Macy's: The Market Is Too Pessimistic

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I want to revisit Macy’s (NYSE:M) as it gets punished by the market due to the recession (debatable as the definition gets changed). The American icon is on sale and deserves a better stock price. It managed previous recessions pretty well and outperformed for the last few quarters. The dividend offers a nice income while I wait for a recovery.

M data by YCharts

My last article about Macy’s dates from December 2021, and the stock is down 32%, underperforming the S&P 500 (down 16.4%). As you can see on the chart, M couldn’t hold the immense gains after excellent quarterly results. The stock continued to publish results above expectations, but the share price hasn’t profited since, on the contrary.

Growth

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Macy’s doesn’t expect much growth in 2022. It targets 0% to 1% growth. There is, however, a large shift in sales. Digital sales accounted for 25% of total revenue in 2019. In 2022, Macy’s expects more or less the same total revenue, with 35% from digital channels. That’s why activists also pushed to separate the growing online channels from the brick and mortar. An unlikely scenario as they are supportive of each other and probably impossible to separate.

It seems unlikely that Macy’s can grow revenue significantly in the future. It can expand its EPS and dividends by generating enough free cash flow to continue buybacks.

Free Cash Flow Generation

Fundamental Chart data by YCharts

Macy’s free cash flow of $2.3B in 2021 is unsustainable. It spent only $354M on Capex and expects to increase Capex to $1B yearly for the next three years. An FCF margin of 4.5-5.5% is reasonable as we advance. It targets a $3.2B-$3.6B FCF over three years. Macy’s has almost no SBC, so there is no need to adjust FCF.

Shareholder Returns

Macy’s interrupted its dividends in 2020 and resumed payments in September 2021. The dividend is now lower than in 2020, at $0.1575 quarterly. Macy’s yields a decent 3.39% dividend and targets 5% annual dividend growth. It starts off at a low payout ratio and can easily maintain dividend growth for a long time.

Macy’s also launched an open share repurchase program for up to $2B for opportunistic buybacks. There was $1.4B remaining on April 30, or ~25% of its current market cap. Another quarter with large buybacks would make sense at the current prices. The buybacks will slow down as it plans to increase Capex and can’t keep dedicating $600M per quarter to buybacks. There should remain room for buybacks, though the current dividend is $45M per year, and the FCF should be north of $1B.

The buybacks also support further dividend growth as there are fewer shares to receive dividends.

Balance Sheet

Macy’s worked on significant debt reduction over the past year. It used the high free cash flows to get debt at a comfortable level and kept paying down debt over the last quarter.

Data by YCharts

It has a targeted leverage of <2.5 DEBT/EBITDA and is well below 1.8. The financial position of Macy’s is excellent

Cheap Valuation

Data by YCharts

I made a similar graph in December and wrote,

These metrics include the below-par fourth quarter of 2020. If Q4 2021 is comparable to 2019, then Macy’s is inexpensive. If Q4 is better than 2019, then it’s very cheap.

As I expected, Macy’s Q4 was better than expected and performed decently the next quarter. Even if earnings and free cash flow go a bit down, which can be expected as Capex increases and the economy slows, the company is still cheap. Analysts expect $4.52 EPS in 2024; the P/E would be 4.

A return to its previous valuation averages offers at least 100% upside, potentially even 300% upside.

My Price Target Increases On Lower Share Count

My last price range was $41.8-$52 or $46.9 at the midpoint. I also made a free cash flow prediction:

This would bring total free cash flow to ~$1.7B for 2021.

I was far off as it generated $2.27B in free cash flow after an outstanding fourth quarter.

Free cash flow will be lower beyond 2021. Management wants to increase capital expenditures to $1B. My forward free cash flow expectations are below 2021.

I’ve slightly adjusted my expectations. They are based on a 4.5%-5.5% FCF conversion and the low end of Macy’s revenue prediction. I now expect somewhere in the $1.1B – $1.35B range for 2022. If I apply a 16 EV/FCF, the EV would be $17.6B-$21.6B. Macy’s debt has been reduced. It now has $5.4B in net debt, so the market cap is $5.4B lower. Outstanding shares also decreased and will probably reduce further.

My price range is $43.1-$57 or $50 at the midpoint. Any upside surprise increases the price potential immensely for Macy’s.

Risks

The current economy could lead to lower revenues in the next few quarters. Macy’s has relatively thin margins and would have significantly lower net income and free cash flow. The company experienced rough times before in 2020 and 2009. The results were disastrous, but the company survived every time. It’s in good shape with reduced debt, and its results have remained satisfactory.

M Revenue (Annual) data by YCharts
M Revenue (Annual) data by YCharts

Both recent recessions show a similar path for Macy’s, revenue declines and net income slumps, but FCF remains relatively positive. The company manages these rough patches pretty well. It did, however, cut its dividend in both periods. A cut could happen again to preserve cash. I don’t think it’s likely as the current dividend payout ratio is low (11% of GAAP earnings, 9% of FCF).

Conclusion

I’m still convinced of what I wrote last time,

I see these multiples come down a lot after the fourth quarter. Based on my estimates, there is ~70% upside.

The upside is even bigger as the share price declined and the outstanding shares reduced significantly. I expect more buybacks at these prices and a continued dividend policy.

It will probably take more than the next quarter’s earnings for the stock to turn around again. The recent earnings beat estimates but didn’t move the stock. The market seems to be focusing on the economic outlook rather than the last quarter; I find it impossible to predict when this sentiment changes.