Smart Money Says Macy's Stock Is Too Cheap (NYSE:M) (2024)

Introduction

Generally speaking, I am very happy with the way most of my calls have unfolded in the past 12 months (and before that).

Nonetheless, I need to start this article by admitting I was wrong on Macy's, Inc. (NYSE:M), a stock I have been neutral on for a while.

After I wrote my most recent article on November 16, titled "Macy's Stock Pops Higher, Yet I Doubt It Will Last," the stock took off. It's now 56% higher after I wrote this:

Although a post-earnings stock price surge occurred, a sustainable consumer recovery is key for a cautious investor like me, which is why I am maintaining a Neutral stance on Macy's.

While I was not bearish (I could have been even more wrong), the stock was propelled higher by takeover interests, which just went into a higher gear - although the stock price chart still looks horrible when zooming out.

Hence, in this article, I'll reassess the new situation, explain why Macy's has been doing so well, what takeover talks are about, and what this may mean for investors.

So, let's dive into the details!

A Higher Offer After An Initial Rejection

Last year, I wanted to avoid the company, as I didn't trust the state of the consumer and because I (generally speaking) dislike the risk/reward of consumer-focused stocks - at least in the lower-income segments.

As it turns out, others disagree, as Macy's is dealing with takeover interest.

On March 3, the Wall Street Journal wrote an article titled "Investors Raise Macy's Buyout Bid," which explains the recent stock price boost.

According to the report, an investor group, consisting of Arkhouse Management and Brigade Capital Management, is boosting its bid for Macy’s after the company rejected their initial offer.

The new proposal is $24 per share, which translates to $6.6 billion.

This is a significant increase from their previous bid of $21 per share, which Macy's received roughly four months ago, on December 1.

After receiving the offer, Macy’s noted that its board would review it, which is one major step in the right direction, as the prior bid was deemed not compelling enough for shareholder value.

The Macy’s, Inc. Board will carefully review and evaluate the latest proposal consistent with the Board’s fiduciary duties and in consultation with its financial and legal advisors. The Macy’s, Inc. Board has a proven track record of evaluating a broad range of options to create shareholder value, is open-minded about the best path to achieve this objective and is committed to continuing to take actions that it believes are in the best interests of the Company and all Macy’s, Inc. shareholders. - Macy's (Emphasis Added).

What's interesting is that Arkhouse has nominated no less than nine candidates for the company's Board, as it believes it will be able to unlock a lot of potential for shareholders.

Founded in 1858, Macy's may be old and far from a fancy tech stock. However, it offers value potential, as it takes just a small improvement in margins to unlock a lot of bottom-line growth.

Macy's is well aware of this, which is why it isn't necessarily keen on being bought.

Sure, $24 may be a >30% premium compared to Friday's closing price.

However, its stock price is still very low compared to the historical prices the company was trading at when it had substantially higher operating margins.

Hence, Macy's is working on a major overhaul, which brings me to the next part of this article.

Macy's Quest To Unlock Shareholder Value

One last thing I want to mention from the Wall Street Journal article is that it mentioned a very important aspect. Essentially, it's the reason why I couldn't get myself to turn bullish on the stock.

As most of my readers may know, the retail landscape, particularly for department stores like Macy’s, has been a minefield due to intense competition and changing consumer behavior.

So far, several major players, including JCPenney, Neiman Marcus, and Lord & Taylor, have filed for bankruptcy, as secular issues were met by very weak consumer sentiment when post-pandemic inflation started to accelerate.

As we can see below, while consumer sentiment has rebounded, it is mainly led by higher-income consumers. Especially poorer consumers are struggling in this environment, as they have not benefited from the rise in asset prices (stocks, hard assets, etc.) while they did suffer from higher consumer prices.

The middle class is in better shape, yet their sentiment is at 2009-2010 levels as well.

In light of these challenges, Macy's is working on a massive transformation to modernize its business, including closing underperforming stores, improving remaining locations, and focusing on Bloomingdale's and Bluemercury stores, two brands that have done relatively well within the past.

Macy's calls all of this "A Bold New Chapter."

Furthermore, one can imagine that the company isn't eager to sell its business when it has high hopes for a transformation that could potentially elevate its business to the next level.

With that said, in addition to improving the Macy's nameplate through better customer service, a revitalized assortment, and a better shopping experience, the company plans to close roughly 150 stores.

This includes its flagship store in San Francisco, a city that has been dealing with elevated crime levels for a while.

The proceeds are expected to be $600 to $750 million.

Macy's believes that by reallocating these resources and optimizing its store portfolio, it can improve square footage productivity and better serve its customers while maintaining a healthy balance sheet.

After cutting less promising stores, like the one in San Francisco, the company will be left with roughly 350 stores, which it will use to implement its new strategies to improve the customer experience.

With that in mind, the company is applying a strategy that does not come as a surprise: a bigger focus on wealthier customers.

As I already briefly mentioned, the company plans to accelerate growth in its luxury segments, Bloomingdale's and Bluemercury, by expanding into new markets, optimizing digital offerings, and investing in customer experience enhancements.

According to the company, Bloomingdale's and Bluemercury are positioned as leaders in identifying trends and brands, which provides the company with accessible and aspirational products, elevated customer service, and an improved omnichannel shopping experience.

The trend to luxury is accelerating, as consumer-focused companies are finding out that richer customers are much more resilient - especially in this environment.

This reminds me of a Tweet I wrote last month.

We are truly in a divided economy, where companies like Dollar General (DG) and even strong consumer defensive stocks like PepsiCo (PEP) are slowly running into pricing power issues.

Meanwhile, companies like Ferrari (RACE) and LVMH (OTCPK:LVMHF) are doing very well, as consumers who can spend hundreds of thousands on cars and handbags do not care if inflation is elevated.

To give you another example, in this environment, it is possible to invest $1 million with minimal risk at 5.3%. That's $53 thousand in annual income.

Nobody in the middle or lower class can compete with that, which is why we are witnessing a bigger divergence between higher and lower-income consumer stocks.

According to Macy's:

To close out the discussion on luxury, we have a high degree of confidence in the Bloomingdale's and Bluemercury and nameplates which are healthy, accretive and have strong investment profiles. Now is the time to capitalize on this momentum, and we expect these investments that we are making will fuel sales growth and margin expansion. - M 4Q23 Earnings Call.

At the end of fiscal 2023, the company operated 33 Bloomingdale's, three Bloomies, and 21 outlets. Over the next three years, Macy's aims to open a combined total of 15 new Bloomies and outlets across both new and existing markets.

Bluemercury operated 159 locations at the end of the fiscal year. The company plans at least 30 new Bluemercury store openings and remodeling approximately 30 others over the next three years.

What's interesting is that most online sales are in regions with physical stores, which opens up new opportunities.

Macy's aims to deliver a more efficient operating model by rationalizing and monetizing its supply chain assets, streamlining fulfillment, improving inventory planning and allocation, and using technologies to scale its operations.

As we can see below, by 2026, the company aims for roughly a quarter of a billion in annual run-rate savings, with $100 million in 2024 cost savings.

It also helps that Macy's has $1 billion in cash and no major debt maturities until at least 2028.

This buys the company a lot of time in this market. That's valuable time that some peers with weaker balance sheets may not have.

While I believe that the transition makes sense, I have doubts about the focus on luxury.

As much as I respect the company's luxury brands, they are not the kind of luxury that is doing very well in this market. It's what I would call middle-class luxury. This market is still prone to economic weakness to a degree that we won't see among major luxury brands like LVMH.

Although the company's rebranding strategy may certainly unlock a lot of value, from an investor's point-of-view, it's not a company I want to own when looking for more "bulletproof" consumer exposure.

Guidance/Shareholder Value

2024 is expected to be a transition year, which makes sense in light of what we just discussed.

For the current year, the company expects net sales in the range of $22.2 to $22.9 billion, representing a 1% to 4% decline compared to 2023.

It expects to keep its margin decline limited and report at least $0.10 in adjusted diluted EPS.

The company also has a vision for 2025 and beyond, which includes its goal for annual O+L+M comp sales growth in the low single-digit range, which indicates a strategic shift towards driving top-line growth.

Please note that O+L+M stands for "owned, licensed, and marketplace."

Additionally, Macy's anticipates annual SG&A dollar growth to remain below the historical rate of inflation, which would allow it to gradually improve margins.

As a result, the company targets annual adjusted EBITDA dollar growth in the mid-single-digit range.

With that said, using the data in the chart below, analysts expect Macy's to generate $2.30 in adjusted EPS in its 2027 fiscal year.

The company has a normalized EPS multiple of 10.1x going back to 2004. Using this multiple, we get a fair price target of roughly $23.30, which is $0.70 below the current takeover bid.

Generally speaking, it seems that analysts are expecting the turnaround to take time, which would make the $24 offer a fair deal.

However, if Macy's is upbeat about its future, I believe it will either push for a higher price or reject the deal again.

If the company finds a path to $3.00 in EPS in the years ahead, it could trade north of $30.

Having said all of this, I'm applying a Buy rating, as I believe the takeover attempt could unlock more value in the mid term.

Unfortunately, I cannot make the case that this is a high-conviction rating, as the takeover is far from a done deal. Especially if Macy's rejects the offer, it will have to prove that its turnaround works.

In this environment, that's not an easy task.

Nonetheless, I'm rooting for the company and believe it may be pushing for a better deal than the $24 offer that's now on the table.

Takeaway

Despite my neutral stance on Macy's in the past, I've changed my mind.

The company's rejection of the first buyout offer reflects its confidence in its ability to transform and unlock shareholder value.

Macy's strategic shift towards luxury segments like Bloomingdale's and Bluemercury, along with store closures and operational optimizations, indicates an aggressive move in a challenging environment.

While the new $24 per share offer may seem tempting, it's crucial to consider Macy's long-term potential, especially as it targets improved margins and top-line growth on a consistent basis.

As an investor, I cautiously give Macy's, Inc. stock a Buy rating, based on the uncertainties surrounding the takeover bid and the potential for enhanced value in the mid term.

Pros & Cons

Pros:

• Value potential: Macy's presents value potential, with the possibility of unlocking significant bottom-line growth through even minor improvements in margins.
• Transformation strategy: The company's transformation strategy, including store closures, operational enhancements, and a focus on luxury segments like Bloomingdale's and Bluemercury, shows a commitment to revitalizing its business.
• Cash position and debt: Macy's strong cash position of $1 billion and no major debt maturities until at least 2028 provide financial stability.

Cons:

• Economic uncertainty: Despite its transformation efforts, Macy's faces challenges from ongoing economic uncertainty, mainly in light of changing consumer behaviors and competition.
• Luxury focus: While the emphasis on luxury segments offers growth opportunities, it also exposes Macy's to potential risks associated with middle-class luxury, which may not be as strong as major luxury brands in volatile economic conditions.

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