The clothing industry is very cyclical, usually peaking in the summer months of June and July, and again during the Christmas season. Consequently, the share prices for industry players also tend to reach their highs during these periods, and then trough in the interim months. Therefore, in the run-up to fourth quarter earnings report, one would expect share prices to appreciate over the coming months in line with shareholders expectations. One potential factor which might slow this appreciation is that consumer spending remains low. This is due to continuing unemployment and a lack of consumer confidence, factors that are not helped by the current government crisis.
I have chosen Macy's (NYSE:M) as my cyclical clothing company to invest in, as its returns have been very consistent over the last couple of years, which should make it easy to predict its Christmas returns. During the fourth quarter, Macy's revenues tend to increase by roughly 50% from approximately $6 billion to $9 billion, while its net income increases by a factor of four from approximately $300 million to around $1.2 billion. Therefore, the 3rd quarter could easily be characterized as the "calm before the storm" as revenues drop off while customers save for the Christmas season.
I believe that this lull has already been priced in, as since June the share price has dropped from a high of $50.77 to its current price of $42.64. Although Macy's reports its third quarter earnings a month from now on Nov. 13, I believe that knowledgeable investors will already start to acquire the company's stock before then in anticipation the share price boost from the upcoming months of high demand and large sales. Consequently, buying while everyone else is fearful definitely applies in this scenario. The key to making a solid investment is looking ahead and anticipating rather than clutching the coattails of a price rise. I would note that this is a short-term play and not a long-term investment, and consequently I will be withdrawing my interest in the stock come December.
Among others, Macy's primarily competes with Kohl's (NYSE:KSS), Sun Art Retail Group, and Marks & Spencer Group (NASDAQOTH:MAKSY). All three companies generally have high earnings compared to the typical retail stores, and all are profitable retail stores. As such I believe that they are good companies to compare Macy's to.
Out of these three, Kohl's is possibly the retailer store most similar to Macy's. Kohl's has many of the same advantages as Macy's, though its rapid growth is now starting to affect the company. The firm seems to have too many stores, and consequently is oversatisfying demand, which might lead to loses over the long term. Kohl's also has another huge disadvantage when competing with Macy's: the Macy's brand is significantly more recognizable and has a much larger reach, along with a very loyal customer base.
Macy's management has recently taken many steps that will move the department store forward. The company have centralized its operations, moving its advertising and purchasing departments (along with others) out of regional stores and into a centralized hub. This will allow it to benefit from increased economies of scale, leading to lower costs and raising both gross and net profits.
It has also started to personalize its individual stores to bring them more in line with local fashions and trends, generating more of a community atmosphere. Macy's new program of releasing merchandise that is differentiated by location sets it apart from other retail stores and will likely lead to higher net sales over the long run. It is also a remarkable turnaround, as in the past Macy's has striven to release the same clothing across its stores. This is a constructive step by management towards acknowledging that this path was not viable.
As the U.S. economy continues to recover, Macy's target range (mostly middle-class families) is better able to afford its products, something that will further help to increase demand over the coming years. Therefore, under current management, Macy's appears to be progressing in a positive manner. Like many other retail stores, the firm will also benefit from rapidly increasing its online sales as customers increasingly prefer to shop through online retail outlets.
To compare Macy's with its competitors, we first need to find the company's enterprise value (EV); we find this by taking its market capitalization of $16.04 billion then adding total debt of $6.914 billion. We then remove cash and cash equivalents of $1.424 billion, allowing us to find its effective value of $21.53 billion. We then use its EBITDA for the trailing twelve months of $2.676 billion to generate a trailing EV/EBITDA of 8.05 times. Although this is slightly higher than the typical value company I examine, it is not unreasonable, and certainly acceptable, considering the expected future growth. Our strong expected future growth is demonstrated by Macy's forward price-to-earnings ratio of 9.6, which is significantly lower than its current P/E of 12.4.
If we calculate the EV/EBITDA for the trailing twelve months for our competitors, Kohl's has a trailing EV/EBITDA of 4.77 times, while Marks & Spencer has a trailing EV/EBITDA of 7.71 times. Macy's seems to be overvalued compared to these companies, and this seems to conflict with our analysis. We have already categorized Kohl's as a higher-risk stock, however, so even though it might be better value it is certainly more risky. Moreover, Macy's for me is a growth investment rather than a value investment and I have chosen two companies with two of the lowest EV/EBITDAs in the retail sector to compare it to. Therefore, I am still confident in my analysis that Macy's is trading at a discount to where its price will be in a couple of months time.
Although a valuation certainly doesn't help my case to invest in Macy's stock, I believe it is necessary to provide investors with as much information as possible. I certainly wouldn't fault you for choosing Kohl Group as a value investment over Macy's growth potential. I usually choose value myself, but this case in an exception. I believe that Macy's is the most attractive retail store for investors to take advantage of strong future sales growth over the Christmas season.
Rupert Nicholson owns shares of Macy's. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.