Morningstar | Strategic Initiatives Begin to Deliver Demand Growth at Macy’s; Shares Remain Overvalued
Macy’s second quarter highlighted the progress of its North Star strategy review but demonstrated the uphill battle the company faces in the competitive retail industry (pressure from off-price and e-commerce, quick turning fashion trends, and non-exclusivity of some products) supporting its no-moat rating. Macy’s second-quarter 0.5% (2.3% year to date) and 5.4% (4.9%) comparable sales growth and operating margin, respectively, are outpacing our 2018 forecast declines of 1.1% and 7.4%. Additionally, management raised full-year fiscal 2018 guidance in response to the solid start to the year. Macy’s now expects comparable sales of 2.1%-2.5% (up from 1%-2% and our flat estimate prior) and earnings per share $0.20 higher ($3.95-$4.15) but not significantly different from our $3.92 estimate. We don’t plan any material change to our $29 fair value estimate, as we anticipate further margin pressure over the second half of the year. Additionally, we don’t intend to alter our long-term outlook for a 1% sales decline on average over the next five years and operating margins falling to 5% by fiscal 2021, against the 8% three-year historical average, as we expect rent and salary savings from store closures will be offset by ongoing mix shifts to e-commerce (increased delivery costs) and additional spending in IT and store remodeling to support the firm's strategic review initiatives.We continue to believe that Macy’s is at the mercy of secular issues, but we are encouraged by the firm's actions to offset some of the headwinds. Since the first quarter, Macy’s has hired a new CTO (Naveen Krishna, the vice president of technology from Home Depot) and CFO (Paula Price, a lecturer from Harvard Business Schools), which we view as a favorable development that will continue to help drive Macy’s progress in omnichannel sales (highlighted by mobile application sales increasing by 50%). Additionally, while the Star Loyalty program (added 1 million new users) and Backstage expansion (65 opened in 2018, 120 expected for full year) continue to track well, we don’t think these initiatives will generate a competitive advantage for Macy’s. While management has noted that loyalty members spend more, we see the benefits provided as similar to other department store retailers, thus not alleviating the lack of switching costs in the industry.
Macy's is an omnichannel retail organization operating stores, websites and mobile applications under three brands (Macy's, Bloomingdale's and bluemercury) that sell merchandise, including apparel and accessories (men's, women's and children's), cosmetics, home furnishings and other consumer goods. The company's wholly-owned bank subsidiary, FDS Bank, provides certain collections, customer service and credit marketing services in respect of all credit card accounts that are owned either by Department Stores National Bank, a subsidiary of Citibank, N.A., or FDS Bank and that constitute a part of the credit programs of the company's retail operations.
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