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Here’s Why Macy’s Stock Very Easily Could Run Back to $30

Luke Lango

Shares of Macy’s (NYSE:M) traded higher on Tuesday, Feb. 26, after the department store retailer reported mixed holiday quarter numbers that largely impressed investors. Namely, things during the holiday period weren’t as bad as most expected, and consequently, Macy’s stock rallied a few percentage points in response to the better-than-expected update.

Macy's stock m stock

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To be sure, things still aren’t good over at Macy’s. Comparable sales growth is slowing, and is expected to slow further in 2019. Margins remain under pressure. Operating costs aren’t coming out of the system quick enough. The long term profit growth outlook remains bleak, at best.

But, things are showing signs of stabilizing at Macy’s. Comparable sales growth was still positive in the quarter, despite a tough lap, and comps are expected to remain positive into next year.

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Gross margins compressed, but comparable inventory levels were down and management is implementing initiatives which should show gross margin improvement throughout 2019. Plus, more costs are coming out of the system, and coupled with positive comps, this should lead to an eventual inflection point in operating margins.

Thus, not all is lost at Macy’s. This struggling department store retailer is actually on the path towards stabilizing operations and profits over the next few quarters and years.

Macy’s stock simply isn’t priced for this stabilization. At just 8x forward earnings with a 6% dividend yield, Macy’s stock is actually set to explode higher if operations and profits do stabilize.

As such, buying Macy’s here makes sense. This isn’t the best company in the world. But, the company is doing just fine, and the stock is priced for death. That valuation mismatch will ultimately correct itself. When it does, Macy’s looks positioned to run back to $30 in 2019.

Macy’s Operations Are Stabilizing

To be frank, Macy’s holiday numbers weren’t all that great. For a while, this company looked like it was getting its groove back. Comparable sales growth was improving and gross margins were turning higher. But, that was six to twelve months ago. Over the past six months, the narrative has been very different. Comparable sales growth has slowed. Gross margins have resumed their retreat. And profit growth has been halted.

The fourth-quarter-earnings report proved that the holiday period was more of the same. Comparable sales growth slowed to under 1%. Gross margins fell back more than 100 basis points. The SG&A rate rose 70 basis points. Adjusted EBITDA fell more than 15% year-over-year.

Worse yet, the guide implied that such struggles will continue for the foreseeable future, as fiscal 2019 comparable sales growth is expected to slow even further, gross margins are expected to keep sliding, and EBITDA isn’t expected to move much higher in 2019, if at all.

Yet, the numbers aren’t that bad, either. Comparable sales growth is still positive, just not as positive as earlier this year. Gross margins are falling, yes, but they appear to be stabilizing the upper 30’s.

The SG&A rate is rising, but the additional expenses are being allocated towards growth initiatives like store improvements, expanded omni-channel capabilities, and an enhanced mobile presence, the sum of which should improve the top-line trajectory. Expense elsewhere are being cut rapidly.

Thus, in the big picture, Macy’s appears to be a on a rather normal growth trajectory. It isn’t good. But, it isn’t bad, either. Instead, this is a company which continues to struggle with heightened retail competition, but which is also stabilizing operations through a series of growth and cost-cutting initiatives. Thus, slow and steady will be the norm going forward.

Macy’s Stock Is Undervalued

If slow and steady is the norm going forward, then Macy’s is undervalued here and now.

Macy’s stock trades at just 8x forward earnings which are guided to be down 25% year-over-year and have a sizable opportunity to improve in the near to medium term. The dividend yield is 6% on a very sustainable 40% payout ratio. The trailing EBITDA multiple sits narrowly above four, on EBITDA that management is expecting to improve over the medium term.

In other words, Macy’s stock is dirt cheap, and priced for continued profit erosion. But, such profit erosion isn’t the most likely path forward. Instead, the most likely path forward is that 2019 serves as a trough year for profits. Thereafter, the trifecta of improved store formats, expanded omni-channel commerce capabilities like BOSS (Buy Online, Ship to Store) and BOPS (Buy Online, Pickup in Store), and an enhanced mobile app will improve top-line results.

Those improvements will pair with cost-cutting measures to drive margin stabilization. That combination should ultimately lead to slight profit growth over the next few years.

At current multiples, Macy’s stock simple isn’t priced for that. Indeed, I think that by 2025, Macy’s earnings will stabilize around $3.50 per share. If so, based on a historically average 11 forward multiple, Macy’s stock should trade around $38.50 by fiscal 2024. Discounted back by 5% per year (5 points below my normal 10% discount rate to account for the big yield), that equates to a fiscal 2019 price target for Macy’s of ~$30.

Bottom Line on M Stock

Macy’s isn’t a great company. But, it’s a solid company successfully navigating the turbulent retail waters. There is visibility to revenue, margin, and profit stabilization within the next few quarters through a combination of growth and cost-cutting initiatives. If such stabilization does materialize, then Macy’s stock will ultimately head significantly higher over the next few quarters.

As of this writing, Luke Lango was long M. 

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