During 2021, Macy's (M 0.74%) cashed in on buoyant demand with a string of strong quarterly profits. The department store chain's impressive rebound from the COVID-19 pandemic -- along with some investors' enthusiasm about a potential spinoff of its e-commerce business -- helped Macy's stock surge as high as $37.95 last fall, up from less than $20 at the beginning of 2020.
More recently, though, investors have grown concerned about the impact of high inflation on retail spending and about the sustainability of the company's sales and earnings momentum. As a result, shares have retreated to around $25. At that price, Macy's stock looks like a bargain.
Taking a thoughtful approach to 2022
Back in late February, Macy's projected that adjusted earnings per share (EPS) would range between $4.13 and $4.52 in fiscal 2022. While that would represent a decline from the company's adjusted EPS of $5.31 last year, management recognizes that the company benefited from unusually strong demand for most of 2021. By contrast, adjusted EPS totaled just $2.91 in fiscal 2019.
At an investor conference last week, CFO Adrian Mitchell acknowledged that high inflation could affect business this year. While management expects consumer spending to be strong, some people may reduce their discretionary retail purchases to pay for pricier vacations or restaurant meals.
In this environment, Macy's is being judicious about inventory purchases rather than buying aggressively to fill its stores and fulfillment centers. This could lead to some lost sales if demand stays red hot, but it will protect Macy's from the risk of having to take big markdowns if its sales momentum cools. That's a worthwhile trade-off that will protect the company's bottom line.
While Macy's is preparing for a possible demand slowdown, sales seem to be holding up well so far. The return of large social events like weddings and proms is boosting sales in many key merchandise categories, offsetting lower spending on casual apparel and home furnishings.
Multiple avenues for growth
The company's 2022 forecast calls for a modest 0% to 1% sales increase. Macy's can probably beat this guidance if the U.S. economy remains relatively healthy. But even if sales don't grow much this year, Macy's is positioning itself for faster growth in future years.
First, the flagship stores will benefit from the return of international tourism over the next couple of years. More broadly, traffic to high-performing malls should continue to recover beyond 2022.
Second, Macy's continues to diversify its business beyond the traditional department store model. The company is opening dozens more Macy's Backstage off-price stores within its full-line locations this year. It is also experimenting with several smaller store formats, enabling it to open stores in locations that are more convenient for customers but not suitable for a full-size department store.
Third, Macy's will launch a curated e-commerce marketplace later this year. That will allow the company to bolster its digital business with additional brands and product categories, unlocking incremental sales.
Real estate provides downside protection
Macy's stock currently trades for less than six times the company's projected 2022 adjusted EPS. Clearly, if the company can grow its earnings from that level -- even slowly -- Macy's stock would be a phenomenal bargain at its current price.
However, department stores (including Macy's) have struggled to produce consistently strong results in recent years. Many investors are understandably worried about Macy's ability to sustain its recent success, which explains why Macy's stock trades at a very low valuation.
That said, the company's massive real estate holdings provide valuable downside protection for shareholders. Macy's owns most of its stores, including prestigious flagships in New York, Chicago, and San Francisco. Many of its suburban locations are quite valuable, too. For example, Macy's recently sold its former store in Boulder, Colorado, for $32 million. It will be redeveloped into office space.
Macy's has 10 developers looking for additional development opportunities at its properties. These could include closing stores for complete redevelopment or selling excess parking lot land for new buildings.
The company's real estate may be worth $10 billion to $15 billion, well above the company's roughly $7 billion market cap. That value could grow with inflation. If the core retail business continues performing well, the company can selectively monetize non-core real estate to help fund dividends and share buybacks. On the flip side, if the core business significantly deteriorates, Macy's can close and sell more stores, providing ample cash to meet the company's obligations while continuing to reward shareholders.
Between the shares' upside potential if Macy's turnaround continues and the downside protection of the company's vast real estate portfolio, Macy's stock looks like a great buy at $25.