Macy's (M 1.19%) posted record results in 2014, but since then, the department store giant has struggled mightily. The retailer has been unable to stem a string of sales declines that stretches back to early 2015. Meanwhile, its profit margin has eroded significantly, and share prices have tanked.
This week, Macy's stock plunged again. At an investor meeting on Tuesday, CFO Karen Hoguet said that gross margin pressure will be greater than initially expected during 2017, a revelation that helped send Macy's shares down 8% to a new multiyear low. The stock has now lost half of its value in the past six months. However, the recent declines smack of irrational panic among investors.
Macy's Stock Performance, data by YCharts.
A gross margin warning
According to multiple media sources, including CNBC, Macy's stock plunged during the investor meeting because Hoguet warned "that the department store's gross margin could be below a forecast given in February." The company now expects gross margin to decline by 60-80 basis points (i.e. 0.6-0.8 percentage points) year over year in 2017.
However, this description isn't quite accurate. Macy's didn't provide a specific gross margin forecast in February. On the company's Q4 earnings call, Hoguet simply stated that gross margin would be down year over year in 2017. Tuesday was the first time the company gave any numerical guidance on gross margin. While Hoguet stated that Macy's has reduced its internal gross margin forecast, she didn't quantify how much the company's expectations have actually changed.
Moreover, Macy's gross margin challenges aren't exactly news. Gross margin declined by 100 basis points year over year in Q1, and Hoguet discussed this issue at length on the company's earnings call last month.
Macy's stock plunged 20% in a two-day period in reaction to the company's poor Q1 performance. This seemed like an overreaction at the time. This week's decline makes even less sense, since investors were essentially panicking about old news.
Macy's is maintaining its earnings guidance
While gross margin will be worse than initially expected at Macy's this year, the company is sticking to its original earnings forecast. Excluding a big gain from the $250 million sale of its men's store in downtown San Francisco, Macy's continues to expect earnings per share in the 2.90 to $3.15 range in fiscal 2017, compared to $3.11 last year.
Macy's is sticking to its original earnings forecast for 2017. Image source: Macy's.
According to Hoguet, the company believes it will fully offset the incremental gross margin pressure it faces through a combination of reduced operating expenses and additional asset sale gains.
Using asset sales to offset weaker operating performance is clearly unsustainable. Macy's does have a ton of assets that it can (and should) monetize, but it's still a finite number. Investors should look for further details on Macy's Q2 earnings call about how much it is relying on asset sales to plug its earnings gap.
Nevertheless, it's encouraging that Macy's still views its original earnings guidance as achievable. (Solid sales results in May also support the company's forecast.) Of course, that's no guarantee that the retailer will meet its targets.
There's a real turnaround plan
Macy's management isn't counting on a rebound in mall traffic, nor on a reversal of the recent gross margin pressure in certain categories to drive improved earnings over the next few years. The company has a credible plan to stabilize sales and improve its profit margin.
One key aspect of its strategy will be an increased focus on exclusive merchandise -- both from brands that Macy's owns and designer brands that it partners with. Exclusive merchandise currently accounts for about 29% of sales. Macy's CEO Jeff Gennette wants to boost that to 40% by 2020.
Unique offerings are crucial in today's ultra-competitive retail landscape. They can drive sales by standing out relative to rivals' wares, while also delivering higher gross margin due to the lack of direct price-based competition.
Macy's is also making big changes to its marketing strategy, refocusing it on the media channels that deliver the best return (in terms of incremental sales) per dollar spent. It plans more product-focused marketing rather than just promoting its big sales. Additionally, Macy's will tweak its Star Rewards program to offer bigger rewards to its best customers that will incentivize them to spend more.
These are just two of the areas where Macy's is making big changes in hopes of stabilizing its business. The company has a lot of initiatives in the works, and while some will probably fall flat, there are plenty of reasons to be optimistic about its prospects -- in contrast to those of many other department store operators.
At just 7 times earnings, Macy's stock appears to be dramatically undervalued today. (This valuation is particularly low given the company's massive real estate value.) Accordingly, I scooped up more Macy's shares on Tuesday.
