Macy’s Stock: Is It Time To Buy The Dip? (NYSE:M)

Investment Thesis

Macy’s (NYSE:M) stock has been hit hard by the declining market. Shares have dropped by nearly 40% year to date. The company is now trading at a very cheap valuation.

I think that Macy’s could be well-positioned for the second half of the year. Its balance sheet reports a healthy inventory position. I think that the risk to reward is favorable at the current price, and shares are a good speculative buy.

A Spending Slowdown

Like other retailers, the company has seen a slowdown in demand starting in the second quarter. Management reported that sales slowed about five percentage points after Father’s Day. In response, the company cut full year guidance on the top and bottom lines.

Macy’s trimmed its full-year sales guidance by $120 million. Projected adjusted EBITDA margins were cut from a range of 11.2% to 11.7% down to just 10.5%. Management’s expectations for adjusted diluted EPS were reduced from a midpoint of $4.74 to only $4.10. This is a sizable cut. But I think that these results are still strong considering the stock’s cheap valuation.

The company is seeing a split between its various nameplates. Macy’s reported a year over year decline in sales. But the company’s upscale Bloomingdale’s brand is continuing to grow at a decent rate. Bluemercury, another high end brand, is also seeing solid growth. These trends are in line with Macy’s peers, such as Nordstrom (JWN). These retailers are also reporting the best performance in their higher priced segments.

Another split is between product categories. Macy’s has reported acute weakness in categories that outperformed during the pandemic. These include casual clothes, sportswear, sleepwear, and some home goods. But occasion based categories are still outperforming. These include suiting, fragrances, shoes, dresses, and luggage. The company announced strong sales results for events like Mother’s Day and Father’s Day.

Macy’s reported that its most affluent customers continued to spend. So far, management hasn’t seen evidence of consumers trading down. If customers do begin to trade down, the business is diversified across price points. This can reduce some of the top-line downside.

Overall, the demand environment is experiencing some volatility. But I think that Macy’s has the flexibility to navigate these headwinds.

A Solid Inventory Position

Macy’s has a good inventory position compared to its peers. A lot of retailers are dealing with excess inventory issues. But Macy’s has only $4.6 billion in inventory on its balance sheet. In fact, the company’s inventory levels are 11% lower than before the pandemic.

The balance sheet still has a lot of inventory in pandemic categories with lower demand. The company has to clear out this old inventory, but there is a lot less of a buildup compared to some of its peers. On their last earnings call, management discussed inventory and supply trends by product category.

So, recognizing that we – when you talk about kind of the occasion based categories in the market brands, our demand is up when you looked at the second quarter up about 7% and inventories are up 5%. So that’s about the level that we want to see is having demand slightly outpace the supply assuming that the year-end question is, is the right base.

And then when you look at the pandemic categories, if you look at our market brands, we’ve really been able to cut that back. So the demand there is down about 24% and supply was down about the same. So we were able to get those in status and I feel pretty comfortable across our brands that we’re in line with the categories that our customers are trending with.

I believe that Macy’s lower inventory levels could be a competitive advantage. This adaptability lets management respond to the rapidly changing environment. In particular, I think that the business is well-positioned to take advantage of strong occasion based shopping. The company can be more agile and react quickly to changing consumer demand trends.

For example, the company expects 55% of their 2022 holiday offerings to be new. This is up from just 25% during the 2019 holiday season. This flexibility should help Macy’s survive what is expected to be a highly promotional year end environment.

Is The Cheap Valuation A Trap?

Macy’s is trading at an extremely cheap valuation. The company has a forward P/E of just 3.8 times. Adjusting for net debt and capital leases, the company has a forward EV/EBITDA of 3.9 times. In the past 12 months, Macy’s generated an impressive 14.1% return on its invested capital. This valuation seems low for a company with this profile.

The company’s debt position is also surprisingly healthy. Although the company has almost $3 billion in long-term debt, almost none of it is due until the end of the decade. The company’s long-term debt is under 1.2 times forward EBITDA, which I consider safe. In the last quarter, the company added a $3 billion revolving credit facility. This should guarantee liquidity in the near future.

I think that Macy’s healthy financial position and cheap valuation have the potential for high returns. The company has a 4% dividend yield that is well-covered by its earnings. Management has said they expect to grow this payout by at least 5% each year. The company also has $1.4 billion remaining on its buyback authorization. But I’m not putting too much weight on these buybacks right now. Management was directly asked about buybacks on their last earnings call. They said that their goal is to preserve liquidity due to macro uncertainty. It sounds like this may cause them to pull back on share repurchases in the immediate future.

Final Verdict

In the long run, I think that Macy’s could deliver strong returns. It looks like the market is pricing in poor future fundamental performance. But the business has a strong inventory position and a diversified set of price points. I think that these advantages make it more resilient to an economic pullback. The company’s cheap valuation should provide some protection against declining fundamentals. I think that this is a good speculative buy at the current valuation.