Macy's (M, Financial) is a retail organization operating department stores and online stores under two brands (Macy's and Bloomingdale's) that sells a wide range of merchandise, including apparel and accessories (men's, women's and children's), cosmetics, home furnishings and other consumer goods. Women's apparel and accessories account for more than 60% of sales. The business overall is simple, just to buy goods from suppliers and sell to customers. The complicated things are the hows. For example, how to initiate and execute strategies to grow sales and expand margins, how to compete with peers, how to build long-term relationships with customers and so on. Those are also the things that differentiate the company and give the company competitive advantages.
The company enjoys a medium moat in my opinion:
1. High barrier to entry
High upfront capital requirement of opening new department stores and building operations should put a high barrier to enter into the industry. It is different than apparel retail stores for example. One can start a couple of small retail stores with a new nice concept with little capital and expand from there. Few people would build a department store chain from scratch now. Acquiring an existing company in the industry would be a far better choice.
2. National scale
Macy's is the largest department store chain in the US and has about 850 stores as end of 2011. It has completed integration as result of May and Federated merger in 2004, and as part of the My Macy's localization initiative, it has consolidated regional divisions and administrative functions. Now it can truly leverage the national scale of operating infrastructure to drive sales growth and margin expansion. Competitors can not easily get to the same level of scale without spending large amount of capital on merger, acquisition or store expansion.
Moreover, the size did not slow down the company. It acts quickly in terms of identifying new opportunities, adopting to market changes and implementing strategies. Based on execution performance of past few years, I think the company can effectively leverage the national scale in its favor.
3. Store brands
Both Macy's and Bloomingdale's brands are world famous brands with good customer recognition. It is a gift from history and certainly a nice thing to have.
4. Unique offerings
Department stores have a very wide range of products available for customers and have the flexibility to choose brands and products to offer. That is an advantage against stand alone apparel retailers, which can not switch to other brands or products when products are out of fashion or are not selling well for some reason. And shopping in a department store is sometimes to some people an entertainment, which is quite different than going to a discount retailer or grocery store. I have seen a lot of customers easily spend half day there checking every section. Macy's and other department stores have a niche market segment that specialty retailers or discount stores can not directly compete.
Macy's also has a dedicated team working on private labels. The offering of private label brands and exclusive brands adds many unique products that customers can not find elsewhere and adds one more competitive strength. The sales of private label brands has been strong in Macy's and represented approximately 20% of net sales in the Macy's-branded stores in 2011.
The management
The management is focusing on three key strategies for continued growth in sales, earnings and cash flow in the years ahead:
(i) maximizing the My Macy's localization initiative;
Localization program is a very good strategy and has been executed very well. Stores customized to local tastes are better positioned to drive sales and to satisfy customers. As part of this strategy, the company consolidated marketing and merchandise purchasing, cut seven divisional offices, reduced central office and administrative expense, and expanded margin. Those helped the company to make decisions faster and partner more effectively with its suppliers and business partners.
(ii) driving the omni-channel business;
The industry has realized that most of future sales growth is going to come from new channels like online store and mobile store. Macy's was one of the fast runners that got out of the great recession with a very good online store. Online sales is growing rapidly and the management expects online and mobile sales to drive meaningful sales and earnings growth not far in the future.
The management is also experimenting new ideas and will scale quickly if anything can effectively drive sales and earnings growth. In fact, localization program was tested successfully in a couple of regions before implemented nationally. One current example is Bloomingdale's Outlet stores. 2011 test results were encouraging and in 2012 the management is planning to open 5 more Bloomingdale's Outlet stores to expand the idea further.
(iii) embracing customer centricity, including engaging customers on the selling floor through the
MAGIC selling program.
Management and analysts think this initiative contributed significantly to revenue growth. I do not disagree but I do not know how to quantify the contribution. I think it is good enough that it is getting employees engaged and energized.
Macy's has a decent talent pool and most of the management team are veterans with the company and grew up from middle or low level positions. They understand the business and the company bottom up and are certainly ideal to run the business. With stock and option compensation programs, the management's interest is partially aligned with shareholders'.
Moreover, the management's capital allocation decisions are creating value for shareholders.
1) Capital expenditure
2012 capital budget is modest at about 850m, which includes renovation of New York City flagship store. New store opening plan is conservative: the company had opened two new Macy's stores and intends to open five Bloomingdale's Outlet stores during the remainder of fiscal 2012. The company has announced that in 2013 and early 2014 it intends to open three new Macy's stores, one Macy's replacement store, one new Bloomingdale's store, one Bloomingdale's replacement store, and may open additional Bloomingdale's Outlet stores. Management does not have aggressive plan of expansion, and will not destroy shareholders' value by investing capital ineffectively.
2) Dividend payout
With strong cash flow, management is returning capital to shareholders. The company recently doubled dividend payout, and dividend yield is a little over 2% now. It is reasonable to believe that the dividend payout will continue to increase over time.
3) Paying down debt
The company still have a large amount of debt on its balance sheet, and management is using cash flow to pay down debt. It is arguable how much debt is ideal for the business, but it is good for shareholders since reducing unnecessary interest expense will boost earnings and cash flow.
4) Repurchasing shares
The board authorized the company to repurchase $1.3 billion shares at the end of fiscal 2011.
That might reduce share count by 30-35m from 416m shares currently outstanding. That is going to increase per share earnings and cash flow for remaining shareholders.
Finance
Total debt stands at 7758m on the balance sheet as of 2011. It is less a concern as interest coverage ratio as of 2011 is greater than 5 and the company is using cash flow to pay down debt.
At the same time the company is using the low rate environment to replace high cost debt to get interest expenses down. In Janurary 2012 S&P upgraded Macy's credit rating to investment grade, which helps the company to lower interests also.
Valuation
EV/EBITDA of Macy's is about 6 at the time of writing. It would not be a terrible idea to start buying at EV/EBITDA 5.5 or below.
There will be volatility in the market and there will be volatility in the stock. Wise investors should use the volatility in their favor. When Mr.Market sells at below intrinsic value, do not miss your chance.
Peer group comparison
Disclosure: Long M
The company enjoys a medium moat in my opinion:
1. High barrier to entry
High upfront capital requirement of opening new department stores and building operations should put a high barrier to enter into the industry. It is different than apparel retail stores for example. One can start a couple of small retail stores with a new nice concept with little capital and expand from there. Few people would build a department store chain from scratch now. Acquiring an existing company in the industry would be a far better choice.
2. National scale
Macy's is the largest department store chain in the US and has about 850 stores as end of 2011. It has completed integration as result of May and Federated merger in 2004, and as part of the My Macy's localization initiative, it has consolidated regional divisions and administrative functions. Now it can truly leverage the national scale of operating infrastructure to drive sales growth and margin expansion. Competitors can not easily get to the same level of scale without spending large amount of capital on merger, acquisition or store expansion.
Moreover, the size did not slow down the company. It acts quickly in terms of identifying new opportunities, adopting to market changes and implementing strategies. Based on execution performance of past few years, I think the company can effectively leverage the national scale in its favor.
3. Store brands
Both Macy's and Bloomingdale's brands are world famous brands with good customer recognition. It is a gift from history and certainly a nice thing to have.
4. Unique offerings
Department stores have a very wide range of products available for customers and have the flexibility to choose brands and products to offer. That is an advantage against stand alone apparel retailers, which can not switch to other brands or products when products are out of fashion or are not selling well for some reason. And shopping in a department store is sometimes to some people an entertainment, which is quite different than going to a discount retailer or grocery store. I have seen a lot of customers easily spend half day there checking every section. Macy's and other department stores have a niche market segment that specialty retailers or discount stores can not directly compete.
Macy's also has a dedicated team working on private labels. The offering of private label brands and exclusive brands adds many unique products that customers can not find elsewhere and adds one more competitive strength. The sales of private label brands has been strong in Macy's and represented approximately 20% of net sales in the Macy's-branded stores in 2011.
The management
The management is focusing on three key strategies for continued growth in sales, earnings and cash flow in the years ahead:
(i) maximizing the My Macy's localization initiative;
Localization program is a very good strategy and has been executed very well. Stores customized to local tastes are better positioned to drive sales and to satisfy customers. As part of this strategy, the company consolidated marketing and merchandise purchasing, cut seven divisional offices, reduced central office and administrative expense, and expanded margin. Those helped the company to make decisions faster and partner more effectively with its suppliers and business partners.
(ii) driving the omni-channel business;
The industry has realized that most of future sales growth is going to come from new channels like online store and mobile store. Macy's was one of the fast runners that got out of the great recession with a very good online store. Online sales is growing rapidly and the management expects online and mobile sales to drive meaningful sales and earnings growth not far in the future.
The management is also experimenting new ideas and will scale quickly if anything can effectively drive sales and earnings growth. In fact, localization program was tested successfully in a couple of regions before implemented nationally. One current example is Bloomingdale's Outlet stores. 2011 test results were encouraging and in 2012 the management is planning to open 5 more Bloomingdale's Outlet stores to expand the idea further.
(iii) embracing customer centricity, including engaging customers on the selling floor through the
MAGIC selling program.
Management and analysts think this initiative contributed significantly to revenue growth. I do not disagree but I do not know how to quantify the contribution. I think it is good enough that it is getting employees engaged and energized.
Macy's has a decent talent pool and most of the management team are veterans with the company and grew up from middle or low level positions. They understand the business and the company bottom up and are certainly ideal to run the business. With stock and option compensation programs, the management's interest is partially aligned with shareholders'.
Moreover, the management's capital allocation decisions are creating value for shareholders.
1) Capital expenditure
2012 capital budget is modest at about 850m, which includes renovation of New York City flagship store. New store opening plan is conservative: the company had opened two new Macy's stores and intends to open five Bloomingdale's Outlet stores during the remainder of fiscal 2012. The company has announced that in 2013 and early 2014 it intends to open three new Macy's stores, one Macy's replacement store, one new Bloomingdale's store, one Bloomingdale's replacement store, and may open additional Bloomingdale's Outlet stores. Management does not have aggressive plan of expansion, and will not destroy shareholders' value by investing capital ineffectively.
2) Dividend payout
With strong cash flow, management is returning capital to shareholders. The company recently doubled dividend payout, and dividend yield is a little over 2% now. It is reasonable to believe that the dividend payout will continue to increase over time.
3) Paying down debt
The company still have a large amount of debt on its balance sheet, and management is using cash flow to pay down debt. It is arguable how much debt is ideal for the business, but it is good for shareholders since reducing unnecessary interest expense will boost earnings and cash flow.
4) Repurchasing shares
The board authorized the company to repurchase $1.3 billion shares at the end of fiscal 2011.
That might reduce share count by 30-35m from 416m shares currently outstanding. That is going to increase per share earnings and cash flow for remaining shareholders.
Finance
Total debt stands at 7758m on the balance sheet as of 2011. It is less a concern as interest coverage ratio as of 2011 is greater than 5 and the company is using cash flow to pay down debt.
At the same time the company is using the low rate environment to replace high cost debt to get interest expenses down. In Janurary 2012 S&P upgraded Macy's credit rating to investment grade, which helps the company to lower interests also.
Valuation
EV/EBITDA of Macy's is about 6 at the time of writing. It would not be a terrible idea to start buying at EV/EBITDA 5.5 or below.
There will be volatility in the market and there will be volatility in the stock. Wise investors should use the volatility in their favor. When Mr.Market sells at below intrinsic value, do not miss your chance.
Peer group comparison
| Company | 2011 OM | 2011 Sales | EV/EBITDA | FCF Yield |
| JWN | 11.50% | 10,877 | 7.4 | 5% |
| JCP | 3.90% | 17,260 | 12 | 2% |
| KSS | 11.50% | 18,804 | 5.4 | 7% |
| M | 9.00% | 26,405 | 6 | 7% |
| SKS | 5.40% | 2,970 | 6.47 | 5% |
Disclosure: Long M
