Please ensure Javascript is enabled for purposes of website accessibility

1 Big Risk for Macy's Shareholders

By Adam Levine-Weinberg - Jul 10, 2021 at 9:07AM

Key Points

  • A lucrative credit card partnership with Citibank produces a substantial stream of high-margin revenue for the retailer.
  • Citibank recently exercised an early termination option in its contract with Macy's.
  • If the company's next credit card deal (with Citibank or a new partner) comes with significantly worse terms, it could negatively affect the company's future profitability.

Motley Fool Issues Rare “All In” Buy Alert

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Citibank recently exercised an option to terminate its credit card partnership with Macy's ahead of schedule. What does it mean for the No. 1 department store operator?

For many years, Macy's (M -6.66%) store-brand credit card has been a huge contributor to the department store giant's financial performance. In fiscal 2019, net credit card revenue totaled $771 million, accounting for more than half of the company's adjusted operating income. Last year, Macy's recorded $751 million of net credit card revenue, despite the pandemic's impact.

However, Citigroup -- the company's credit card partner -- recently exercised an option to terminate its contract with the retailer ahead of schedule. That creates a ton of uncertainty for shareholders that won't be resolved until the two sides negotiate a new contract or Macy's chooses a new credit card partner.

Why the credit card program is so important

A Citibank affiliate (Department Stores National Bank) issues credit cards on behalf of Macy's and its upscale Bloomingdale's brand. These include a simple store credit card that can only be used at Macy's and a co-branded American Express card that can be used with any merchant that accepts AmEx. Macy's and Bloomingdale's-branded cards account for 40% to 50% of spending at the retailer in a typical year.

Store credit cards tend to carry high interest rates, making them very lucrative for banks. Under its agreement with Citibank, Macy's receives payments based on amounts charged to its private label and co-branded cards, as well as bounties for signing up new card accounts and profit-sharing payments based on the performance of its card portfolio.

The exterior of Macy's Manhattan flagship store.

Image source: Macy's.

These high-margin revenue streams have always contributed significantly to earnings at Macy's. However, they have become even more important in recent years, as favorable portfolio performance has driven growth in net credit card revenue, even as profit margins in the core retail business have fallen significantly.

A change is coming

The long-term agreement with Citibank gave the bank an early termination option if sales in any 12-month period at Macy's fell more than 34% compared to the period from July 2006 to June 2007. Because of the impact of the COVID-19 pandemic, sales for the 12-month period ending in February 2021 fell far enough to trigger this option.

In its most recent quarterly report, the company revealed that Citibank exercised its early termination option on June 4. Macy's has six months from that date to decide to purchase the credit card receivables itself or to choose a new credit card partner to purchase them on its behalf. It then has six additional months to complete the transaction.

Of course, Macy's and Citibank could also choose to negotiate a new agreement. Macy's CFO Adrian Mitchell recently stated that the two companies are still having discussions about a new contract.

Not a disaster, but something to watch

In his comments at recent investor conferences, Mitchell has noted that the company's credit card portfolio is very healthy and should be attractive to many financial institutions. Additionally, department stores' sales have come roaring back year to date.

M Revenue (Quarterly YoY Growth) Chart

Macy's revenue (quarterly YoY growth), data by YCharts. YoY = year over year.

In May, Macy's boosted the midpoint of its full-year sales guidance by more than $1.7 billion. It now expects sales to rebound by at least 25% from fiscal 2020 levels this year. The company also nearly tripled the midpoint of its full-year earnings guidance.

The rapidly improving sales and earnings performance should give potential Macy's partners more confidence in the sustainability of its business -- and thus, its credit card program. Still, Citibank wouldn't have exercised its early termination option if it were unwilling to lose the Macy's credit card business. That makes it unlikely that another credit card issuer will offer Macy's better terms than what it had under the deal that Citibank just terminated.

On the bright side, Macy's remains a big retailer and will likely generate close to $10 billion of sales from its credit cards this year. That should make its credit card portfolio attractive enough that the terms of its next credit card deal won't be too much worse than the previous one. But until Macy's signs a new agreement and explains the impact on its future credit card revenue, the uncertainty about this important revenue stream will continue to represent a big risk for shareholders.

American Express is an advertising partner of The Ascent, a Motley Fool company. Citigroup is an advertising partner of The Ascent, a Motley Fool company. Adam Levine-Weinberg owns shares of Macys and is short August 2021 $17 calls on Macys, short January 2022 $27 calls on Macys, and short January 2023 $25 calls on Macys. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Macy's, Inc. Stock Quote
Macy's, Inc.
$17.53 (-6.66%) $-1.25

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/09/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.