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Should You Follow David Einhorn Looking For The Magic Of Macy's?

Summary

Several investors wonder whether the magic of Macy's is still there.

Other investors are debating with themselves about whether to buy Macy's after Einhorn added to his position a few months ago.

Truth is that Macy's is working hard to pull off a successful turnaround and bounce back from an ugly performance in 2015.

On that front, Macy's is betting on slimming down while also evaluating the idea of monetizing part of its real estate portfolio to improve its fundamentals.

Nevertheless, Macy's upside potential at $44.5/share doesn't lure me to initiate a long position because from a risk/reward perspective, I have much better picks on my watchlist.

Introduction

I have been following the consumer goods sector very closely over the last four years. And this is why I suggested the subscribers to my Premium Research short Restoration Hardware (NYSE:RH) at $105/share in November 2015. Just three month later, Restoration Hardware stands at $39/share and my bearish article is here.

Actually, Restoration Hardware's ugly fundamentals were not the only reason behind my bearish approach. Over the last years, I have noticed that jittery American shoppers gradually switch to a more frugal mindset while flocking to online and/or small-format, bargain stores for their shopping therapy. The consumer goods sector is in a transitional phase, and this is why CEO Terry Lundgren has been trying to find a formula that could save Macy's (NYSE:M) from a rather dismal future tied to large, mid-priced department stores and restore it to its glory days.

Truth is that Macy's stores have a much better welcoming feel to them relative to Sears Holdings' (NASDAQ:SHLD) outdated stores where it feels somewhat repelling. But the way it feels wasn't the key reason why I recommended investors short Sears at $26/share in September 2015. Back then, Sears' fundamentals were awful. Sears currently stand at $16.5/share and my bearish article is here.

After all, where does Macy's stand from a fundamental perspective? What's the company's upside potential at $44.5/share? Or to say it differently, does Macy's at $44.5/share have the same downside potential as Sears Holdings at $26/share and Restoration Hardware at $105/share? This is what I am going to analyze in the next paragraphs.

Macy's At A Glance

Numbers speak volumes and the table below shows Macy's at a glance over the last four years:

FY 2015

(ended 1/31/16)

FY 2014

(ended 1/31/15)

FY 2013

(ended 1/31/14)

FY 2012

(ended 1/31/13)

Revenue

($ Billion)

27.08

28.1

27.9

27.7

Operating

margin (%)

7.5

10

9.5

9.5

Net Income

($ Billion)

1.07

1.5

1.5

1.3

Net Debt (*)

($ Billion)

6.5

5.1

4.9

5.1

Free CF

($ Billion)

0.89

1.74

1.76

1.4

(*): Interest-bearing debt minus cash & cash equivalents.

Also, in fiscal 2015, the company repurchased approximately 34.8 million shares of its common stock for approximately $2.0 billion, while paying a quarterly dividend of $0.36/share that currently translates into an annual yield of 3.25%.

And this is Macy's stock market performance over the last two years:

Obviously, investors unloaded their shares because they didn't like the mix of increasing net debt, collapsing free CF, thin margins and decreasing profitability that started to become evident in late 2015. Or to say it differently, the increasing net debt coupled with the plunging free CF in 2015 far outweighed the dividend, the revenue stability and the company's hefty buyback program in this evolving retail landscape.

In addition, Macy's didn't fully fund its dividend and its hefty buyback program in 2015 through free CF. In 2015, Macy's funded a big portion of its dividend and buyback program through debt. This is the cold hard truth. And as such, if I owned Macy's, I would definitely sell my shares looking for greener pastures.

The Initiatives And The Strategy For 2016

Fierce competition and strong dollar aside, the unexpectedly warm weather as a result of El Nino coupled with changing shopping habits are the key reasons behind the company's dismal results and ugly performance. Surprisingly enough, the American consumers purchased last year new vehicles at levels not seen since prior to the Great Recession and refrained from shopping during the key Back-to-School shopping season. And of course, an increasing trend for online shopping which accounted for 7.5% of U.S. retail sales in Q4 2015, resulted in sluggish mall traffic throughout the second half of 2015.

To turn things around and evolve in this challenging retail landscape, Macy's has taken several key initiatives over the last months. It announced licensed department arrangements with companies including Luxottica's (NYSE:LUX) LensCrafters, Men's Wearhouse (MW) and Best Buy (NYSE:BBY) to add new categories to the Macy's store assortment. It acquired Bluemercury, which added capabilities to its signature beauty business. It debuted its new discount concept called Backstage in an effort to compete with off-price chains like Ross Stores (NASDAQ:ROST) and the TJX Companies (NYSE:TJX) which are very popular with value-oriented shoppers who enjoy the treasure hunt-like experience.

Meanwhile, the mobile enhancements started to bear fruit and the sales via mobile devices more than doubled in 2015 while becoming the fastest-growing component of the company's business.

Furthermore, Macy's will continue its international expansion both in China, Kuwait and UAE. In China, it recently began testing of online selling on Alibaba's (NYSE:BABA) web shopping portal Tmall.com projecting approximately $50 million in online sales in China in 2016. Macy's is the first U.S. department store to join Alibaba's Tmall Global. In Kuwait, it will open a new Bloomingdale's store in...


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