Shares of Macy’s surged following its fiscal first quarter report May 16 as the department store beat estimates and raised its full-year guidance. That said, we continue to be cautious on the long-term prospects of big box retailers and the department stores, in particular. You won’t see us adding any department store to the simulated newsletter portfolios. J.C. Penney might be a $0 during the next downturn, whenever that comes.
By Kris Rosemann
Management at Macy’s (M) is full of confidence following a strong fiscal 2018 first quarter report, results released May 16, and Chairman and CEO Jeff Gennette believes his team has found the winning formula for the company in “a healthy brick & mortar business, robust e-commerce and a great mobile experience.” Though we are not making a trend of one quarter–and the omni-channel approach from a general perspective is hardly a conceptual breakthrough for retailers–he may not be too far off as Macy’s turned in comparable sales growth of 4.2% on an owned plus licensed basis from the year-ago period and raised its full-year earnings per share guidance to a range of $3.75-$3.95, a 20 cent hike over its previous guidance.
Management pointed to execution of its North Star Strategy, which is focused on merchandising and marketing initiatives, healthy levels of consumer spending, and increased international tourism as key drivers of its success in the quarter, and it was able to grow its digital business by double-digits yet again. Though Macy’s comparable sales growth impressed in its first quarter, the measure was boosted by the shifting of its ‘Friends and Family’ event from its second quarter to the first. When accounting for this change, comparable sales rose 1.7% on an owned plus licensed basis.
Macy’s gross margin expanded 70 basis points in its first quarter from the year-ago period, and SG&A spend as a percentage of revenue fell 90 basis points, which, along with a lower tax bill, helped the company grow adjusted earnings per share to $0.42 from $0.12 a year earlier. Free cash flow generation in the quarter more than doubled from the first quarter of fiscal 2017 to $132 million and was sufficient in covering cash dividends paid in the quarter of $116 million. Macy’s net debt load remains somewhat menacing at nearly $4.4 billion at the end of the fiscal first quarter, but a cash balance of more than $1.5 billion offers some liquidity.
We’re still not looking to the company as an income idea despite shares yielding ~4.7% at the time of this writing as its Dividend Cushion currently sits at 0, but free cash flow coverage of dividends paid by a retailer in the first quarter is certainly a welcome development. Macy’s hasn’t been able to do so since the first quarter of fiscal 2013.
Strong consumer spending may be one of a few factors that can resurrect the traditional retail space, and Macy’s appears to be effectively tapping into the strength found in discretionary income from American consumers. Management called the improvement in international tourism “significant” in its first quarter, and the confluence of these factors enabled it to raise its full-year guidance. In addition to the aforementioned bottom-line guidance hike, total sales are now expected to be between down 1% and up 0.5% from fiscal 2017 levels (previous guidance was for a decline of 2%-0.5%), and comparable sales on an owned plus licensed basis are now expected to grow 1%-2% compared to previous guidance of flat to up 1%.
All things considered, we like what we saw in Macy’s fiscal first quarter report, but given the prolonged struggles traditional retail has faced and the ongoing proliferation of e-commerce, we’re not overreacting to any one quarter, as strong as it may have been. Healthy consumer spending is providing a solid backdrop across the retail space, which was supported by a strong April retail sales report that saw 4.1% year-over-year growth in the clothing/clothing accessories category.
Macy’s progress in its digital business is encouraging as well, and we currently value shares at $27 each, though the upper half of our fair value range may be an appropriate intrinsic value estimation given its recent guidance increases. We’re not looking to add exposure to department-store retail at this point in time, and J.C. Penney’s (JCP) recent weak showing and lowered full-year 2018 guidance only raises more red flags about the group’s longevity. Given the secular trends that continue to work against the space, but strong consumer spending is a rising tide that has the potential to lift all retail boats in the near term. However, we think J.C. Penney may be a $0 during the next downturn, whenever that comes.
Retail – Multiline: DDS, JCP, JWN, KSS, M, SHLD
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.