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Macy's Inc.'s Weak Q1 Looks Like Just a Blip on the Radar Screen

http://www.fool.com/investing/general/2014/05/15/macys-incs-weak-q1-looks-like-just-a-blip-on-the-r.aspx

Adam Levine-Weinberg
May 15, 2014

Top department-store operator Macy's (NYSE: M) has been on a roll for the last five years or so. The company's net income has more than tripled since 2010, with the stock price not far behind.

M Net Income (TTM) Chart

Macy's Price vs. Net Income (TTM), data by YCharts.

On Wednesday, Macy's reported a surprising 1.6% revenue decline for the first quarter of its 2014 fiscal year. That left it about 3% short of the average analyst revenue estimate of $6.46 billion. Despite the weaker-than-expected sales, Macy's managed to post a solid 9% EPS gain.

Most important, it now seems clear that bad weather in the northern part of the U.S. was the primary cause of Macy's weak Q1 sales performance. As springtime arrived, shoppers started to come out again. This puts Macy's on track to have another year of strong earnings growth.

A quick turnaround
Macy's CEO Terry Lundgren noted in the company's earnings release that sales were soft from January to March, except around Valentine's Day. But Macy's fiscal Q1 runs from February to April, and sales trends improved during April. Lundgren also explained that a shift in the timing of the "Friends & Family" promotional event pushed some sales from Q1 to Q2 this year.

In the last few weeks, Macy's has been benefiting from the release of pent-up demand from the rough winter. CFO Karen Hoguet told analysts on the company's conference call that strong sales in the first week-and-a-half of Q2 (which included the last two days of the Friends & Family event) had returned Macy's to positive sales growth year to date.

This implies that Macy's has seen exceptionally strong revenue growth in the first half of May. As a result, management felt comfortable reiterating the initial guidance for full-year comparable-store sales growth of 2.5%-3%.

Macy's has experienced a big bounce in sales in the past few weeks.

Macy's has a big opportunity to make up ground on its sales forecast this quarter. Last year, the company was too conservative in terms of promotions during the spring season, resulting in a sales decline during Q2. This creates an easy comparison this year -- and Macy's already seems to be taking advantage of that fact.

Margin trends look promising
Typically, sales declines lead to margin declines for retailers, as fixed expenses soak up a larger percentage of the shrinking revenue pie. This can cause a modest sales drop to translate into a sharp earnings decline. But Macy's managed to widen its operating margin by 30 basis points last quarter, despite the drop in sales.

First, while Macy's expects gross margin to be flat or down slightly for the full year, gross margin rose from 38.8% to 38.9% in Q1. Second, Macy's more than made up for the sales decline with expense reductions, driving a 20-basis-point reduction in operating expenses.

So far, CFO Hoguet is sticking to her forecast that Macy's gross margin will decline this year, despite the gain in Q1. She also highlighted a few timing issues that will cause operating expenses to rise for the full year despite the expense decline last quarter.

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