With the holiday season in full force, it’s likely that many of you have browsed your fair share of shopping aisles. Now this could – and likely does - mean any one of a variety of retailers. Yet Cincinnati, Ohio based Macy’s (M) and this time of year tend to go hand-in-hand – after-all it’s not just called the “Thanksgiving Day Parade” but rather the “Macy’s Thanksgiving Day Parade.”
With sales nearing $30 billion under the Macy’s and Bloomingdale’s brands, Macy’s operates over 800 stores in 45 states. Over 175,000 people are employed by this department store and as of late they’re doing a solid job – improving earnings per share in each of the last 15 consecutive quarters.
With this performance comes commensurate shareholder rewards. For instance, Macy’s has reduced common shares outstanding from about 546 million in 2006 to today’s number closer to 368 million – an impressive 5% yearly decrease. In addition, the company has about $1.75 billion remaining of its current share repurchase authorization or about 9% of the company’s current market capitalization.
On the dividend front, it is true that the payout record has been a bit spotty. For instance, the company cut the dividend significantly in 2009 and kept it frozen at a reduced rate for 2010. However, more recently Macy’s has been doing a good job of increasing the payout – moving from 20 cents in 2010 to today’s payment of $1.00. Still, despite this multi-year string of increases, the company is only paying out about a fourth of its expected year-end earnings – projected to be in the $3.80 to $3.90 range.
Interestingly, although all company boards are theoretically incentivized to act on behalf of shareholders, Macy’s has a specific policy in place to promote this. According to the company’s guidelines, Board members are required to hold common stock that is equal to 5 times their direct Macy’s compensation. Although nothing can guarantee a pursuit of the shareholder’s best interest, this seems like a pretty good place to start.
Additionally, the most recent earnings call appeared to offer an upbeat view towards the upcoming quarter. Chief Financial Officer Karen Hoguet had this to say:
“So while we are very satisfied with our performance in the third quarter, all eyes at Macy's and at Bloomingdale's are now focused ahead to the fourth quarter. And we are very excited about what we see for the holiday season. We feel especially prepared this year.”
Yet none of this is to suggest that the company is without risks. As seen in the last recession, earnings can fall, the dividend can be cut and the market might act emphatically. Furthermore, the inherent switching costs for customers are effectively negligible - meaning that Macy’s has to continuously innovate and draw customers in to their stores. With that, let’s turn to the past operating history of the company.
13 Years of Growth
Macy's has grown earnings (orange line) at a compound rate of 7.1% since 2001, resulting in a $19+ billion dollar market cap. In addition, Macy's earnings have risen from $1.57 per share in 2001, to today’s forecasted earnings per share of approximately $3.84 for 2013. As described, Macy’s dividend (pink line) has been up and down, but increasing as of late.
For a look at how the market has historically valued Macy's, see the relationship between the price (black line) and earnings of the company as seen on the Earnings and Price Correlated F.A.S.T. Graph below.
Here we see that Macy's market price previously began to deviate from its justified earnings growth; starting to become overvalued in 2007 and coming back to fair value during the most recent recession. Today, Macy's appears fairly valued to slightly undervalued in relation to both its historical earnings and relative valuation.
In tandem with the strong earnings growth, Macy's shareholders have enjoyed a compound annual return of 7.4% which correlates closely with the 7.1% growth rate in earnings per share. A hypothetical $10,000 investment in Macy's Inc on 12/31/2000 would have grown to a total value of $25,207.44, without reinvesting dividends. Said differently, Macy's shareholders have enjoyed total returns that were roughly 1.6 times the value that would have been achieved by investing in the S&P 500 over the same time period.
But of course – as the saying goes – past performance does not guarantee future results. Thus, while a strong operating history provides a fundamental platform for evaluating a company, it does not by itself indicate a buy or sell decision. Instead, an investor must have an understanding of the past while simultaneously thinking the investment through to its logical, if not understated, conclusion.
In the opening paragraphs a variety of catalysts and risks were described. It follows that the probabilities of these outcomes should be the guide for one’s investment focus. Yet it is still useful to determine whether or not your predictions seem reasonable.
Twenty-one leading analysts reporting to Standard & Poor’s Capital IQ come to a consensus 5-year annual estimated return growth rate for Macy's of 12.7%. In addition, Macy's is currently trading at a P/E of 13.6, which is inside the “value corridor” (defined by the orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Macy's valuation would be roughly $105 at the end of 2018, which would be a 16.6% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator below.
Now, it’s paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for next two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company. However, a F.A.S.T. Graphs’ subscriber is also able to change these estimates to fit their own thesis or scenario analysis.
Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk treasury bonds. Comparing an investment in Macy's to an equal investment in a 10-year treasury bond, illustrates that Macy's expected earnings would be 5.0 times that of the 10-year T-Bond Interest. This comparison can be seen in the 10-year Earnings Yield Estimate table below.
Finally, it’s important to underscore the idea that all companies derive their underlying value from the cash flows (earnings) that they are capable of generating for their owners. Therefore, it should be the expectation of a prudent investor that – in the long-run – the likely future earnings of a company justify the price you pay. Fundamentally, this means appropriately addressing these two questions: “in what should I invest?” and “at what time?” In viewing the past history and future prospects of Macy's we have learned that it appears to be a strong company with reasonable upcoming opportunities. However, as always, we recommend that the reader conduct his or her own thorough due diligence.
Disclosure: No position at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.