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Macy’s - Results Were Good but Not Great
Posted by: Sarfaraz A. Khan (IP Logged)
Date: November 25, 2013 10:22AM
Earlier this month, the second largest departmental store in the U.S., Macy’s Inc. (M) reported its third quarter’s results. The business surprised Wall Street as it managed to surpass analysts’ estimates for both sales and EPS. The market’s expectations were already lower as the company reported disappointing results for the second quarter. Investors were clearly delighted as the company’s shares rose more than 9% on the day of the earnings release. However, the company’s gross margins dropped which indicates that Macy’s has likely reduced prices to drive sales. Due to the lower margins, I believe this was not a high-quality earnings beat.
During the quarter, Macy’s reported revenues of $6.28 billion, showing an increase of 3.3% from $6.08 billion in the same quarter last year. Meanwhile, earnings rose 22.1% to $177 million or $0.47 per share. On the other hand, according to data compiled by Thomas Reuters, the markets were expecting earnings of $0.39 per share from revenues of $6.19 billion.
During the quarter, Macy’s comparable sales increased by 3.5% which was attributed to its promotional activities, omnichannel integration and localization initiatives. The increase in comps sales is closer to the higher end of the company’s guidance of between 2.5% and 4%
As several analysts have already pointed out before, in this difficult economic environment, if retailers continue to pursue higher sales by increasing promotional activities, then their margins will take a hit.
Margins Under Pressure
This is what Macy’s has done. While its sales increased, its gross profit margin dropped by 40 basis points to 39.2%, from 39.6% a year ago. To some extent, the shipping costs related to omnichannel business and a drop in merchandise margin was also responsible for the decrease in gross profit margin. The CFO has explained the company’s move by saying that they had to “intensify our marketing and enhance our value offering to drive the business in the current economic environment," Moreover, the company will stick with this strategy. During the conference call, Macy’s has also confirmed that its margin will remain under pressure throughout the fourth quarter.
Similarly, in its recent earnings, Kohl’s Corp (KSS) also reported a drop in gross margins by 60 basis points to 37.49% but unlike Macy’s, Kohl’s sales also dropped by 1% to $4.4 billion while earnings fell by 18% to $177 million. Meanwhile, the struggling J.C. Penney (JCP) has reported a loss of $1.81 per share and while its gross margin dropped significantly to 29.47% from 32.52% a year earlier.
Historically, online shipping has dragged Macy’s margins but this year, it was joined by merchandise.
Over the long run, the company’s gross margins have stayed between 38.50% and 42%, which is shown in the picture below. However, the previous quarter’s gross margin was the lowest for the third quarter over the last several years.
To offset this pressure on margin, Macy’s has been trying to keep a lid on its SG&A expenses. In the previous quarter, these expenses dropped by 70 basis points (as a percentage of sales). The business’s management has shown cost discipline by keeping a strict check on its expenditure. Macy’s increased its expenditure on omnichannel and marketing to give its customers a new feel of the stores, but overall, its reported expenses were nearly flat.
Overall, the industry is expecting improvements in the current quarter on the back of the holiday season. The current earnings beat has come at the cost of lower margins but it will give the management some confidence as the firm moves into the most important quarter. This is a crucial period for Macy’s which, last year, earned more than a third of its revenues and half of its earnings in the holiday season.
The company’s shares have risen by more than 30% this year and are currently trading at 14.4 times the company’s trailing earnings. At these price levels, I believe the shares are reasonably valued. Therefore, Macy’s is currently a hold. The company has a decent track record of beating bottom line estimates (12 times out of the previous 13 quarters) while markets are expecting double digit growth in the bottom line for the next two years. On the other hand, Macy’s comes with a lot of debt (its current long-term debt-to-equity ratio is 123.7). Moreover, the company’s current growth strategy will continue to drag its margins which can have an adverse impact on its bottom line growth.
For the current year ending in February, Macy’s is expecting growth of 2% to 2.9% in comparable sales and earnings of between $3.80 and $3.90 per share. The market’s consensus estimate is set closer to the high end of its guidance at $3.87 per share.
Macy’s Q3 Earnings Press Release
Macy's Management Discusses Q3 2013 Results - Earnings Call Transcript
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.
Stocks Discussed: M, KSS, JCP,