Stock of the Week - Macy's (12.12.2024)

Macy's, the largest department store chain in the United States, faces mounting challenges as it navigates a critical turnaround effort amid accounting irregularities, activist pressure, and shifting consumer behavior. While the company's "Bold New Chapter" strategy shows early promise in select locations, broader headwinds and execution risks create uncertainty around the retailer's transformation plans.

Q3 FY24 Results 

For the third quarter, Macy's reported:

• Revenue: $4.74 billion (-2.4% year-over-year) vs. estimate $4.76 billion
• Adjusted EPS: $0.04 vs. estimate $0.035
• Comparable sales: -1.3% (owned plus licensed) vs. estimate -1.39%
• Gross margin: 39.6% vs. 40.3% year-over-year
• Inventory: $6.26 billion (+3.9% year-over-year)

Earnings vs Estimates. Source: Bloomberg

Accounting Investigation Impact 

The company recently concluded an investigation into accounting irregularities, revealing that a single employee had hidden approximately $151 million in delivery expenses from Q4 2021 through Q3 2024. The discovery has led to reduced FY24 adjusted EPS guidance to $2.25-2.50 from the previous $2.55-2.90, and a lowered gross margin forecast to 38.2-38.3% from 39.0-39.2%. While Macy's stated there was no material impact requiring restatement of previous financial statements, the company has implemented strengthened financial controls. Importantly, the accounting issues had no impact on cash position or vendor payments, as all vendors were fully paid during this period.

Turnaround Strategy Progress 

The "Bold New Chapter" initiative is showing encouraging early signs of traction, with the "First 50" locations achieving +1.9% comparable sales growth in Q3. The company has seen broad-based improvement across nameplates, with Bloomingdale's posting +3.2% growth and BlueMercury continuing its streak of positive performance with +3.3% growth. November comparable sales are trending ahead of Q3 levels, suggesting potential momentum heading into the crucial holiday season. Under new CMO Sharon Otterman, strategic marketing initiatives are gaining traction, particularly around key events like the Thanksgiving Day Parade. The company continues to execute its store optimization strategy, with approximately 65 store closures planned for fiscal 2024.

3Q24 Earnings Presentation Source: Company

Activist Pressure and Real Estate Value 

New activist investors Barington Capital and Thor Equities have emerged with a comprehensive proposal for change at Macy's. Their plan includes creating an internal real estate subsidiary, reducing capital expenditures, implementing a $2-3 billion stock buyback over three years, and exploring strategic alternatives for Bloomingdale's and BlueMercury. The activists are also seeking board representation for both firms. The real estate strategy notably differs from previous activist proposals by suggesting an internal structure rather than immediate monetization through sale-leaseback transactions.

Market Challenges and Risks 

Macy's continues to face significant headwinds in executing its strategy. The ongoing shift in consumer shopping patterns away from department stores presents a fundamental challenge, while increased competition from off-price retailers and specialty stores intensifies pressure on market share. Weather-related impacts have affected seasonal merchandise performance, and the promotional environment continues to pressure margins. The company must balance required investments in store experience against activist demands for reduced capital expenditure, creating potential tension in execution of its turnaround initiatives.

Investment Perspective 

While Macy's trades at a compelling valuation relative to peers and historical levels, the investment case requires careful consideration of multiple factors. The early positive signs from strategic initiatives must be weighed against broader industry headwinds, and the potential value of real estate assets must be balanced against operational challenges. The company's strong cash generation capabilities provide some flexibility, but capital allocation priorities remain a point of contention. The premium performance of luxury segments Bloomingdale's and BlueMercury contrasts with struggles in the core business, creating strategic questions about portfolio composition.

Analyst Commentary 

Wall Street maintains a cautious stance on Macy's prospects. Citi (Neutral, PT $16) warns that improving sales trends may be promotion-driven, while Evercore ISI (In-line, PT $16) emphasizes the need for deeper understanding of baseline profitability post-accounting adjustments. Morningstar analysts see a "glimmer of hope" in go-forward locations but maintain skepticism about broader turnaround potential. TD Cowen highlights consumer caution on big-ticket purchases as a potential headwind for holiday performance. The consensus view suggests that while execution risks remain significant, the success of strategic initiatives in select locations provides some basis for cautious optimism.

Valuation

We based our projections on historical averages and company projections, assuming a positive scenario for the company. This results in a 4% revenue growth and a 5% operating margin across the 5-year forecast. Considering the substantial influence of terminal value in DCF analysis, especially for shorter forecast periods, we’ve applied a 3% revenue growth and 7% terminal WACC, down from 7.2% in forecast years.

Under these assumptions, our model suggests an intrinsic value of $20.47 per share, indicating an upside of 23.5% to current share price. It’s important to note the high sensitivity of DCF-derived intrinsic values to input assumptions. Below, two sensitivity matrices illustrate different Operating Margin and Revenue Growth scenarios, as well as Terminal WACC and Terminal Revenue Growth variations.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

To evaluate Macy’s performance relative to its peers, we analyzed a group of three comparable companies with similar business models: Dillards, Nordstrom, and TJX Companies. Across all key metrics, Macy’s outperforms the peer group average, as reflected in the mean, median, and cap-weighted multiples we calculated.

Three separate valuations for Macy’s, based on these multiples, suggest significant undervaluation. The current market price appears to reflect investors' skepticism about a successful turnaround. However, the multiples indicate that Macy’s is fundamentally a “cheap” company, offering potential value if its strategy proves effective.

Source: Bloomberg Finance LP, XTB Research

Recommendations: Macy’s has 14 recommendations, with 4 "buy" and highest price of $25, 9 “hold” and one “sell” with the price of $16. The 12-month average stock price forecast is $16.91, implying a 2% upside potential from the current price.

Technical analysis (Daily interval): 

The stock price is currently trading between the 23.6% and 38.2% Fibonacci retracement levels, which are acting as key support and resistance zones. The three EMAs are converging around the 23.6% Fibonacci retracement level, suggesting it is a strong support area. Historically, such EMA tightening has often preceded periods of increased volatility.

The RSI remains in the neutral zone, indicating a lack of a clear trend. Meanwhile, the MACD is tightening, hinting at the possibility of a bearish crossover, which could signal downward momentum if confirmed. These technical factors point to a critical juncture, with potential for significant price movement in either direction.