Is Macy's Done Growing?

For the past three years, Macy's (M 4.92%) has done exceedingly well at increasing both its earnings and net revenue. Most importantly, Macy's has become the most profitable among its competitors in terms of increasing revenue, same-store sales, and net profit year over year. While Macy's continues to generate and maintain heavy foot traffic through its stores, competitors J.C. Penney (JCP +0.00%) and Sears Holdings (NASDAQ: SHLD) continue to lose customers to Macy's, which has allowed Macy's annual profit to remain strong year after year.

However, all of this success has caused an interesting problem for what is perhaps the strongest department store in the United States -- it can no longer profitably invest all of its capital directly into expanding the organization overall. Which leads Foolish investors to wonder, what exactly does Macy's do with all of its profits?

Best of breed
Not only does Macy's provide the best exclusive and non-exclusive brands of any department store, but it also delivers exciting, innovative promotions that drive consumers to shop and spend more. Furthermore, at Macy's, consumers are willing to spend a little more on a pair of shoes, bedding accessories, apparel, and other items because they trust Macy's to sell items of high quality. By looking at the two tables below, it is quite obvious that Macy's is the most profitable when compared to J.C. Penney, Kohl's, and Sears Holdings.

Unlike the other department-store retailers, Macy's revenue has continued to grow year over year despite economic turmoil. Although Sears Holdings' revenue is much higher than Macy's, Sears' top-line performance has continued to fall over the past three years. Furthermore, unlike Macy's, Sears has also been enduring a net loss despite having higher revenue.

Before the great recession hit, J.C. Penney was one of Macy's biggest threats, but unfortunately, you can see that is no longer the case by looking at the company's loss in revenue and net income over the past three years.

Out of all of these retailers, Kohl's is Macy's biggest competition, as Kohl's continues to earn high revenue and net income year after year. Nevertheless, Macy's is still outshining the rest as its annual revenue and net income continue to grow higher and higher. The company also has a high return on equity.

Expanding has not been a priority
Any time a company manages to produce a net profit once all fixed and variable expenses have been accounted for, the company has three options to invest its capital. Companies can expand operations by opening new stores, pay dividends to shareholders, or buy back shares. While many retailers choose to expand their operations in order to generate more customers and sales, other retailers, like Macy's, have chosen not to expand.

For the past several years, Macy's has used its profits to pay dividends and buy back company shares. In the first chart below, you can see how the number of outstanding shares has slowly decreased over the years as Macy's continues to buy back shares. By using its accumulated earnings to buy back shares, Macy's remaining shareholders have benefited. This is because Macy's net income has continued to increase, and its earnings per share each year have increased even more as the shares outstanding have declined, which means more money for investors.

It is clear that Macy's has not been investing in expansion because its total store count for the last three years has actually been going down. In fact, it has closed nine underperforming stores in just three years, while revenue from the stores that remained open continues to increase. This isn't necessarily a bad thing, and may have been the best use of the profits generated by the retailer. However, such moves cannot go on forever, and if Macy's is going to continue to grow its business, it needs to invest its net income in expanding operations rather than paying dividends and buying back shares.

Foolish takeaway
Macy's is not necessarily done growing. It has the means to continue to grow if it would start investing its net income in the business through opening new stores and expanding its omnichannel division to compete with changing market trends. While dividends and share buybacks have allowed Macy's to shower rewards on its shareholders, this strategy cannot continue if Macy's wants to remain the country's top department-store chain.

Foolish investors would be wise to do more research on Macy's outstanding shares, and pay close attention as to where Macy's invests its profits for the current year. It may be best to hold off on making an investment in Macy's until the company begins to make moves to expand operations.