These 2 Department Stores Are Winning the Post-Lockdown Turnaround

Retail stocks surged on the morning of Thursday, Aug. 19, after big department store companies Macy's (M 4.92%) and Kohl's (KSS 3.00%) reported strongly positive results, with Macy's stock price racing more than 19% higher by midday after its second-quarter 2021 earnings release.

The sizzling results signaled not only a strong rebound for the two companies but lifted the entire retail sector as investors reveled in the news. It's possible to question the sustainability of the department store sector's revival, but overall, indicators point to the bulls likely being correct.

Image source: Macy's.

A look at the big winner, Macy's

Shattering Wall Street consensus estimates, Macy's is the star of the department store recovery show. Its top line beat the average analyst prediction by 13% and its bottom line surpassed it by 516.6%, according to sources that aggregate forecasts. Comparing key metrics for 2020 and 2019 provides a snapshot of Macy's rebound from last year's COVID-19 economic crash and its pre-pandemic operations:

Data source: Macy's earnings reports. 

Macy's Q2 results show both a full recovery from 2020's lows and incremental growth above 2019. While 2019 was actually down slightly from previous years, the latest showing seems to point to Macy's regaining positive momentum in the wake of the COVID-19 lockdowns. With lockdowns ended and significant vaccination numbers providing reassurance to shoppers concerned about the coronavirus, the department store chain appears to have returned to growth, for the time being anyway.

The 6% decline in quarterly digital sales year over year is likely not a worrisome sign, either. Instead, it probably indicates how strongly enthusiasm for brick-and-mortar shopping is surging, with customers responding to the easing of government restrictions by visiting the store even in cases where they would ordinarily buy online, savoring the in-person retail experience.

Macy's ended the quarter with $2.1 billion in cash, which management said it plans to use for multiple purposes. It is finally reinstating its $0.15 per share quarterly dividend, with the next payment to come on Oct. 1. It's also looking to improve the quality of existing investments through a freshly approved $500 million share buyback program. It also intends to deleverage from some of the debt it incurred, aiming to improve the long-term health of its balance sheet. The company says it "now expects to exceed its target leverage ratio and achieve a ratio of no more than 2.5x by the end of fiscal 2021."

Though not directly part of its Q2 results, Macy's announced on the same day that it is resurrecting the Toys R Us brand in the U.S. to complement the 900 stores it still has overseas. The brand already has an online store on the Macy's website, and will appear in the brick-and-mortar retail space in 2022 with approximately 400 "shop-in-shop" physical stores inside Macy's locations. The move "changes the retail landscape by combining two beloved retail brands together for consumers across the nation," according to Toys R Us CEO Yehuda Shmidman, adding the potential for increased traffic and revenue into the future.

The news follows up on Q1 results that also beat Wall Street consensus and suggest the company's "Polaris" strategy is effective at seizing the opportunity provided by the recovering economy. The Polaris strategy is a three-year plan, launched in the first days of 2020, involving closing underperforming stores, reducing fixed costs, bolstering the company's loyalty program, and launching four billion-dollar private brands, among other initiatives.

Why Kohl's spearheaded the surge, too

Macy's department store competitor Kohl's also reported outstanding Q2 results on Aug. 19. Revenue of $4.45 billion beat Q2 2020 by 30.5%, while adjusted EPS rose from a loss of $0.25 per share last year to Q2 2021's positive $2.48 EPS. The company's top-line performance is just slightly better than Q2 2019's $4.43 billion revenue. However, EPS is much higher than 2019's $1.55, highlighting improved margins and better shareholder value. Kohl's will also pay a quarterly dividend on Sept. 22.

Company executives say Kohl's is now positioned to launch growth strategies previously devised, with "accelerated" share buybacks to help prepare the ground further by making the enterprise a more attractive investment. Many other parallels exist with Macy's situation, including growth driven by the robust expansion of Kohl's loyalty program. According to Kohl's Q2 2021 earnings presentation, LVMH-owned personal and beauty care product retailer Sephora will provide a strong in-store partner, echoing Macy's Toys R Us alliance. According to the presentation, Sephora is launching digitally this month, will have a physical store-in-store presence in 200 Kohl's locations by autumn 2021, and will grow this number to 400 next year and 850 the year after.

Sephora, though described as the most important partnership, is just one of several that Kohl's plans to roll out in the coming months. Kohl's CEO Michelle Gass, speaking during the Q2 earnings conference call, said the company is "on the eve of launching several transformational partnerships that will drive sustainable growth for years to come." Some of the upcoming brand partnerships include Calvin Klein and Tommy Hilfiger, both subsidiaries of PVH Corp.

Kohl's appears to be benefiting from a strategy that is nearly a mirror image of Macy's, and it's also building on the powerful rise of retail shopping now that people can return to stores.

Is the retail sector really back?

The surge in share prices of both department stores after their earnings releases shows that investors view their double success as a barometer of a continuing rally in the retail sector through the end of 2021, and likely beyond. The two companies have both revised their guidance, too, predicting better than expected performance for the whole year. Both say they have taken COVID-19 uncertainties into account in making their predictions, along with accounting for supply chain problems, and still expect a strongly positive back-to-school and holiday shopping season. They also both expect continued positive results from their respective strategic initiatives.

For the full year 2021, Macy's raised its previous net sales guidance of $21.73 billion-$22.23 billion to $23.55 billion-$23.95 billion. It expects $3.41 to $3.75 adjusted EPS, up from the earlier prediction of $1.71 to $2.12. Kohl's, for its part, no longer expects mid- to upper-teens percentage growth in revenue, but low 20s percentage growth instead. Adjusted EPS rose from $3.80 to $4.20 to a new guidance of $5.80 to $6.10, while operating margin is expected to be a percentage point or two higher.

Retail sales dropped about 1.1% overall in the U.S. economy between June and July, but the results of Macy's and Kohl's may be a positive indicator nevertheless. Both were confident enough to pay dividends, repurchase stock, deleverage, and provide upbeat numerical guidance.

A single major data point could be deceptive, but two give more credence to a rebound that's gathering strength regardless of COVID-19 variant worries. These two department store stocks at least are looking positive in the short and longer term, and may indeed be signaling the approach of better days for retail stocks in general. Some of the gains in these department store companies result from competitors going out of business, though, and if department stores continue to lose popularity they could see future declines resume. There is some risk to both Kohl's and Macy's for this reason, and investors interested in the sector should proceed with caution.