On November 21st, Macy’s (M) reported third-quarter earnings that painted a very concerning picture. Same-store sales declined -3.5%, with profitability falling to roughly breakeven (vs. +$37 million a year ago after adjusting for one-time gains/ losses). This resulted in a revised annual guidance downwards across the board, and investors should be wary before considering to pick up shares of what looks like a deep bargain opportunity.
Heading into the all-important holiday season, Macy’s is in a position where the company must shoot the lights out or else likely see a debt raise as it faces a working capital shortfall.
It’s no secret that department stores have been in a long-time struggle to keep up with the behemoth that is Amazon (AMZN), as well as more efficient big-box retail outfits (Walmart (WMT), Target (TGT)), and off-pricing alternatives (TJ Maxx (TJX)). However, until recently, Macy’s had been holding out rather well and was one of the few brick-and-mortar retailers willing/able to re-invest into the business via store renovations and technology. But secular trends seem to have finally caught up to the company, and today Macy’s faces its toughest challenge yet.
The department store industry is notoriously difficult – on the one hand, it is extremely sensitive to any economic weakness (as products tend to be higher-priced versus competitors), while on the other hand, merchandise selection is prone to the vicissitudes of the ever-changing consumer taste. These factors, together with a competitive landscape that only continues to get tougher, put Macy’s in a very precarious position that is not yet fully evident in today’s financial statements.
Bargains in the retail sector have long been the bane of many value investors. Hedge fund superstar Eddie Lampert’s fund bled for countless year trying to turn Sears (OTCPK:SHLDQ) around, while Bill Ackman suffered major losses trying to do the same with J.C. Penney (JCP). Even famed oracle Warren Buffett barely broke even in his 1966 investment in Baltimore department store Hochschild Kohn, despite buying it at a substantial discount to book value.
Although Macy’s is yet to be the latest victim of the retail apocalypse, in the retail industry (and especially department stores today), things can turn for the worse very quickly. Which is why it is critical that management monetize their valuable real estate footprint as soon as possible to fortify the balance sheet and crystallize returns for shareholders before it’s too late.
Today, Macy’s sits on an enviable real estate portfolio of 350+ stores across roughly 50 million square footage of space.
Source: Macy’s 2019 10-K
Estimates for the value of the company’s real estate range anywhere from $6 billion to $12 billion. Much of that value is likely concentrated in two of its most famous locations – Macy’s Herald Square in New York City and Macy’s Union Square in San Francisco.
Putting it together, if we assume the real estate is sold near the low end, shareholders may breakeven or lose -20% from a share price of $15, based on Macy’s current enterprise value of ~$9 billion. It could get worse if the company is unable to favourably negotiate termination of its existing leases, which stand at around $4.3 billion.
Source: Macy’s 2019 10-K
Should the company be able to monetize its real estate towards the high end (or above), shareholders stand to gain 60%+, or $25/share (which reflect an enterprise value of ~$12 billion) should the company hang on for a bit longer and breakeven on its leases. Of course, if the business turns around and Macy’s sees more years of profitability, the upside could get much more interesting.
That said, there is no reason to assume that the business will get better. All indicators – from the micro economics of Macy’s business to the broader macro landscape – suggest the company will struggle to tread water at best. Management likely understands this, which is somewhat reflected in its updated guidance to achieve $150 million in asset sales (vs. $100 million at the beginning of the year). However, that is far too little.
Given a favourable interest rate environment for real estate as well as a resilient US consumer, Macy’s has a lot opportunity to pursue a meaningful real estate monetization program while the economy is still running hot.
Macy’s is a collection of iconic brands with an impressive legacy woven into the American cultural fabric. But even the best investors and managements could not save some of the most iconic American retailers from sinking amidst deep and negative secular trends. With its impressive real estate footprint and a business that is yet to bleed red, Macy’s still has a chance to avoid being a casualty of the retail apocalypse. If the company seriously embarks on a property monetization path, this could be a great opportunity for shareholders. For now, the best course of action would be to observe management’s capital allocation policies going forward.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.