Macy's (M +0.06%) shares are down 46.26% year to date and the price plunge raised its dividend yield to 9.42%. Since the dividend yield is derived by taking the dividend per share and dividing it by the price per share, the increase was not management's choice, but due to the decline in the stock price. The high yield during a challenging environment for the company puts the question to management if it would be prudent to reduce the dividend, which the company has spent an annual $460 million paying, for the last three years.
In its latest quarterly earnings release, Macy's experienced a decline in comparable-store sales of 3.5% and management lowered its guidance for the year's earnings per share to a midpoint of $2.67, down from a midpoint of $2.95. It attributed the sales and earnings drop to mismatched inventory, and the need to make significant changes to its website to be ready for the holiday quarter.
Source: Macy's
Will earnings be enough to support the dividend?
Ultimately, dividends are paid out from earnings, and the most critical contributor to net income is sales. To boost sales, Macy's is investing in upgrades to its facilities with its growth 150 initiative, which is proving to be successful as its updated stores are outperforming the rest of its fleet. The program started in 2018 with 50 stores and the success led management to expand it to an additional 100 locations in 2019, and the work is now complete.
Recognizing the rising popularity of the off-price concept, Macy's is capitalizing on the trend by creating more of its Backstage stores -- it opened 50 of these off-price concept stores year-to-date. The concept originated in 2015, and Macy's has expanded Backstage to 215 locations within Macy's stores nationwide and opened seven freestanding locations. Backstage stores that have been open for more than 12 months had comparable-store sales growth in the mid-single digits. The locations inside Macy's stores don't appear to be cannibalizing sales from its main store, as the Q3 report said 15% of customers who shop at Backstage also buy in the main store during the same trip, and cross-shopping customers spend around 25% more.
To get a better look at the sustainability of Macy's dividend, let's look at its dividends and earnings over the last four years. In theory, a company cannot sustain a dividend higher than its net profit for an extended length of time -- in the same way a household can't maintain its lifestyle by drawing from its savings account. Eventually, savings will drop to zero and spending will need to adjust to the current level of income.
| Metric | 2016 | 2017 | 2018 | 2019 (expected) |
|---|---|---|---|---|
| Dividend per share | 1.49 | 1.51 | 1.51 | 1.51 |
| Earnings per share | 2.03 | 5.13 | 3.6 | 2.67 |
Source: Macy's 10K
As the table shows, because the earnings per share are comfortably larger than dividends per share, it does have room to support the dividend even through further moderate declines in earnings per share. The 2019 expected dividend payout ratio would be roughly 0.56, calculated by taking the expected dividend per share total for the year divided by the mid-point of expected EPS for 2019. Macy's has a dividend payout ratio slightly above the industry median. Higher dividend payout ratios are typical for companies with limited or no opportunities to invest in growth. If a company does not have profitable use for its cash, investors prefer the funds be returned to them so they can put the money to work elsewhere.
Can it sustain dividends from cash reserves and asset sales?
Macy's long-term debt position is $4.7 billion, down from $5.5 billion a year ago. Its balance sheet has improved from the same period a year ago as a result of management proactively reducing its long-term debt. According to its press release on Dec. 17, the company made another tender offer to bondholders to buy back up to $525 million in bonds. By completing the tender offer, it expects interest expense savings of around $24 million annually over the term of the bonds, which range from three years to ten years.
Macy's has $8.3 billion in current assets, with $7.3 billion in merchandise inventories in preparation for the holiday season, and $6.5 billion in current liabilities. In February 2019, it held $5.3 billion in inventories. Its business is seasonal, and it must ramp up and down inventories in preparation for peak shopping seasons.
Macy's is identifying underperforming stores and selling those properties if it owns them. It has a mix of stores it purchased and stores it leases. Each property it sells brings in a lump sum of cash to fortify the balance sheet. Over the last three years, it has brought in a total of $1.56 billion from property sales and paid out a total of $1.38 billion in dividends.
Will the one-two punch of earnings and asset sales be enough to sustain the dividend?
Management is conscious of the challenges they are dealing with and the company is adapting. Macy's is moving in the right direction by investing in remodeling stores, opening stores in the off-price category, and investing in the customer experience through its omnichannel offering where the customer can make purchases online and pick up in-store or check out in-store through its mobile app. The decision to place its off-price stores inside Macy's locations gives shoppers more reason to visit its stores. Purchases made in-store offer higher margins because of the lower cost of fulfillment, and shoppers who buy in-store return items less often.
In its earnings call, management said, "it remained committed to paying an appropriate cash dividend to our investors." This statement leaves it wiggle room to lower the dividend if it is deemed appropriate to do so. In the near-term, this gives Macy's the flexibility to reduce its dividends to survive the retail apocalypse while strengthening its balance sheet and improving its competitive position to pay out dividends for the long-term.
Even though sales and earnings growth have been disappointing, the amounts are enough to support the dividend. As a backup during times of depressed earnings, its asset sales can provide cash to pay dividends. Furthermore, the completion of the 150-store upgrade program reduces the cash need for capital expenditures in the near-term. Investors who are considering buying Macy's shares for dividend income should feel secure in its sustainability.
