Shares of Macy's (NYSE:M) tumbled 7% on Nov. 14 following the release of the retailer's third-quarter earnings report. Its revenue rose 2% annually to $5.4 billion, matching expectations, and its non-GAAP EPS grew 29% to $0.27, beating estimates by $0.12.

Macy's comparable-store sales rose 3.1% on an owned basis and 3.3% on an owned-plus-licensed basis. It maintained its full-year revenue forecast for less than 1% growth, but it now expects its earnings to rise 9%-14%, compared to its prior forecast for 5%-10% growth and a consensus forecast for 8% growth.

A Macy's store.

Image source: Macy's.

Those numbers seemed solid, but investors still dumped the stock. But after that sell-off, Macy's trades at just 8 times this year's earnings and pays a hefty forward dividend yield of 4.1%. Should investors consider it an undervalued income stock?

A closer look at Macy's valuations and dividends

Macy's P/E ratio is very low relative to those of industry peers Kohl's (NYSE:KSS), Nordstrom's (NYSE:JWN), and Dillard's (NYSE:DDS).

Company

Estimated EPS growth

P/E ratio*

Macy's

13%

8

Kohl's

32%

14

Nordstrom's

24%

17

Dillard's

30%

12

As of Nov. 15. Source: Yahoo Finance, *Current fiscal year.

Macy's is generating weaker growth than those three retailers, but its P/E ratio is still low relative to its potential earnings growth. Moreover, Macy's yield and consecutive years of dividend hikes make it a more reliable income stock than all three companies:

Company

Forward yield

Consecutive years of dividend hikes

Macy's

4.1%

7

Kohl's

3%

7

Nordstrom's

2.3%

0

Dillard's

0.5%

4

As of Nov. 15. Source: Yahoo Finance.

Macy's is paying out $1.51 in dividends per year, which is easily covered by the $4.10 to $4.20 per share it expects to earn in fiscal 2018. This means investors can expect Macy's streak of dividend hikes to continue for the foreseeable future.

Grading Macy's core business

Macy's core business looked sickly last year as the store struggled with sluggish mall traffic, competition from e-tailers, oversized stores, and an overextended brick-and-mortar footprint.

But it finally broke out of that rut by shuttering weaker stores, selling and leasing back its real estate, expanding its Backstage off-price stores, and expanding its mobile ecosystem and loyalty program. Those efforts clearly paid off over the past four quarters:

 

Q3 2017

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Owned

(4%)

1.3%

3.9%

0%

3.1%

Owned plus licensed

(3.6%)

1.4%

4.2%

0.5%

3.3%

Comparable store sales growth. Source: Macy's quarterly earnings.

Macy's margins have also been improving. Its gross margin rose 50 basis points annually to 39.9% during the quarter, and its operating margin grew 30 basis points to 2.7%. Those numbers indicate that Macy's hasn't fallen into the trap of using markdowns to drive sales.

During the conference call, Macy's CEO Jeff Gennette stated that the retailer "will hit $1 billion in mobile sales" this year (4% of its estimated revenues) and that the company has "the right strategies, the right merchandise and marketing, and the right experiences to win with today's consumer" during the holiday season.

A Macy's store.

Image source: Macy's.

Macy's also has other catalysts on the horizon. It could benefit from the death of Sears, its Backstage stores could lure customers away from The TJX Companies' off-price chains, and its growing Bluemercury brand could gain traction in the cosmetics and in-store spa and salon market against Ulta Beauty. It's also shrinking its underperforming stores and launching smaller neighborhood stores to boost its sales per square foot.

So is Macy's an undervalued dividend stock?

Macy's business looks healthier than ever, its stock is cheap, and it pays a generous and sustainable dividend. Investors were probably just taking profits after its big rally this year, so this sell-off should be considered a good opportunity to start a fresh position or accumulate more shares.

 

Leo Sun has no position in any of the stocks mentioned. The Motley Fool recommends Nordstrom, The TJX Companies, and Ulta Beauty. The Motley Fool has a disclosure policy.