Consumer Goods: Why Macy’s Is a Great Retail Income Stock *** INDUSTRY FOCUS ***


Sean O’Reilly: We’re going shopping for
consumer goods dividends… on this CG edition of Industry Focus. Greetings Fools, I am Sean O’Reilly here in studio at Fool headquarters in Alexandria
Virginia. It is Tuesday, November 17th and this week is dividend week on Industry Focus.
Vincent Shen is out today and filling in for him and joining us on the phone from the Windy
City, Chicago Illinois, is Motley Fool contributor Adam Levine-Weinberg.
Morning, Adam and how’s it going? Adam Levine-Weinberg: I’m doing well, how
are you Sean? O’Reilly: Not too shabby. I’ve got my
coffee, got my water, ready to talk some dividends, it’s all good.
Levine-Weinberg: That sounds great. O’Reilly: So Adam I talked to you a few
days ago about today’s show, and once again thanks for filling in for Vince. And you’re
willing to dive right into the carnage of the retail sector for some reason I’ll never
understand. You picked Macy’s for a great consumer sector
dividend stock, which I happen to agree with and we’ll get into the reasons why in a
few. Before we get into the new gritty of Macy’s as an income stock, can you just
give listeners some perspective as to what’s been going on in the retail sector? Because
last week alone was a bloodbath. Levine-Weinberg: Yeah that’s right, Sean.
Retail stocks really got hit hard last week and Macy’s was definitely one of the big
reasons for that. Macy’s stock peaked in mid-July at $73.61. But since then it’s
fallen by nearly 50% and as of this morning it’s below $39.
So a lot of that drop has happened in just the last week or two after its Q3 earnings;
which were already expected to be pretty bad, were even worse than that. And the company
is seeing strong, big sales declines. But the result of this is that the quarterly dividend
is still $.36 and so the annual yield which in the middle of July was a little under 2%,
is now 3.7%. And that really makes Macy’s an intriguing stock at least for dividend
investors. O’Reilly: Yeah that is just crazy. Because
that’s more than a 30-year treasury right now. I mean these are higher than bonds in
the U.S. Government. So what’s going on with the business?
Because you and I did a, you were very gracious enough to call in a number of months ago and
we talked about Macy’s then as well. And we both, I think were, I mean their returns
on equity, their shift to doing the online and the stores, it was all just awesome. They
were clearly the strongest player especially compared to a JCPenney or a Sears. What’s
going on with the fundamentals? Because long-term I think the story’s intact.
Levine-Weinberg: Yeah so obviously you wouldn’t want to invest in Macy’s just because of
the high dividend yields if you really thought that the business was in grave danger. Because
sooner or later if you’re not making money, have to cut the dividends and then as income
year after year. O’Reilly: Then game over.
Levine-Weinberg: You’re out in the cold. There’s no guarantees to dividend. The company
can stop it at any time. Though looking at Macy’s, last quarter their
comparable store sales, so that’s sales in stores that have been open for at least
a year, declined 3.6% from the prior year quarter. And Macy’s is expecting another
decline on comparable sales for about 2% across the full year.
So that’s definitely not good and Macy’s has definitely seen a trend in the past 2
to 3 years of slowing comparable store sales gains. But this is the first time in quite
a while, really since the Great Recession that you’ve had a year-long […] decline
in comp sales. On a year-to-date basis, Macy’s EPS is $1.56
or $1.76 excluding some asset impairments and that’s down year over year. Last year
it was $2 and a penny. And Macy’s current guidance fiscal year implies that you’ll
see that some of its decline continued into the 4th quarter. Again excluding any gain
from asset sales or special items. But you have to put this in the broader context because
Macy’s has come out of a six-year streak of double-digit EPS growth.
So it’s not like this is a company like you mentioned, Sears, JCPenney, where there’s
been a lot of struggle. There, a few bad quarters could be a really bad sign. For Macy’s,
the company’s basically been doing well until this year. And so it’s worth looking
[…] to see why it’s not doing well in 2015 and whether it might be able to recover.
O’Reilly: Yeah, so they’ve got this shift to where they’re trying to meet consumers
in cyberspace as well. I mean, they built that huge distribution facility which as I
understand it and I’ve talked about it before, they built it in Oklahoma and I’m pretty
darn sure it rivals an Amazon warehouse. Like it’s top of the line, it cost them $3-4
million and it was it. Is online sales balancing these declines in physical stores at all?
Levine-Weinberg: So Macy’s a couple of years ago stopped reporting its online sales separately.
And it had for a long time just reported the gross numbers for online sales without necessarily
breaking out the exact dollar amounts. But as of a few years ago they were already at
$2 billion and rising by at least 20% a year. And a in a lot of years they’re rising like
40%. So they’re actually growing their online business faster than Amazon for quite some
time. O’Reilly: That’s an achievement in itself
I would think. Levine-Weinberg: Yeah, and so that’s definitely
a big business for them. But it’s still smaller than the retail stores and the comp
sales figures that I was discussing earlier, that actually includes the online.
So you can, that’s if the online is still growing at a healthy clip and if the retail
is declining even faster. And so that’s creating some need to kind of rebalance and
figure out a new strategy to get the most value out of the stores that are in the network
right now. O’Reilly: So comps are dropping, they’re
projecting decline in earnings for this year. What are they doing to recover?
Levine-Weinberg: So Macy’s is basically going after this with a multi-prong strategy.
So the first thing is they’re trying to explore some new growth avenues beyond the
traditional department store and even beyond the online component of its traditional department
store business. So one thing that they’re doing is they bought the Bluemercury chain
which is sort of luxury fashion or beauty stores. More boutique size. So quite small
compared to a department store. And they are building more of those standalone
Bluemercury stores and at the same time they’re putting Bluemercury boutiques into existing
Macy’s department stores to make better use of space and to boost sales in the beauty
department of each Macy’s store. They’re also testing Macy’s Backstage which is a
new off-price concept. So it’s like a T.J. Maxx or a Nordstrom Rack.
O’Reilly: I was about to say that’s reminiscent of Nordstrom’s Nordstrom Rack and that’s
been a huge success. Levine-Weinberg: Yeah and Macy’s has already
been in that business to some extent because they also own the Bloomingdale’s chain which
is upscale relative to Macy’s. And Bloomingdale’s has a chain of outlet stores. So Macy’s
is trying to sort of move that more into the mass-market now. And it’s just a test at
the moment, but they are really talking about rolling that out more broadly over the next
few years. And Macy’s is even testing an e-commerce
joint venture in China. So they have a bunch of different things that they’re trying
which will hopefully add more growth. At the same time they also need to focus on getting
costs down to be more in line with the sales they’re seeing today.
So the company announced last week as part of its earnings report that they’re cutting
their SG&A spending by about a half billion dollars relative to their prior plan. And
that will be implemented by 2018. So you’ll see incremental improvements in their selling
cost over the next few years. As part of that they’re closing 35-40 stores in early 2016
and plan to continue closing stores that are underperforming.
O’Reilly: Now those are essentially, sorry to interrupt, low traffic, unprofitable stores
obviously not the big ones in urban areas. Levine-Weinberg: Right. That’s true for
the most part. There are some stores in urban areas where they’re closing the store not
because it’s unprofitable, but because the real estate is so valuable that they can make
more money by selling the building to someone who wants to redevelop it. But in most cases
yeah, the stores that are closing are the ones that are in the lower performing malls
where there’s just less traffic. Maybe these are malls where JCPenney’s or
Sears had a store which closed and so now there’s fewer people coming to the mall.
And you know there’s been a problem in the U.S. for quite some time that there’s just
too many malls relative to how many people want to go to the mall these days. And so
this is just a process that’s going to continue for a while with paring down to a number of
stores that’s more in line with today’s reality, where you don’t actually need to
go to the store for every single purchase. Some things you might just want to buy online.
O’Reilly: Got it. Well before we move on, no go ahead.
Levine-Weinberg: Go ahead. theme, I wanted to point our listeners to
a special article written by five industry focus contributors detailing their top picks
for dividend stocks. Just head to to learn our picks for the best dividend stocks
of 2016. Once again that’s So Adam, getting back to Macy’s, I was talking
a little bit about the dividend sustainability in the context of the cost cuts and everything,
and actually their growth potential. Because if they aren’t growing that dividend will
not last for long. Levine-Weinberg: Sure. So if you look at the
annual payout, it’s now $1.44. And that’s up from just $.20 during the Great Recession.
So you can see that Macy’s really has been increasing its dividends quite rapidly in
the past few years. So $1.44 is about 40% of Macy’s projected EPS for this year excluding
any asset sale gains or special items. So that’s a pretty good payout ratio.
It means that you’re getting a good proportion of the income but it’s not so high that
you’d have to worry that a small blip in earnings would make the dividend too high
to afford for Macy’s. On a cash basis Macy’s has generated operating
cash flow of about $2.2 billion over the past 12 months. And the current dividend payout
comes to roughly $450 million annually. So this means that Macy’s has really plenty
of cash to cover its planned capital expenditures which it’s reducing to under $1 billion
a year going forward. And still have a lot of money left over for dividends and also
for some share buybacks. And just like if it were able to get its profit
margins back to last year’s model, see who could boost its cash flow, because if you
look at its operating cash flow which is $2.2 billion in the past 12 months just a year
ago it was $2.7 billion. So there’s definitely some opportunity just in doing the retail
basis a little bit better. And Macy’s is also likely to bring in a lot of cash from
selling off real estate. Either real estate in stores where it doesn’t want to operate
a store anymore, or in some cases it could be really large stores in urban areas like
New York, Chicago, and San Francisco where the stores are so massive that you could sell
off the upper floors of those stores, bring in a lot of money, and still keep most of
the sales because you’d have a lot of space left.
So Macy’s is actually working with a real estate company to identify potential deals,
both for these flagship stores in those three cities I mentioned, as well as a few other
stores. And while those proceeds might get distributed through buybacks rather than dividends,
the faster Macy’s can reduce its share count the less it has to pay out in dividends for
any given dividend rate. Which means it can basically raise its payout faster.
O’Reilly: Yeah, on a per share basis. Yeah. Levine-Weinberg: Yeah, exactly.
O’Reilly: So for Foolish investors you’ve made a lot of great points. What’s the bottom
line, the conclusion that Foolish investors or just our listeners can go to check out,
do their own research, but that you want them to know?
Levine-Weinberg: Yeah so I think the main take away here is that Macy’s has suddenly
become a high-yielding stock with a 3.7% dividend yield. And the payout ratio remains quite
modest. And beyond that Macy’s profitability should improve going forward due to its cost
cuts, attempts to sell off real estate, and that leaves a lot of room for dividend growth
in the future. O’Reilly: Awesome. Well, thank you for your
thoughts and I can’t thank you enough again for filling in for Vince, Adam.
Levine-Weinberg: You’re very welcome. O’Reilly: Have a great day. That is it for
us Fools. If you are a loyal listener and have questions or comments we would love to
hear from you. Just email us at [email protected] Again that’s [email protected]
As always people in this program may have interests in the stocks they talk about and
the Motley Fool may have formal recommendations for or against those stocks. So don’t buy
or sell anything based solely on what you hear. For Adam Levine-Weinberg, I am Sean
O’Reilly. Thanks for listening and Fool on!


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