A Valuation of Macy's Properties

In 2003, Mohnish Pabrai (Trades, Portfolio), then a relatively unknown investor, made a bet on an obscure Norwegian oil shipping company called Frontline Ltd. (FRO), which at the time was suffering from a cyclical contraction in the crude oil industry.

Oil tanker rates vary somewhere between $6,000 a day to $80,000 a day, and they need about $18,000 a day to break even. But at that particular time, the rate was at $6,000 a day and the stock went from $11 per share to $3. The company owned about 60 to 70 ships and if it simply shut down and sold the ships, equity holders would have gotten around $16.5 per share. To be short, the axiom “what goes up must come down” holds for cyclical businesses and soon sales started to pick up and the stock rallied up to $140 per share.

The fairy tale in the equity investment world doesn't happen that often.

Although not quite the same, a very similar situation is happening right now with Macy's Inc. (M).

I certainly don't believe that the department store has a strong macroeconomic trend behind it like Frontline had, but Macy's has an interesting portfolio of real estate that is worth looking into.

Macy's portfolio

As of the beginning of 2020, Macy's had 839 total stores, of which 342 were company-owned. The following table summarizes some of the major geographic presence for company-owned locations:

According to Macy's most recent investor presentation, class A properties and freestanding, off-mall locations constitute about 50% of the portfolio and make up 66% of total sales.

Moreover, it has new developmental projects in Burlington Mall in Massachusetts, a prime location with a $250 million value and 1.5 million square foot office tower above the invaluable Herald Square store. There are more upcoming projects in San Francisco's Union Square and Geary Street Shops as well.

The value of the portfolio

Starboard Value, a hedge fund that works with deeply undervalued companies, proposed to separate its real estate assets from the retail operations by spinning off a real estate investment trust. By doing so, it valued the whole real estate portfolio at around $20.7 billion.

The following table summarizes the properties' valuations.

Furthermore, Starboard valued the credit card business at $8 billion, Bluemercury at $1 billion and the retail business at $4 billion.

In early 2017, investor Bill Zettler went even further and compared the company with successful REITs such as Simon Property Group Inc. (SPG, Financial), whose portfolio of real estate is quite similar to that of Macy's in both size and substance. For instance, both companies have class A retail properties. Simon Property has about 160 million square-feet in property, while Macy's has about 80 million square-feet as of September 2017. At that time, Simon Property had an enterprise value of around $77 billion. So essentially, he may be implying that if we value its credit card business, Bluemercury and the retail business as worth a penny, the real estate business alone should, with all other things being equal, at least have an enterprise value of around $19.25 billion if we assume all of Simon's properties and 50% of Macy's properties are class A.

In a late 2017 study, investment bank Cowen valued the properties at $16 billion.

My estimation of portfolio value

While I'm not a real estate expert, I don't need to be one to determine a rough estimate of the property value.

We can try to estimate it by using the financial statements.

Macy's reported property, plant and equipment equalled $7.6 billion in 2016 and $6.6 billion in 2019. In the meantime, $1.74 billion worth of property was sold. So the market value of PP&E in 2019 would be 1,743 multiplied by 6,633 and then divided by (7,616-6,633), which is $11.7 billion. According to management, Macy's divested of its worst-performing properties, so that makes $11.7 billion an absolute floor value for the current real estate.

Conclusion

So the bottom line is what is the implication for the stock price?

With a current market cap of around $2 billion, it not hard to see that it is way below our floor value of $11.7 billion, which set the credit card business, Bluemercury and the retail business at zero.

And then there's the iconic Herald Square flagship property. Located in Manhattan covering over 2,500,000 square feet, in normal times, it is valued around $3 billion to $4 billion, which is 50% to 100% higher than its current total market cap.

I know there are lots of short-term hurdles to overcome as just a few days ago the company hired Kirkland & Ellis to restructure its debt as short-term obligations are almost $4 billion.

As both long-term and short-term credit ratings have already been lowered by rating agencies, it will be a once in a lifetime challenge for the current management team.

This will definitely have a negative effect on the stock price in the short term.

But for a value investor, even with these short-term concerns, it is not so hard to see that the stock will bump up again.

Disclosure: I don't own any of the stocks mentioned and do not have the intention to own in the near future.

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