Backstage's business model appears to have promise. However, its AUR is lower than certain other businesses. Nonetheless, Macy's was able to increase its blended AUR despite the outsized influence of Backstage.

The company's digital sales have also performed well. Macy's has invested heavily in its omni-channel to help improve customers' online shopping experience. In 2019, Macy's saw its online sales increase by over 50%. The company's mobile app contributes about 20% of the Macy's brand digital sales. According to management, the digital business generates about $6 billion in revenue. This implies digital is over 24% of total net sales, which is stellar for a traditional retailer like Macy's.

Margins Declined

As digital becomes a higher percentage of total revenue, Macy's has to ensure its cost structure is more conducive to digital pricing. Gross margin during the quarter was 36.8%, down over 60 basis points versus the year earlier period. The growth of lower margin businesses hurt gross margin this quarter. On a dollar basis, gross profit fell 1% Y/Y. SG&A expense of $2.5 billion declined 1%. It was 29.3% of revenue, up about 10 basis points versus the year earlier period. Macy's must continue to invest in its digital channel and fulfillment services in order to keep pace with Amazon (AMZN), Target (TGT) and Walmart (WMT). It could be difficult to make deep cuts to SG&A expenses even if revenue declines.

Macy's may have to deal with falling gross profit and rising SG&A expense for the foreseeable future. The fallout was that EBITDA of $1.1 billion fell 5% Y/Y. EBITDA margin of 12.3% was down 50 basis points versus the year earlier period. On an annual basis, the company's EBITDA fell by double digits Y/Y and its EBITDA margin declined by 100 basis points. It is difficult to make a bull case for Macy's with these type of results.

Underwhelming Outlook

Macy's confirmed its 2020 guidance presented at its February 5th Investor Day. The company expects to generate net sales of $23.6 to $23.9 billion. The midpoint of the range ($23.8 billion) would be about 3% below the $24.6 billion in net sales reported for FY 2019. For the month of January, retail sales through department stores fell 4% Y/Y, yet rose double digits through non-store retailers. This implies fewer customers are shopping at physical locations. The window of opportunity for Macy's to arrest its revenue slide could be closing. Secondly, if we are at peak economy, then total retail sales could decline at some point. This could make even a 3% revenue decline hard to meet.

Macy's plans to close 125 of its least productive stores over the next three years. It is in the process of closing 30 now. The 125 stores account for about $1.4 billion in annual sales. Closing inefficient stores is prudent, in my opinion. The question remains, "Can Macy's capture those lost sales through its remaining store count or via its digital platform?" The company is expected to continue to grow its digital platform and Backstage operations. Macy's may have to adjust its price points and cost structure to accommodate these sales channels. Optimizing its new business model amid a rapidly changing retail landscape could be a challenge going forward. Macy's could face more stagnant revenue growth and margin erosion.

Conclusion

Macy's is still running in quicksand. The stock is off by over 40% Y/Y and could fall further. Sell Macy's.

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.