Earlier this month, Macy's (M +5.09%) reported a tentative turnaround in sales trends for the November-December holiday shopping period. As a result, the struggling department store giant modestly raised its full-year earnings per share guidance. Macy's now expects to post adjusted EPS of $3.11-$3.21 -- including a $0.05 benefit from federal tax reform -- up from $2.91-$3.16 previously.
Despite the improving sales trends, many analysts expect Macy's to face continued earnings pressure in 2018. The average 2018 EPS estimate -- which probably ignores the recently implemented tax reform law -- is just $2.86.
Bears often point out that Macy's adjusted EPS forecast for 2017 includes $275 million-$300 million of expected real estate gains, which will add about $0.60 to EPS. They see these gains as unsustainable. However, while that may be true in the long run, Macy's has lots of real estate deals in the pipeline now, which means that real estate gains will continue rolling in during 2018.
More gains from downtown real estate in 2018
Over the past few years, Macy's has captured substantial real estate gains from selling excess space in various large downtown stores across the U.S. In some cases, Macy's has even closed its downtown stores entirely in order to sell off the real estate.
Macy's owns prominent buildings in several major U.S. cities. Image source: Macy's.
This will probably be a key source of asset sale gains in 2018, as well. Most notably, Macy's hopes to sell about 700,000 square feet of lightly used space on the upper floors of its Chicago flagship store. Reports that it has a deal in place with Brookfield Asset Management (BAM +0.30%) haven't been confirmed by either company. Nevertheless, Macy's is likely to complete a sale of this excess real estate -- whether to Brookfield or to another buyer -- in the coming year. This deal alone would likely generate a gain in excess of $100 million.
Macy's will also record the last gains from selling part of its downtown Brooklyn store this year. Based on the company's estimates as of early 2017, it will recognize a gain of roughly $33 million for the Brooklyn store during 2018.
Additionally, Macy's may be looking to subdivide and sell part of its Cincinnati headquarters, according to a recent report. In light of Macy's ongoing initiatives to streamline operations, it probably doesn't need all of the office space it currently occupies.
Finally, Macy's Manhattan flagship store is by far its most valuable real estate asset. The company does plan to monetize some of that value in the future, but given the importance of that store and the complexity of any potential deal, it's unlikely that anything will happen in 2018.
Macy's Manhattan flagship store may be worth as much as $4 billion. Image source: Macy's.
The Brookfield partnership should start to pay off soon
Macy's real estate partnership with Brookfield Asset Management could become another big source of real estate gains starting in 2018. For the past year, a dedicated team at Brookfield has been looking at options for additional development (or redevelopment) at roughly 50 properties owned by Macy's. Brookfield's exclusive window for proposing development plans expires after 24 months, so there will probably be a flurry of activity this year.
Brookfield Asset Management is likely to propose development plans for about two-thirds of the 50 sites it is examining, according to Macy's CFO Karen Hoguet.
The exact timing of when Macy's realizes asset sale gains for these properties will depend on its strategy. If it chooses to sell development sites to Brookfield, it will capture asset sale gains now. By contrast, it could opt to form a joint venture with Brookfield Asset Management to do the development work together. This would create significant upside for Macy's -- but it means the asset sale gains wouldn't come for several years.
Store closures pave the way for additional asset sales
Finally, Macy's may continue to capture smaller asset sale gains by selling recently closed store properties. For example, the company found a buyer for its store in Burlington, Vermont within days of announcing plans to close it earlier this month.
For vacant properties in less desirable locations, Macy's is working with a commercial real estate auction site to solicit bids. Some of these properties may not generate any asset sale gains, but Macy's would still get a small cash inflow and would no longer need to cover the cost of upkeep.
Still in the early innings
Macy's has captured over $1 billion in asset sale proceeds in the past few years. However, the company's real estate value has been estimated at anywhere from $16 billion to $20 billion or more.
Just between Macy's remaining downtown real estate and the properties that Brookfield Asset Management is studying, there could be billions of dollars of value creation opportunities. Thus, real estate gains could remain a significant source of income for Macy's for many more years -- and perhaps even decades.
