Macy's: Still Not Out Of Woods

Introduction

Earlier this month, Macy's (M) reported their first-quarter earnings which were sub-par but not surprising. The company had already pre-leased its headline numbers ahead of this disclosure, this disclosure had an additional significant one-time $3.1 bn non-cash goodwill impairment charge and $80 mn long-lived asset impairment charge as a result of COVID-19. As highlighted in several of my previous articles, Macy's woes predate the current COVID crisis and they have been facing several structural challenges. We have already looked at how Macy's padded its balance sheet with smart real estate and inventory transactions to weather through the storm.  As such, We focus on the long term sustainability of the business going forward in the post-COVID world. Key takeaways from the management following the release were:

Long Term Employee Restructuring

On June 25, Macy's announced a long term employee restructuring plan slashing 3,900 jobs in corporate and management roles and thereby saving an additional $365 mn in costs in 2020 (~$630 mn on an annualized basis) to adjust for weaker sales demand. Mind you, this is on the top of the 2,000 job cuts (~9% of employees) already announced during the Investor day presentation in February. The company had already announced a $1.5 bn in run-rate savings by 2022 through cost-containment measures involving job cuts, marketing expenses, and others. We believe the management expects sustained degrowth of 8% in sales beyond 2020 ($630 is 8% of 2019 SG&A expenses excluding non-cash charges).

Management's Forecasts for Store Productivity

Management noted that Macy's are currently operating at ~65% productivity with the management taking a conservative view and forecasting similar levels through the back of the year. It also noted that places where the COVID-19 cases spiked up recently, the likes of Arizona and Texas, the productivity declined a further 15% to ~50%. It also expects $0 sales in international tourism (which formed 4% of 2019 sales) for the rest of the year and a larger impact on its flagship and urban center stores which are at a higher risk with local neighborhood stores outperforming. The silver lining was the expectation of digital sales growth in high teens for the fall season as customers continue to shift to online shopping as the pandemic continues with full-year digital sales growth to be around low to mid-teens.

Margin Pressure

While the company has shown progress moving to the digital front, this is not likely to translate into better margins factoring in the added shipping, logistics, and fulfillment costs. Most of the retailers from the likes of Walmart (WMT) and Costco (COST) to Amazon (AMZN) have been known to grapple with a common challenge of margins sacrificed for digital sales. And as Macy's embark on the journey to boost its digital presence, the margins will remain under pressure due to digital growth along with the merchandising discounts which would follow.

Outlook

We had recommended an entry point in this stock at a level of $5 back in April and had recommended an exit at $10 post the massive run-up witnessed amidst the euphoria of the economy reopening leading to a massive 100% gain. The stock currently trades a little under $7 per share with its long term support of 50-DMA placed some 30 cents below the market price. We believe the sales and margin face a downside risk going forward and the current environment does not warrant long term investors to click the buy button on the stock. We would remain on the fence for now and ascribe a NEUTRAL rating on the stock with a price target of $7.5 per share at 3x EV/ 2021 EBITDA.

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