Macy's: Headwinds Blowing Too Hard

Summary

• Macy's minute growth leaves the company stagnant.
• Industry is hyper-competitive, and the pandemic accelerated Macy's loss of market share.
• Discount retailers, e-commerce, and weak stores are all notable headwinds.
• Nike and other brands that are reaching into direct-to-consumer may drop Macy's as a distributor.

Michael M. Santiago/Getty Images News

Investment Thesis

It's often easy to get caught up in the numbers when dealing with stocks, but on a fundamental level, a stock is only as desirable as the underlying business. As an investor who focuses on long-term investment prospects, I do my best to ignore short-term fluctuations in value and focus on the deeper, intrinsic worth of a business. To me, Macy's (NYSE:M) is a remnant of a deteriorating industry whose business model loses viability every year -- there simply isn't enough incentive to shop Macy's anymore. Macy's faces a preponderance of headwinds that have severely muted forward progress. Lackluster organic growth opportunities, a highly competitive market, and unideal store locations handicaps Macy's long-term prospects. Its current valuation is not low enough to warrant a buy, especially when risk outweighs reward. I recommend a SELL in Macy's.

Revenue & Profit

After the pandemic recovery, I find Macy's growth opportunities to be stunted in both the short and the long terms.

Macy's biggest problem is the lack of a moat. Department stores are categorically becoming less relevant in recent years, especially as the pandemic accelerated the transition toward e-commerce and other alternative retailers.

Department Store Sales, 1992-2021 (Billions of $) (Statista)

Even prior to the pandemic, department store sales were falling at a rapid rate. This implies that a recovery of the industry is unlikely, especially as e-commerce becomes more prominent and even stores like those owned by TJX Companies (TJX), Burlington (BURL), and the Ross chains (ROST) steal away pieces of market share.

It is my personal belief that Macy's, despite its attempts at retaining relevance, is helpless in the face of market change. This is reflected in its organic growth prospects.

Macy's Q4, and, really, its 2022 results in general, were quite subpar -- despite revenue growth, Macy's recorded declines in nearly all relevant metrics, including net sales, net income, EBITDA, and EPS.

Macy's 8k

I'll go over the positives first. Blue Mercury and Bloomingdale's saw increases in active customers (12% and 5% respectively), and they are proof that Macy's business strategies, such as Polaris, are at least somewhat effective at adapting to current market conditions.

Macy's does own a significant amount of real estate, which could potentially be used to either finance new investments/CapEx or to pay down Macy's debt.

There were also some small strides made in inventory productivity, which speaks well of Macy's supply chain, though it should be noted that some of the decline in inventory can be attributed to markdowns.

Unfortunately, this is where the good bits end.

Macy's has a litany of qualitative issues that I'll discuss later, so for now let's focus on just the numbers. Although its operating margin did spike up to 9% in 2021, it currently hovers below 7%. Its net margin sits just below 5%. When margins are this slim and unlikely to expand (especially in the current macroeconomic environment), Macy's only saving grace would be some kind of organic growth tailwind that it just doesn't have. Revenue has still not recovered to 2019 levels, falling a few hundred million short, and is growing at a depressing pace -- Morningstar suggests Macy's revenue will rise at a CAGR of less than 1% over the next decade. I am in agreement -- Macy's store closures and lack of growth opportunities hinder its top-line growth significantly. There's not really much else to say -- SG&A increases, margin contraction, a 4% decrease in Macy's active customers: nearly all Macy's news is bearish.

Qualitative Factors

The flaws that I hinted at above are, in my view, too significant for Macy's to be able to address them fully. My most prominent worries are as follows:

• Macy's store closures are indicative of weakness and the decline of department stores in general.
• Macy's and other department stores have been losing market share to e-commerce and other retailers in the space, such as specialty stores or discount retailers, and this trend was probably accelerated by the pandemic.
• The Polaris plan is too little, too late.
• Macy's lacks any semblance of a moat.

I'll go through each in sequence.

Store Closures

In 2020, Macy's announced a plan to close 125 stores over three years. This was probably unavoidable -- shopping malls are no longer nearly as relevant as they once were (plus, stores in smaller, suburban malls weren't very productive anyways). Regardless, this raises a few red flags for me.

First, regardless of the relative production level of the stores that are closed, it is still lost revenue that Macy's may find difficulty replicating in other areas. Much of the 2020 decline in revenue came from store closures as a result of the pandemic, and I suspect that these closures are also a major factor in the bleak revenue outlook.

In addition, this goal of 125 stores represents nearly 1/4th of all Macy's stores. To me, the store closures send a signal to investors, customers, and competitors that Macy's is facing serious challenges. While the impact this may have is very nebulous, brand perception is important for any company.

Industry Headwinds

As I touched on earlier, department stores haven't had the best time in recent years.

Consumer behavior has shifted towards online retailers instead of brick-and-mortar stores. Obviously, this has led to a decline in foot traffic in malls and department stores, and many retailers, including Macy's, have been unable to mitigate the impact of this trend on business. I'll put the graph from above here as well for reference.

Department Store Sales by Year (Statista)

This shift in preference has been accentuated by the rise of "fast fashion" and discount retailers, like H & M (OTCPK:HNNMY), Zara (OTCPK:IDEXF), and even Walmart (WMT) or Target (TGT) have stolen market share from traditional department stores like Macy's.

Furthermore, consumer preferences in fashion have changed (Macy's is trying to keep up with Polaris) towards more casual, comfortable clothing rather than the traditional offerings of department stores.

Of course, the operating costs for department stores are generally higher than their competitors as well -- the stores have a high physical footprint and their need to maintain diverse inventory can put significant upwards pressure on operating costs.

Polaris & Business Strategies

Macy's has enacted quite a few business strategies in recent years. I'm going to focus my efforts on their "Polaris" set of initiatives.

Macy's Q4 2022 Polaris Updates (Macy's Q4 2022 Earnings Presentation)

It's concerning to hear that Macy's has yet to see tangible results from their Polaris initiatives despite introducing them in 2020. While the intentions behind the goals are noble, it's clear that the initiatives haven't addressed the core problem of the business's declining merchandise offerings.

It's also alarming to hear that digital penetration is down since Q4 2021 across Macy's, Bloomingdale's, and Blue Mercury brands. This indicates that Macy's, despite some valiant efforts, is struggling to adapt to the increasingly digital landscape of retail, which is essential for success in today's market.

It may be worth considering additional strategies to revitalize Macy's business and merchandise offerings, such as exploring new product lines or partnerships, re-evaluating pricing strategies, or enhancing the overall shopping experience for customers. It's crucial for Macy's to prioritize these efforts to reverse their declining sales and remain competitive in the retail industry -- but that begs the question: if Polaris isn't good enough, are there even steps that can be taken to propel Macy's back towards growth?

I won't give Macy's lack of a moat its own section, because it's obvious that a company lacking in competitive advantages, especially one whose growth outlook is as limited as Macy's, is in an unattractive position.

Valuation

On the surface, Macy's appears to be attractively valued. I won't deny the possibility that, in the short-term, Macy's may be slightly undervalued. However, without recycling the tired statement of "time in the market beats timing the market", I don't find the margin of safety on a Macy's investment to justify the buy given all the other options out there.

Seeking Alpha

At first glance, this all looks great, though I feel as though comparing Macy's to the broader consumer discretionary sector may not be the most relevant. When you look at its more direct competitors, such as Nordstrom (JWN)

Seeking Alpha

Or Dillard's (DDS)

Seeking Alpha

The metrics are put into perspective. This, coupled with the modest target prices suggested by amalgamations of DCF estimates (ranging from $18 to ~$25), are not enough to justify a buy. I may suggest a hold until the price reverts back closer to reason after its recent downtrend.

The Bottom Line

Macy's is a member of a dying race. Despite its best efforts to try to turn itself back towards relevance and growth, Macy's remains stagnant and unattractive as an investment. It would be an overstatement to call Macy's top line growth even marginal, and with a distinct lack of compelling advantage on any qualitative front, Macy's situation looks unlikely to improve. Despite small successes with the Blue Mercury and Bloomingdale's brands, Macy's core brand has become less and less relevant. The series of initiatives adopted by management to fight against the company's current trajectory have not done enough, with digital growth decelerating into the negatives since this time last year. Coupled with the absolutely horrendous future financial projections agreed upon by most analysts, I find Macy's to lack a compelling qualitative or quantitative element that might warrant owning the stock. Despite potential undervaluation in the near-term, I find Macy's to be unviable as a long-term position.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.