Less than two years ago, Macy's (NYSE:M) faced a nasty combination of slumping earnings and a heavy debt load. This sent investors fleeing for the exits -- and caused the company to abruptly halt its share-repurchase program to focus on paying down debt.

However, since late 2017, Macy's has stabilized its sales, which has allowed it to return to earnings growth. Meanwhile, it has been able to rapidly reduce its debt. Last week, Macy's announced that it plans to use a big chunk of its holiday-quarter cash flow to pay off more debt, which will put it in good position to start buying back stock in 2019.

Confronting the debt problem

For the past several years, Macy's has had a leverage ratio target of 2.5 to 2.8. That means it aimed to keep its debt (after some adjustments) between 2.5 and 2.8 times its adjusted earnings before interest, taxes, depreciation, amortization, and rent (EBITDAR).

Unfortunately, a steep decline in its earnings power between 2014 and 2016 caused Macy's leverage ratio to balloon to 3.3 times adjusted EBITDAR by the end of its 2016 fiscal year. That's why management decided in early 2017 to devote all of the company's excess cash flow (after capital investments and dividends) to debt reduction.

The exterior of the Macy's flagship store in Manhattan.

Image source: Macy's.

Over the past seven quarters, Macy's has made incredible progress. Through a combination of scheduled debt repayments, repurchases on the open market, and public tender offers, Macy's has reduced its balance-sheet debt from $6.9 billion to $5.5 billion. This brought the company's leverage ratio down to 2.6, well within its target range.

Macy's rolls out another tender offer

Due to the timing of inventory purchases and sales, Macy's typically generates all of its free cash flow in the fourth quarter of its fiscal year. Between Thanksgiving and Christmas in particular, Macy's rapidly converts inventory into cash.

A year ago, Macy's used this holiday-quarter cash flow to fund a $400 million debt tender offer. This year, it's going even bigger.

On Nov. 28, Macy's announced a $600 million debt tender offer, which is expected to close later this month. This will add to the $351 million of debt the company has already repurchased since the beginning of the fiscal year, bringing its debt load firmly below $5 billion.

Most of the retailer's remaining debt is eligible for this tender offer. However, Macy's is prioritizing paying off debt with coupon rates exceeding 6%. As a result, the tender offer will likely reduce Macy's annual interest expense by about $40 million.

Time to reward shareholders?

Assuming that adjusted EBITDAR holds steady at around $3.4 billion as of the end of fiscal 2018, the current tender offer will reduce Macy's leverage ratio to around 2.4. Rising interest rates should also improve Macy's pension funding, reducing its adjusted debt -- and potentially pushing its leverage ratio as low as 2.3.

In any case, Macy's will probably end fiscal 2018 with a leverage ratio below its target range. Furthermore, even after completing the tender offer, the department store giant could still end the year with roughly double the $736 million in cash and cash equivalents that it had on its balance sheet in early November.

The combination of surpassing its leverage ratio target and ending fiscal 2018 with plenty of excess cash could encourage Macy's to resume repurchasing shares next year.

With Macy's stock trading for less than 10 times earnings, even a relatively modest buyback program could significantly boost earnings-per-share growth and lift the stock price. And given how much cash the company has been generating recently, Macy's could maintain its dividend, repurchase $500 million of stock annually, and still keep reducing its debt -- providing important protection in the event of an economic downturn.

Adam Levine-Weinberg owns shares of Macy's. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.