The past week has been painful for retail giant Macy's (NYSE:M). Investors saw the value of their shares plummet despite the department store chain delivering solid second quarter earnings and raising its full year guidance.
The embattled retailer reported on August 15 that comparable store earnings, including business in departments it licenses to third parties and its e-commerce segment, rose 0.5%, beating the 1% drop Wall Street had expected. Macy’s also raised its full year sales growth forecast to between $3.95 and $4.15 a share, excluding some items.
Growth, however, comes at a cost for this retailer. Macy’s executives warned that gross margins are expected to decline in the second half of the year compared with the first half, on higher costs associated with the company’s new loyalty program.
Still, beneath the surface there's solid evidence that Macy’s turnaround plan remains on track and is already showing positive results. The company’s spending to improve its digital presence—by adding more local merchandise and refreshing in-store fixtures—is helping to bring in more store traffic even while boosting online sales.
In the second quarter, Macy's digital sales rose by 10%, for the 36th straight quarter. The retailer expects to exceed $1 billion in mobile sales this year.
Right now, Macy's is just one of the two department store chains that let customers check prices on its app, track order history, do visual searches for products and also chat with customer representatives. The strength of its e-commerce activity shows that the retailer is well-positioned to defend its turf against much bigger rivals Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT) and Target (NYSE:TGT).
Winning Turnaround Formula
Chief Executive Officer Jeff Gennett’s winning formula—a healthy bricks-and-mortar business, robust e-commerce and a great customer experience via mobile—has all the necessary ingredients to sustain the company’s turnaround momentum. On the bricks-and-mortar front, Macy’s has taken a number of concrete steps that are improving the sales outlook.
It closed many of its non-profitable locations and is selling some of its valuable real estate to generate cash. Its Growth50 initiative, a plan to revamp some of its stores with new merchandising efforts and improved fixtures and facilities, has been a success. It also lays the groundwork for a broader restructuring of the business.
The company is also investing heavily in its Bluemercury chain of specialty beauty stores as well as its discount outlet, Macy's Backstage.
From a macro perspective, the environment looks very supportive for Macy’s to continue on this upward growth trajectory. With the currently strong employment situation and attendant wage growth, consumers should continue to spend more.
Bottom Line
Macy’s bears may view all this differently. For them, the company’s turnaround strategy might not be dynamic enough to ensure the store's long-term survival, given the massive disruption that’s taking place in the retail space.
If that theory is correct, then this is probably the right time for investors to cash out after a massive rally in the retailer's share price over the past one year. Even after the 14% plunge on the day of of its earnings report, Macy’s shares are still up over 100% in one year, having bounced back from their five-year low or $18.37 reached in late October.
At $38.24 as of last night's close, Macy’s stock is trading at about 11 times earnings, with a 4% annual dividend yield. This valuation looks compelling if you compare this price-to-earnings ratio with other retailers, such as Ross Stores (NASDAQ:ROST). and Nordstrom (NYSE:JWN) which have P/E ratios of 24.20 and 20.25 respectively.
That said, we think Macy’s stock already reflects all the positive news from its first round of fixes, which were relatively easy to make. Entering in the game when Macy’s stock is trading close to the 52-week high is highly risky. For those who already own this stock, we don’t think this is the right time to book gains. A healthy consumer spending environment and the company’s turnaround strategy are likely to fuel more gains in the second half of this year.