U.S. Markets closed

Macy’s Stock Looks Like It Can Rally Back to $30

Luke Lango

For Macy’s (NYSE:M) stock, the past five years have been painful.

Why the Worst May Now Be Over for Macy's (M) Stock

Source: Shutterstock

The brick-and-mortar retail giant has been consistently pressured by growing threats in the digital channel, the sum of which have stolen its market share, put the brakes on its revenue growth, and pulled down its profit margins.

There was a glimmer of hope of a turnaround in late 2017 and early 2018 as the company’s numbers started to improve. That improvement didn’t last. The numbers reversed course. So did Macy’s stock price, which is now just a few points north of its five-year lows.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

But not all is lost for Macy’s and Macy’s stock. There are broad signs out there that the brick-and-mortar retail world is stabilizing, and that the digital retail world is democratizing. Both of those trends imply healthier numbers for Macy’s going forward.

Plus, the U.S. economy appears to be finding its footing after its slowdown in late 2018. This re-acceleration of economic expansion and consumer confidence should provide a tailwind for Macy’s growth in 2019.

Most importantly, Macy’s stock is dirt cheap. The forward price-earnings multiple of Macy’s stock sits below 8, and its dividend yield is north of 6%.

With improvements on the horizon, and Macy’s stock price sitting at dirt-cheap valuation levels, now actually seems like a good time to get bullish on Macy’s stock. I think that Macy’s stock price can reach  $30 by the end of the year, implying 20%-plus upside over the next eight months.

The Consensus View Is Bearish

The consensus view on Macy’s is pretty simple.

According to the consensus outlook, the digital-retail channel continues to steal share from the brick-and-mortar retail channel, and within the brick-and-mortar retail channel, Macy’s isn’t a highly distinguished player.

As a result, Macy’s physical stores won’t stage a big comeback anytime soon. Meanwhile, Macy’s continues to struggle in the digital channel, and without robust digital growth, Macy’s overall revenue growth trajectory will be flattish over the next several years.

Meanwhile, according to the Street’s consensus outlook, Macy’s gross margins will continue to come under price pressure from e-commerce players, while its wage costs will rise and its revenue will remain flat. Furthermore, the company’s profit margins will compress, and its profits will drop.

That’s why analysts’ consensus-earnings-per-share estimates for Macy’s stand at $3.10 for 2019, $2.95 for 2020, and $2.70 for 2021.

The Street Shouldn’t Be So Bearish on  Macy’s Stock

This consensus view, however, feels overly pessimistic to me.

Although the digital channel continues to steal share from the brick-and-mortar channel, digital-retail-sales growth is slowing. For the past several years, e-commerce sales growth in the U.S. has consistently run around 14%-16%. But, in 2018, that growth meaningful slowed for the first time, reaching 12% by the end of the year. Not by coincidence, most retailers also reported better in-store numbers in 2018, too.

Further, while Macy’s digital business isn’t growing as fast as bulls would like it to, it is still growing at a strong, double-digit percentage pace. Meanwhile, e-retail behemoth Amazon (NASDAQ:AMZN) has seen its e-commerce business slow meaningfully, against the backdrop of the red-hot e-commerce businesses at Target (NYSE:TGT) and Walmart (NYSE:WMT). Thus, the digital-retail world is democratizing. That’s a positive sign for M stock.

On the margin front, gross margins were hit hard in the second half of 2018. But that’s mostly a function of inventory clearing, and at the end of 2018, Macy’s comparable inventory was down year-over-year. Thus, its gross margins should move higher in 2019. Also, Macy’s wage expenses will continue to rise, but it’s fairly reasonable to assume that its wage increases will be offset by revenue growth as the retail world stabilizes.

All in all, the consensus’ belief that profits will keep dropping at Macy’s over the next several years seems overly pessimistic. Instead, I think the company’s revenues will be stable, and its margins will stabilize, leading to mild profit growth. If that happens, then Macy’s stock price can rise tremendously from its current levels.

Fundamentals Imply That Macy’s Stock Price Can Rise Meaningfully

The math is simple.

Macy’s revenue is expected to be roughly $25 billion this year. Assuming some combination of flattish in-store performance and double-digit digital-sales growth, Macy’s should be able to increase its top line at a 0%-1% rate over the next several years.

Meanwhile, its 2018 gross margins came in narrowly above 39%, and should be stable going forward because its inventory and competition difficulties have eased. The company’s operating-spending rates are climbing, but should stabilize as inflation remains muted.

All together, Macy’s top line looks poised to increase very slowly, while its margins should be stable.  Assuming the company continues to buy back Macy’s  stock, its earnings per share should increase slowly . I see EPS of $3.50 as doable by fiscal 2025.

Based on Macy’s  longtime average forward price-earnings multiple of 11, that equates to a fiscal 2024 price target of $38.50. Discounted back by 5% per year (below my normal 10% discount rate to account for the yield), that implies a fiscal 2019 price target for Macy’s stock of just over $30.

The Bottom Line on M Stock

Macy’s stock isn’t a big winner. It’s currently facing fundamental challenges which will keep its profit growth depressed for the foreseeable future. But the consensus view on Macy’s stock is far too pessimistic, and that has left M stock unreasonably undervalued. As a result, this seems like an opportunity to buy Macy’s stock on weakness.

As of this writing, Luke Lango was long M, AMZN, and TGT. 

More From InvestorPlace

Compare Brokers

The post Macy’s Stock Looks Like It Can Rally Back to $30 appeared first on InvestorPlace.