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Is It Finally Safe to Buy Macy's Stock?

Leo Sun, The Motley Fool

Macy's (NYSE: M) lost about 20% of its value over the past three months amid concerns about its slowing growth and lackluster turnaround efforts. A big guidance cut in January, which was attributed to soft holiday sales, seemingly confirmed those fears.

Despite those challenges, Macy's fourth quarter numbers still beat analysts' expectations. Its revenue fell 2.5% annually to $8.46 billion, but beat estimates by $20 million. However, Macy's fourth quarter included one less week than the prior year quarter. Its comparable store sales, which excludes that impact, rose 0.4% on an owned basis and 0.7% on an owned plus licensed basis. On a "shifted" basis, which aligns with the calendar years more closely, its owned plus licensed comps rose 2%.

A Macy's store.

Image source: Macy's.

Macy's adjusted net income fell 3% to $850 million. Its adjusted earnings declined 4% to $2.73 per share, but still beat expectations by $0.20. On a GAAP basis, which includes certain one-time benefits and charges, its EPS declined 46% to $2.37.

For the full year, Macy's expects its sales and comps (on an owned plus license basis) to stay roughly flat, and for its adjusted EPS to fall 22% to 27%. Analysts had expected less than 1% sales growth and a milder 22% decline in earnings.

Macy's growth initially looks dismal. But at $25, the stock only trades at about eight times its projected earnings this year, and it pays a hefty forward dividend yield of 6%. Will that low valuation and high yield limit Macy's downside potential?

What happened to Macy's?

Macy's was on the verge of a turnaround a year ago. It finally broke a streak of negative comps growth by closing weaker stores, opening more Backstage off-price stores and Bluemercury beauty stores, and expanding its digital platform and loyalty program. It sold and leased back its real estate to cut costs, and tested out smaller store formats to further cut costs and inventory levels.

Macy's comps growth remained positive over the past year, but its growth failed to accelerate after the first quarter:

Comps growth

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Owned

1.3%

3.9%

0%

3.1%

0.4%

Owned plus licensed

1.4%

4.2%

0.5%

3.3%

0.7%

Source: Macy's quarterly earnings.

This indicated that Macy's was still struggling with sluggish mall traffic and competition from Amazon (NASDAQ: AMZN), Walmart (NYSE: WMT), and Target (NYSE: TGT). But the bulls noted that Macy's gross margins were still expanding, so it wasn't relying too heavily on promotions to drive its sales growth.

Unfortunately, that margin expansion hit a brick wall during the fourth quarter. Its gross margin fell 110 basis points annually and 280 basis points sequentially to 37.5%, mainly due to markdowns aimed at reducing its inventory and higher sales from its lower-margin digital and loyalty platforms. Macy's weak earnings forecast for 2019 indicates that this contraction will continue over the next few quarters.

A Macy's Bloomingdale's store.

Image source: Macy's.

What's Macy's turnaround plan?

Macy's will focus heavily on selling real estate assets and cutting costs in 2019. It expects to generate $100 million from asset sales for the year. Excluding that $0.25 per share gain, Macy's expects its adjusted EPS to decline 28%-33%.

Macy's expects its ongoing restructuring plans, which include additional store closures and the streamlining of its business via its "North Star" initiative, to generate another $100 million in annual savings. It plans to spend most of its cash on buybacks, dividends, and extinguishing its debt instead of a major expansion of its digital or delivery platforms.

Macy's focus on near-term cost cutting instead of longer-term strategies is troubling. Its digital business posted 38 quarters of double-digit sales growth, but that still doesn't move the needle for its top line growth. Macy's also seems reluctant to dramatically expand its digital efforts and renovate its stores, as Walmart and Target did, to keep pace with Amazon.

Instead, Macy's is arguably falling into the same trap as Sears and J.C. Penney (NYSE: JCP), which both padded their earnings with asset sales and cost-cutting efforts instead of improving their stores or online platforms. In other words, Macy's focus on gross margins could prevent it from making the necessary sacrifices to stay relevant over the long term.

Is it safe to buy Macy's stock?

Macy's is still in the penalty box. Its comps will likely stay flat over the next few quarters as it desperately tries to cut costs to protect its margins. Meanwhile, superstores like Walmart and Target could keep stealing customers away with their upgraded digital and delivery platforms.

Macy's stock is cheap for obvious reasons, and it probably won't rebound until it generates meaningful comps growth again, expands its margins, or offers meaningful ways to keep up with its rivals. Macy's isn't the next Sears or J.C. Penney yet, but investors should probably stick with healthier retail stocks for now.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.