Macy’s: Ample Room for Earnings Upside and Multiple Expansion
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Recently, Macy's Inc (NYSE: M) announced its 2Q12 EPS of $0.67, which exceeded consensus estimates of $0.64 and 22% above 2Q11 EPS of $0.55. Macy’s continues to gain market share from struggling retailer JC Penney (NYSE: JCP) which posted 22% SSS decline in the second quarter as opposed to the 3% SSS gain posted by Macy’s. Going into Q3, the company also has a better SSS momentum with better July sales trends as compared to Nordstrom (NYSE: JWN) which is one of its key competitors. Macy’s July SSS growth of 4.1% was well above Nordstrom’s 0.9%. Macy's continues to gain market share despite a slow macroeconomic environment, weaker international tourist spending and the company's renovation of its Herald Square, NY, flagship store. The strongest categories during the quarter were watches, handbags, cosmetics, textiles, furniture and mattresses. The South and North were the strongest performing regions during the quarter, but Macy’s also experienced strong sales performance in Oregon, Cleveland and Colorado.
As we discussed in our previous article (See Macy’s: Consistent yet Undervalued), Macy’s has been a consistent performer in the past and we expect the company to post good results in the future too. We believe Macy’s strong free cash flow generation, market share gains and upward estimate revision potential make it a good investment. The following are some other positives that make us bullish on this stock.
Sales momentum continues and inventory in check
Macy’s same store sales gain of 3.0% in 2Q12 was balanced across the country but was especially strong in the South. The company has been executing well when it comes to inventory management. Inventory levels were up 1.8% and significantly below total sales growth of 3.0%. In addition, AUR was up 8% in the spring.
Encouraging signs in women’s apparel and Juniors Business
Although women's apparel remains a difficult category across all department stores, Macy's saw improvement in its Juniors business during 2Q. We view this as an indication that the company's three-year millennial strategy, designed to drive 13-30 year old customers into its stores, is working. This bodes well for Macy’s heading into the back-to-school selling season. In 2Q, Macy’s also saw encouraging trends in some of its private-label women’s classic business, including Charter Club (Macy’s recently retooled this brand) and Karen Scott. Overall, we are encouraged by improving trends in the otherwise struggling women’s apparel segment.
Although the company has raised its annual guidance by $0.05 to $3.30-$3.35, we believe there is still room left for upside. We expect sales outperformance to drive positive EPS revisions. The company may achieve gross margin upside from higher penetration of private/exclusive brands and Omnichannel rollout. We expect lower product costs to drive 2H merchandise margin improvements and more than offset rising shipping costs from Omnichannel growth. In addition, Macy's has potential for more top line momentum from expansion of the Bloomingdale's outlet and online businesses.
Macy’s is trading at a forward P/E of 10.03 against a peer group average of 13. Even JC Penney is trading at a higher valuation than Macy’s. Thus, we believe the market is under appreciating Macy’s continued market share gain potential, as well as the retailer’s best in class FCF yield and ability to buy back shares. In addition to earnings upside we see potential for multiple expansion as Macy’s transitions from a debt pay down to a capital allocation story. We recommend it as a good long term investment.
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