2023 started off strongly for value stocks, only to take a major turn down after the demise of SVB Financial, and the other banks that failed in their liability management activities. While the overall markets have performed quite well on the back of the largest tech-oriented companies, many stocks are languishing far worse than the overall fundamentals of the businesses would imply. While retail is not my favorite industry to invest in, sometimes you find really attractive opportunities with a strong margin of safety, and I believe such an opportunity exists in the common stock of Macy’s (NYSE:M), after its 31.5% decline over the last three months. At a recent price valuation of roughly 5.7x the low-end of likely trough earnings per share guidance, I believe the stock has roughly 50% upside from current levels.
Macy’s has reinvigorated itself by becoming an efficient omnichannel retailer. The company utilizes its stores for pickup and deliveries and has significantly expanded its brands with BlueMercury and Backstage. Macy’s has made solid progress monetizing its valuable real estate over the years, while also investing in off-mall locations to diversify. The company was hurt badly by the lockdowns in 2020, where it had to increase its debt, but has been whittling that down the last few years, while benefiting from the collapse of competitors such as JC Penney. Diluted EPS in 2022 and 2023 were $4.55 and $4.19, respectively, which combined are over 50% of the current share price. That seems a bit too cheap to me, which is why we have recently been increasing our exposure in the stock through various strategies.
On June 1st, Macy’s reported adjusted diluted EPS of $.56, down from $.98 a year ago. Total revenue of $5.173B was down from $5.565B. Net sales of roughly $5B declined by 6.8% YoY. Credit card revenues were down $29MM to $162MM in the quarter, hurt by higher bad debt within the portfolio. Operating income was $244MM, down from $463MM. Gross margin actually improved to 40%, up from 39.6%, as inventories were in a very healthy place going into the quarter. Delivery expense improved by 40 basis points and inventory declined 7% YoY, in line with the net sales decline. SG&A increased by $45MM, or 2.4% to $1.95B. Macy’s increased its minimum wage on May 1st of last year, which was the primary reason for the increase.
As April progressed, Macy’s saw sales decline, particularly among the lower- and middle-income Consumer. By nameplate, Macy’s net sales declined 7.7% and comparable sales declined 7.9% on an owned plus licensed basis, compared to a 10.1% increase last year. Bloomingdale’s held up a lot better with net sales declining by 2.3% and comparable sales down 4.3% on an owned plus licensed basis, compared to a 26.9% gain last year. Beauty, men’s and women contemporary apparel, and housewares performed relatively well. Blue Mercury continues its ascension with net sales growing by 4.4% and comparable sales increasing by 4.3%, versus a 25.2% gain last year, bolstered by strength in clinical and medical skin care, as well as hair color.
Macy’s significantly reduced its guidance with the high-end assuming heightened macro pressures experienced in mid-March through April persisting, while the low-end contemplates potential deterioration as the year unfolds. The company expects comparable sales to be down 6-7.5% YoY, and a gross margin rate of 38-38.5%, as the company expects to take deeper markdowns. Adjusted EBITDA as a percentage of revenue is expected to be roughly 8.8-9.4%, or 9.1-9.7% as a percentage of net sales. Annual adjusted EPS is expected to come in between $2.70 and $3.20, down from the prior expectation of $3.67-$4.11. For Q2, Macy’s expects net sales of $5-5.1B and diluted EPS of $.1-$.15. The company is taking the right steps to reduce slow-moving inventory with promotions, so that it can move quickly into the right areas when demand picks up. Macy’s announced that they are bringing back Nike in the Fall, which should be a nice addition to the floorplan.
Macy’s has done a good job over the last five years in improving its cost-efficiency, recently identifying $200MM of cost savings for this year and roughly $300-$350MM in 2024. The company also reduced its Capex spending by roughly $50MM. Long-time CEO Jeff Gennette is stepping down for Tony Spring in February of next year. The company intends to continue reinvigorating its private brands, expand to smaller off-mall locations, and focus on more personalized offers by utilizing technology. Brands such as Bloomingdales, Backstage, and BlueMercury have bolstered returns for the overall company, and there is still a strong runway for continued investments. The store within a store concept helps to generate better returns from Macy’s valuable real estate, and nearly every store is profitable after the pruning of weaker locations over the last few years. Management’s goal for 2024 is single-digit sales growth and a sustainable low double-digit adjusted EBITDA margin.
Macy’s current valuation of 4.1x trailing earnings, and 3.8x trailing EV/EBITDA is very undemanding. The current dividend yield is a healthy 4.14% and the market cap is around $4.2B. Macy’s does carry roughly $3B of long-term debt, while also having nearly $3B in long-term lease liabilities, so I believe the company should continue to prudently reduce debt with its free cash flow. While I believe that Macy’s is undervalued, investors looking for a more conservative strategy to invest in the stock might utilize the selling of cash-secured puts. For example, one can sell the January 24 $12 put expiring in 229 days for $1.04. This equates to a roughly 9.5% return, or 15.3% annualized on the maximum risk. Your worst-case scenario is owing Macy’s at a breakeven price of $10.96 per share, which I believe would position you for a likely double upon the next strong recovery in retail spending. I realize this investment isn’t as sexy as Nvidia or AI in general, but successful investing is taking advantage of opportunities as they present themselves. Macy’s can drop by nearly 29% further from its current share price of $15.42 to hit breakeven, which I believe in addition to the attractive current valuation, provides a very strong margin of safety.