For Macy’s, Good Isn’t Good Enough

What's a department store got to do to get some respect around here? Though investors late last year finally noticed the value Macy's (NYSE: M  ) represents, running its stock price up to nearly $42 a share in late November, it didn't take long for edgy retail shareholders to jump ship.

Now? Macy's is once again priced at or near the low end of its industry. Economic concerns, uncertainties surrounding consumer's willingness to spend, and Macy's recent lowering of expectations have all played a part in the stock's underperformance, which is why it's such a good value.

The numbers
As a rule, Macy's December quarter-vs.-quarter revenue increase of 3.6% compared to 2011, along with same-store sales improvement of 4.1% compared to last year, would be cause for celebration -- from both investors and management. For Macy's, the operations improvements last month caused little more than a blip on investors' radar screens, as the share price has since fallen nearly 2.8%.

In keeping with CEO Terry Lundgren's omnichannel strategy, a plan to connect with the technologically savvy 13- to 30-year-old "millennials," Macy's online sales take on added significance. Not only are Macy's online results a gauge to measure performance relative to its strategic, omnichannel initiative, but in a market that could see $1 trillion in sales globally by 2016, traditional retailers must garner a piece of this growing pie.

With all those online sales predicted by 2016, a Morgan Stanley analyst suggests as much as 25% of it will belong to Amazon.com (NASDAQ: AMZN  ) . Whether that pans out or not, Macy's, or any brick-and-mortar retailer, won't unseat Amazon's leading position in online retail sales. Nor does it need to. Implementing a strong online and mobile computing strategy to capture part of the exploding millennial market is enough to drive significant growth.

Another leading retailer, Target (NYSE: TGT  ) , certainly understands the necessity of generating online sales. As it announced a few days ago, it is taking its holiday online price-matching guarantee to new levels, extending the price initiative to directly compete with the online prices of Amazon, Wal-Mart, and Best Buy, among others.

Macy's focuses on the higher-end consumer more so than a Target or Wal-Mart, of course, but Lundgren can certainly look to the two low-price leaders as examples of committing to online expansion efforts. Based on December's 51.7% jump in Macy's online business unit, though, Target and Wal-Mart executives may be better served following Lundgren's lead.

Why the anti-Macy's sentiment?
It's not all wine and roses at Macy's. There are reasons -- some legitimate, some not so much -- for its meandering share price. Macy's was recently downgraded by analysts, largely based on the "lower-than-expected Q4 earnings" Lundgren alluded to in his recent press release. Macy's is now expecting diluted earnings per share of $1.91 to $1.96 in its most recent quarter, compared to earlier projections of $1.94 to $1.99. And to make matters worse, Macy's same-store sales aren't expected to grow 4.2%, as Lundgren had suggested.

Lower earnings, slower same-store sales growth? Those add up to a "sell" recommendation, right? Before you go online to execute your Macy's sell order, a closer look at the "lower expectations" is warranted.
Even if Macy's comes in at $1.91 a share in earnings for Q4, that's head and shoulders above 2012's $1.74 a share. Same-store sales are still expected to rise 3% to 3.5% compared to Macy's Q4 of 2011.

Uncertainty surrounding the Martha Stewart Living situation, in which Macy's is trying to prevent J.C. Penney from selling its exclusive Martha Stewart products, hasn't helped Macy's share price. The Martha Stewart infringement lawsuit will be heard in February, and no damages are expected to be awarded. Also generating some investor uncertainty is the news that Macy's will close six stores in the spring of this year. That's a bad sign, right?

As for Macy's store closings, they're actually right in line with Lundgren's previously announced plans to "... selectively close under-performing stores that no longer meet our performance requirements..." Somewhat lost in the store closure announcement are Macy's plans to open five new stores this year and replace or expand four others. The store closings will result in Macy's taking a one-time, $2 million to $4 million charge in Q4.

So, what now for Macy's?
Nordstrom and Saks (UNKNOWN: SKS.DL2  ) get all the attention from investors, and much of it is warranted. But at 16 and 23 times earnings, respectively, it could be successfully argued that the upsides of both Nordstrom and Saks are limited, at least in comparison with Macy's. With a trailing earnings multiple of 11.6, and a current share price trading at a mere 9.8 times future earnings, you'll be hard-pressed to find a better value in the industry than Macy's.

Macy's $1.26 billion in cash, compared to its $6.6 billion in long-term debt, is hardly the envy of the high-end retail industry. But with more than adequate cash to continue paying shareholders their 2.1% dividend yield, consistent same-store and revenue growth, and an online strategy that is already paying off, Macy's is a solid opportunity at these levels.


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