Don't Be Tempted by Macy's Big Dividend Yield

Macy's (M +0.12%) stock recently tumbled to a 10-year low after the retailer posted second-quarter earnings. Its revenue fell 0.5% annually to $5.55 billion, meeting expectations, but its adjusted EPS plummeted 60% to $0.28 and missed expectations by $0.17.

Macy's reaffirmed its guidance for roughly flat sales growth for the full year but slashed its EPS guidance from $3.05-$3.25 to $2.85-$3.05 -- which would equal a 27% to 32% drop from 2018. Wall Street had expected a 27% decline.

Macy's big post-earnings drop reduced its forward P/E to 6 and boosted its  dividend yield to 8%. That low valuation and high yield might look tempting to value-seeking investors, but I think it's still a falling knife.

Image source: Getty Images.

Macy's is starting to look like J.C. Penney

For a while, it seemed like Macy's was weathering the "retail apocalypse" better than struggling peers like J.C. Penney (JCP +0.00%). Its comparable-store sales growth was stronger, and its gross margins were stable.

Macy's comps growth stayed positive over the past year, but it's barely keeping its head above water.

Source: Macy's quarterly earnings.

It expects its comps (both owned and owned plus licensed) to be roughly flat for the full year.

Macy's gross margin expanded 60 basis points sequentially during the most recent quarter, but fell 160 basis points from the prior year -- mainly due to what the company termed "unanticipated markdowns" for clearing out inventories and supporting its lower-margin loyalty program and online business.

Source: Macy's quarterly earnings.

Its operating margin fell sequentially and annually as it booked lower gains from real estate sales while its expenses edged higher. Simply put, Macy's is sacrificing its margins to boost its comps growth -- a strategy that rarely ends well for retailers.

For example, J.C. Penney's comps flatlined in the second half of 2018 and have been negative ever since. Its margins also contracted as it desperately tried to clear out excess inventory with markdowns. Like Macy's, J.C. Penney also started to sell real estate and other assets to temporarily boost its profits and cash flow.

Macy's is in better shape than J.C. Penney, but it's being battered by the same competitors -- Amazon, superstores like Walmart and Target, and fast-fashion apparel rivals like Zara. Sluggish traffic in malls, where most of Macy's stores are located, is exacerbating the pain.

Image source: Macy's.

Macy's full-year guidance doesn't factor in the potential impact of a fourth tranche of tariffs on Chinese goods, some of which were recently delayed from Sept. 1 to Dec. 15. During the conference call, CEO Jeff Gennette warned that customers don't have "much appetite" for tariff-induced price hikes, but CFO Paula Price stated that Macy's was holding "active discussions" with its vendors to "mitigate tariffs and minimize customer impact."

Uninspiring turnaround plans

Macy's is expanding its online presence, and its digital sales grew by double digits in the second quarter, for the 40th straight quarter. Unfortunately, those sales still account for a tiny sliver of Macy's overall sales and clearly aren't boosting total revenues. Moreover, the expansion of the digital business, which requires tech infrastructure and logistics expenses, weighs down long-term margins.

Macy's is also opening more Backstage discount stores, but goods at these stores reportedly often cost more than comparable goods at dedicated off-price retailers. Other turnaround efforts include STORY, which lets brands set up experience-oriented shops inside Macy's; The Market @ Macy's, which features pop-up shops; and more freestanding Bluemercury beauty stores.

However, Macy's comps growth indicates that these efforts aren't bringing shoppers back to its brick-and-mortar stores. It also recently started testing out a clothing subscription service at Bloomingdale's and a clothing resale marketplace, but those initiatives could cannibalize its own apparel sales.

J.C. Penney tried many of the same strategies, including stores-in-stores for brands like Nike, a big partnership with LVMH's Sephora, and a now-discontinued clothing subscription service, but those moves also didn't attract enough shoppers.

The yield isn't worth it

Macy's dividend is still easily sustainable, since it only accounts for about half of its expected earnings this year. However, that cash ($233 million in the first half of 2019) could arguably be better spent on other turnaround initiatives. Its payout ratio will also rise as Macy's earnings wither, which would heighten investor concern.

Macy's looks like a high-yield trap. It might look cheap at these levels, but plenty of investors said similar things about J.C. Penney when its stock still traded in the teens. Now it's worth less than a dollar.