Not too long ago, shares of department store giant Macy's (NYSE:M) were priced for disaster. The stock bottomed in early November at $17.41, just six times the company's 2017 adjusted earnings-per-share guidance.
Since then, Macy's shares have recovered nicely, thanks to corporate tax reform and solid fourth-quarter sales and earnings results. However, last week, analysts from two Wall Street investment banks warned investors that the stock may have risen too far. Macy's Q1 earnings report -- due out on Wednesday morning -- has thus taken on increased significance.
Is Macy's stock too hot to handle?
Macy's share price nearly doubled between early November and late April, when it reached a new 52-week high above $32. But since then, the stock has retreated, as analysts have begun to question whether there is any upside remaining for the No. 1 department store.
The first word of warning last week came from analysts at Deustche Bank, who pointed out that poor weather may have hurt department stores' comp sales growth last quarter. (Weather-related concerns have been echoed by other department store analysts recently.) The Deutsche Bank report also suggested that Macy's shares are priced for perfection after their recent rally.
Later in the week, analysts at Morgan Stanley downgraded Macy's, pointing to the sharp deterioration of its core retail business in recent years and ongoing declines in its in-store sales. The analysts also opined that Macy's recent track record of recording substantial real estate gains each year isn't sustainable.
A chance for Macy's to prove the doubters wrong
During Q4, Macy's posted a 1.4% increase in comparable-store sales, breaking a streak of 11 consecutive quarterly declines. The company also projected that comp sales growth would stay positive in fiscal 2018, rising 0% to 1% for the full year. That said, Macy's executives have acknowledged that comp sales may drop modestly in the first half of the year, as many sales growth initiatives -- like the expansion of Macy's Backstage, the company's new off-price concept -- will roll out gradually over the course of 2018.
As a result, investors may not have sky-high expectations for the first and second quarters. And while weather may have impacted sales last quarter, Macy's faced an extremely easy year-over-year comparison. (Comp sales plunged 4.6% in the first quarter of fiscal 2017.)
Considering these offsetting factors, analysts may be too pessimistic about Macy's first quarter performance. Furthermore, with consumer confidence near an 18-year high, Macy's could have a solid second quarter if weather trends become more favorable.
Real estate will remain in focus
Analysts may also be underestimating Macy's future real estate income. It's true that selling properties isn't a sustainable long-term strategy, but the company still has a lot of runway to monetize its most valuable real estate.
For example, Macy's hopes to sell its 240,000-square-foot I. Magnin building in downtown San Francisco -- which could fetch roughly $250 million -- during 2018. Just six months ago, this potential deal wasn't on investors' radar screens. Macy's has also hired real estate brokers to study a potential sale of the ground lease for its Bloomingdale's Home store in Chicago's River North neighborhood. A deal for this property could be announced sometime this year.
Looking ahead, Macy's partnership with Brookfield Asset Management (NYSE:BAM) will become one of its biggest sources of real estate gains in 2019 and beyond. In February, Macy's management announced that the company had agreed to terms for development projects on nine of 50 real estate assets that Brookfield has been studying. If Macy's opts to sell its interest in those future projects, the total proceeds would be $50 million or more.
Macy's has indicated that Brookfield is likely to recommend proceeding with development projects on two-thirds of the 50 assets it is studying, so there could be more announcements coming in conjunction with the first-quarter earnings report.
Importantly, Macy's has the right to form joint ventures with Brookfield Asset Management for the development projects on its properties. If Macy's goes this route, it will benefit from a longer-term income stream, not just a one-time real estate gain.
Can Macy's give investors confidence about the future?
Despite rallying over the past six months, Macy's stock still trades for less than 10 times forward earnings. This low valuation indicates that investors still doubt that the company will be able to withstand the challenges it faces from pure-play off-price and e-commerce competitors.
However, Macy's is implementing several new strategies to reinvigorate sales growth and boost earnings. Many of these moves will take time to pay off, such as the relaunch and expansion of its Star Rewards loyalty program, the growth of Macy's Backstage, and the addition of new retail or mixed-use space on some of its properties.
If management can convince investors of the company's turnaround potential based on the early returns from these initiatives, Macy's stock could keep flying higher in the months ahead.