Shares of Macy's (NYSE:M) plunged earlier this year as investors panicked about a potential cash crunch. The iconic department store operator wound up reporting a $630 million adjusted net loss for the first quarter of fiscal 2020, due to the impact of the COVID-19 pandemic.
Macy's ultimately landed a $4.5 billion financing package in early June to shore up its liquidity. Moreover, the company has trimmed its losses faster than expected over the course of 2020. The widespread rollout of COVID-19 vaccines next year will help the business continue to recover. That should enable Macy's to repair its balance sheet within a few years.
Losses are receding
While Macy's continued losing money in the second and third quarters of fiscal 2020, its losses were dramatically smaller than what analysts had predicted for each of those periods. Furthermore, earnings before interest, taxes, depreciation, and amortization (EBITDA) turned positive in the third quarter.
Even more impressively, Macy's generated positive free cash flow last quarter. Through the first three quarters of fiscal 2020, it burned just $142 million in cash. As a result, it hasn't touched the $3.15 billion of new credit facilities it arranged in June (and doesn't plan to for the foreseeable future). Meanwhile, the $1.3 billion of secured debt it issued at the same time has bolstered the company's cash balance, which exceeded $1.5 billion at the end of October. In fact, Macy's net debt was lower at the end of last quarter than it was a year earlier.
Deleveraging could happen quickly
Despite having lower net debt than it did a year ago, Macy's needs to reduce its debt further, because the pandemic is weighing on its earnings power (at least temporarily). It will start by repaying $530 million of debt that is maturing in January.
At first glance, deleveraging further might seem challenging. The analyst consensus calls for Macy's to post adjusted earnings per share of just $0.74 next year. For comparison, adjusted EPS totaled $2.91 in fiscal 2019 ($2.53 excluding asset sale gains). However, analysts' estimates could be overly conservative, as they were for the past two quarters. Macy's has implemented aggressive cost cuts this year and expects to bring a lot of that savings to the bottom line as sales recover over the next couple of years.
Furthermore, free cash flow will probably continue to outpace book earnings. Macy's is on track to receive over $600 million of tax refunds (net of repayments for deferred taxes) next year, which should offset any cash flow pressure from rebuilding its inventory. Meanwhile, the company will probably continue to manage capital spending more tightly than in the past. (It is planning for capex of $450 million in fiscal 2020, down from an average of more than $1 billion annually in the prior two fiscal years.)
Lastly, Macy's is likely to ramp up the pace of asset sales over the next few years after pulling back in 2020. As of February, it expected to bring in about $700 million between fiscal 2020 and fiscal 2022 from selling assets. So far, it has received only $39 million. Importantly, many of the properties it is likely to sell can be repurposed for nonretail uses (such as housing, distribution centers, or offices). As a result, the current retail slump won't necessarily undermine the value of the assets Macy's is looking to monetize.
Debt reduction could move quickly
In addition to the $530 million maturing in January, Macy's has a $450 million debt maturity in January 2022 and $850 million of maturities in 2023. If the pandemic eases by next summer, there's a good chance that the department store giant will be able to cover the 2022 and 2023 maturities from free cash flow and asset sale proceeds.
Furthermore, Macy's is permitted to redeem the $1.3 billion of secured debt it issued earlier this year at a roughly 4% premium to par starting in June 2022. This debt carries an 8.375% interest rate, so redeeming it early would drive substantial interest cost savings, contributing to Macy's earnings recovery.
Even if sales never quite reach 2019 levels, Macy's could be back to generating solid profits and free cash flow within two to three years. Assuming this earnings recovery materializes, Macy's will also have a stronger balance sheet by then than it did at the beginning of 2020. That would put the retailer in good position to restart its dividend and even consider other ways to reward shareholders, such as share buybacks. It could unlock substantial upside for Macy's stock, too.