After recording 11 consecutive quarterly comparable sales declines, Macy's (M -2.97%) has finally gotten back on track in the past year. During the first half of fiscal 2018, comps increased 2.3%, including licensed departments. This performance helped drive a 30% surge in operating income, from $390 million to $507 million, excluding real estate gains and impairment costs.
This improving sales and earnings trajectory caused Macy's stock to more than double between late 2017 and mid-2018. However, the stock plunged following the Q2 earnings report, even though the company's performance exceeded management's expectations. Macy's stock has recovered somewhat in recent weeks, but it remains 10% below its 52-week high.
Investors seem to be demanding more proof that the comeback is for real before rewarding the company with a higher valuation. Let's look at how Macy's could potentially satisfy those demands with its upcoming earnings report, which is due out Wednesday morning.
Can Macy's capitalize on an easy year-over-year comparison?
In last year's third fiscal quarter, Macy's faced a variety of revenue headwinds. Sales to international tourists were still declining at the time. Furthermore, major hurricanes affected several key markets during the quarter, while unseasonably warm weather weighed on fall-season sales. As a result, comps declined 3.6% year over year.
That means Macy's faced easy year-over-year comparisons last quarter. While the timing of back-to-school sales may have partially offset this tailwind, there's still a good chance that comps growth accelerated relative to the first half of fiscal 2018.
While Macy's didn't give specific guidance for the third quarter, it projected back in August that comps would increase 2% to 2.5% in the second half of the fiscal year. A Q3 gain in comparable sales significantly above that level might give management the confidence to raise its full-year sales forecast for the third time.
Macy's has stated that operating expenses will increase in the second half of fiscal 2018 because of the company's investments in improving the customer experience. As a result, operating income growth will slow compared in comparison with the first half of the year. Nevertheless, if sales surpass expectations, there's a good chance that Macy's earnings forecast will move higher, too.
Any progress on the real estate front?
A second potential catalyst for Macy's shares would be positive news regarding its efforts to monetize excess real estate. About two years ago, Macy's created a real estate alliance with Brookfield Asset Management (BN -1.81%). A dedicated team at Brookfield is examining 50 Macy's properties, with the goal of identifying real estate development opportunities within that portfolio.
Early this year, Macy's said it had agreed on terms with Brookfield Asset Management for nine properties. However, as of then, Brookfield expected to eventually proceed with development plans for about 36 of the 50 properties covered by the alliance.
Brookfield's 24-month exclusivity window for creating "pre-development" plans ends soon. There could therefore be a flurry of real estate activity announced either in conjunction with the upcoming earnings report or sometime early in 2019. The potential windfall to Macy's from the Brookfield partnership could easily total hundreds of millions of dollars.
Sales momentum is the key
Real estate activities still represent a major long-term opportunity for Macy's. The company's success in monetizing part of its downtown San Francisco real estate highlights the opportunity from pursuing a similar strategy with its Manhattan flagship store. Meanwhile, by looking for development opportunities on its underutilized parking lots, Macy's can potentially realize an upfront windfall from selling the land, followed by a long-term benefit from increasing the level of foot traffic near its stores.
That said, investors mainly care about sales growth right now. There's still a lot of uncertainty about the company's ability to stay relevant in a fast-changing retail landscape. The more Macy's can do to convince investors that its return to comp sales growth is sustainable, the higher its valuation is likely to be. Thus, comparable sales growth is the first thing I'm going to be looking at when the iconic retailer releases its third-quarter earnings report later this week.