Preliminary 2018 holiday retail sales reports were pretty good. Widely followed reports from Mastercard and Adobe both pegged the 2018 holiday season as being a record one, powered by healthy labor conditions, rising wages, strong credit and continuing red-hot growth in the digital segment. As a result, retail stocks rebounded in a big way at the end of December and into January. During that two week stretch, the SPDR S&P Retail ETF (NYSEARCA:XRT) rallied 15%.
As it turns out, though, the 2018 holiday season wasn’t a big success for everyone in retail. Case in point: Macy’s (NYSE:M). The department store stalwart reported holiday numbers in early January that came in well below expectations, forcing the retailer to cut its full-year revenue and profit guides. In response, Macy’s stock dropped 20% to below $30.
It’s hard to argue against the drop. Macy’s holiday numbers weren’t good, and it is becoming increasingly clear that this is not the same company it was even a few years ago. Other retailers are adapting better to today’s dynamic retail environment. Meanwhile, M finds itself somewhat in the gray area of decent prices and decent quality, but doesn’t dominate in either category. That lack of dominance equates to a lack of moat — and that is why consumers are so easily forgetting about Macy’s.
As such, the qualitative narrative here is troubled.
But that doesn’t mean Macy’s stock is doomed. Instead, despite the troubled qualitative narrative, this is still a department store giant that has staying power due to its scale, convenience and affordable prices. That long-term staying power implies stable revenue and earnings power over the next several years.
Such stability isn’t priced into Macy’s stock (now below $30), meaning this dip offers an interesting opportunity for contrarian investors.
Macy’s Holiday Numbers Don’t Spark Much Confidence
The plain and simple here is that Macy’s holiday numbers weren’t good. While peer Target (NYSE:TGT) — which has been actively developing multiple omni-channel sales strategies — reported a 5.7% comparable sales increase during the holiday period, Macy’s holiday comp increase was just 1.1%. That’s bad, and it speaks to just how slow Macy’s has been in adapting to today’s retail environment.
Moreover, the 1.1% rise marks a significant slowdown from the typical 3%-and-up adjusted comps Macy’s has reported all year long. Thus, the sales trajectory is worsening, not improving. Also, margins must’ve been hit in the quarter, because management not only revised its full year comparable sales growth guide down, but also pushed its margin and profit guides lower, too.
As of three months ago, this was a positive-revenue-growth company with expanding gross margins and a stable opex rate. Now, revenue growth is expected to be flat this year, gross margins are expected to be down, and the opex rate is expected to rise.
None of that is good news.
However, there was one positive takeaway from the holiday report. On a two-year stack basis, comparable sales growth during the holiday period was actually as good as it’s been all year. Through the first three quarters of 2018, comparable sales growth was running around 3% and up. But, the laps were in the -2% to -5% range, so the two year stack comp was never greater than 0.4%.
Holiday 2018 comparable sales rose 1.1%, on top of a 1.1% gain last year. Thus, on a two-year stack basis, comparable sales rose over 2%. That’s markedly better than the year-to-date trend and provides some relief and hope for bulls.
Macy’s Stock Is Reasonably Undervalued
The decline in comparable sales growth as the lap got tougher in 2018 implies that this isn’t a growth company. But improvement in the two-year stack comp does imply that the company has long-term staying power, since it implies sales on a two-year basis are actually fairly stable.
This lines up with common sense. Macy’s is a big retailer. Sure, the company is old and hasn’t adjusted all that well to the digital era, but it has a huge presence, wide reach, competitive prices and offers all-in-one convenience. As a result, while these stores aren’t doing more business than ever, they also aren’t going away any time soon.
In terms of modeling, that implies tepid sales growth over the next several years alongside flattish margins. That combination strongly implies that Macy’s long-term earnings power should stabilize somewhere around $4 per share. The market won’t pay a big multiple for that. Historically, Macy’s stock trades around 11 times forward earnings.
Let’s say $4 per share is sustainable in five years. That implies a $44 price target in four years. Discounted back by 10% per year, that implies a price target today of $30.
Thus, under $30, Macy’s stock looks reasonably undervalued — even under the assumption that revenues and earnings are simply stable over the next several years.
Bottom Line on M Stock
Macy’s holiday report was ugly, and not the sort of report that gets bulls excited. But, below $30, all you need for Macy’s stock to work is stability in the company’s operations and profits over the next several years. That seems doable, making this dip look like a contrarian buying opportunity.
As of this writing, Luke Lango was long M and TGT.