U.S.-China trade tensions took a turn for the worse last week, after President Trump announced a new round of tariffs on Chinese imports. As of Sept. 1, the U.S. will impose a 10% tariff on the remaining $300 billion of annual imports that are not already subject to tariffs.
Not surprisingly, investors have been dumping retail stocks ever since this news came out. For example, shares of Macy's (NYSE:M) plunged as much as 14%, from around $23 just a few days ago to a low of $19.80 on Monday. This left Macy's stock trading near a multiyear low.
However, the market is overreacting to this tariff news -- at least with respect to Macy's. As a result, investors are getting a great opportunity to snap up Macy's stock at a bargain price.
The tariffs won't hurt Macy's as much as investors fear
On the Q1 earnings call a few months ago, CEO Jeff Gennette said that if additional tariffs on Chinese imports went into place, they could have a significant impact on the company's business. He also cautioned that the company's guidance for full-year adjusted earnings per share between $3.05 and $3.25 didn't incorporate the potential impact from any future tariff increases.
This probably explains why Macy's stock plunged after the recent tariff announcement. But in reality, the pending tariff increase will be very manageable for Macy's.
First, Macy's has already imported most of its fall inventory ahead of the critical back-to-school shopping season. Winter items would typically arrive in September, but there's a good chance that Macy's will be able to import most of its China-sourced winter-gear inventory before the new tariffs go into effect. Thus, any cost increases would really hit in 2020.
Second, Gennette was speaking specifically about the possibility of a 25% tariff on all Chinese imports when he warned that guidance didn't account for additional tariffs. By contrast, a 10% tariff would probably have a negligible impact on the business. The falling yuan is naturally offsetting some of the impact of the expected tariffs, and Macy's should be able to force suppliers to absorb the rest of the hit, thanks to its substantial buying power.
Third, while the latest tranche of tariffs may rise to 25% at some point in the future, Macy's has been working for months, if not years, to adjust its supply chain. By the time 2020 rolls around, it should have much less exposure to China -- and, thus, less to fear from the ongoing trade war.
Tariffs could knock weaker competitors out of the game
While a 10% tariff on the remaining $300 billion of Chinese imports isn't likely to damage most retailers' profit margins very much, a few companies are already at the breaking point.
For example, luxury department store chain Barneys New York is on the verge of declaring bankruptcy because of high costs and too much debt. At best, it hopes to slim down to seven stores, compared with 13 full-line stores and nine warehouse stores today. But that requires finding a buyer, which will be challenging. Even modest additional profit pressure from tariffs could be the final nail in the coffin for the storied brand, leading to a complete liquidation.
Barneys is hardly the only retailer in a precarious position like this. To the extent that higher tariffs force these companies to go out of business, Macy's and its upscale Bloomingdale's brand will have an opportunity to make market-share gains that will boost future profits. This would pave the way for Macy's stock to move higher in the long run.
Real estate is a huge safety cushion
Finally, even if further tariff increases could pinch profits over the next year or two, shareholders can rest easy knowing that the company's real estate holdings are more valuable than its current enterprise value.
Indeed, while Macy's isn't expected to sell much real estate in 2019 compared with some recent years, the company brought in $43 million of asset-sale proceeds in the first quarter. It sold two more properties last quarter for a total of approximately $52 million.
Macy's owns hundreds of additional properties like these. For now, it's keeping most of them because it expects to make more money by operating them as retail stores than by selling them and directing shoppers to other nearby stores or its e-commerce sites. But if conditions changed, Macy's could earn big profits by selling more of its real estate, and it could return much of the resulting cash windfall to shareholders.
Today, Macy's stock trades for less than 7 times earnings. This is an absurdly cheap valuation for a company that has finally gotten comparable store sales growing again -- hinting at the possibility of a durable turnaround -- and owns a vast portfolio of real estate. Macy's stock could easily be worth at least twice the current share price. When the dust settles after the current trade war, Macy's shareholders are likely to be handsomely rewarded.