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Macy’s: 5%+ Dividend Yield and Trading Well Below Book Value

Published by Nicholas McCullum on May 12th, 2017

The retail industry is undergoing a seismic shift right now because of new competitive pressures from e-commerce companies. Technology conglomerate Amazon (AMZN) is leading the charge.

Because of these difficulties, the stock prices of many retail stocks have been driven down – which increases dividend yields.

Macy’s (M) is an example of this. The stock’s $0.3775 quarterly dividend yields 5.9% on today’s stock price of $25.80. This makes Macy’s a member of the unique group of publicly traded securities with 5%+ yields, ideal for retirees and other income-oriented investors.

You can see the full list of 295 established 5%+ yielding stocks here.

Further to Macy’s attractive dividend yield, the company ranked as a Top 10 Stock using The 8 Rules of Dividend Investing in the most recent edition of the Sure Dividend Newsletter. The company’s high dividend yield & attractive valuation make it appealing from a number of perspectives.

This article will analyze the investment prospects of Macy’s in detail.

Business Overview

Macy’s was founded in 1858 and has since grown to be one of the nation’s largest retailers with fiscal 2016 sales of $26 billion, a market capitalization of $9 billion, and ~140,000 employees.  The company’s long corporate history makes it a member of the blue chip stocks list.

The company operates more than 700 stores under the Macy’s and Bloomingale’s brands, as well as ~125 specialty stores under the Bloomingdale’s The Outlet, Bluemercury, and Macy’s Backstage brands.

Macy’s operates in four core segments:

Current Events

Macy’s stock price suggests the company is fighting for its life, as it has declined by nearly 20% over the past year.

This stock price decline is partially driven by sentiment – Macy’s saw revenues decline by 5% and earnings-per-share decline by 18% in fiscal 2016. Both fundamental metrics declined by less than the company’s share price.

Looking ahead, the company’s adjusted earnings-per-share in 2017 is expected to be in the range of $2.90 and $3.15. This represents a decline of just 2.7% using the midpoint of the guidance range.

Macy’s also reported first-quarter earnings on May 11. Adjusted earning-per-share in the quarter were $0.24, which compares unfavorably to the $0.40 of adjusted earnings-per-share in the same quarter a year ago. This 40% decline in adjusted earnings-per-share has driven Macy’s stock downwards by almost 13% in the first day of trading after the earnings announcement.

Investors should be happy to see that Macy’s sales were not hit nearly as hard in the quarter. The company reported first quarter sales of $5.338 billion, which is a decrease of 7.5% over the $5.771 billion of sales in the same period a year ago. This sales decline was driven by both store closures and a 5.2% decline in comparable same store sales.

Altogether, this was not a good earnings report for Macy’s. Many other retailers – including Target (TGT) and Wal-Mart (WMT) – have seen their stock prices drop on fears that these companies will be affected by similar consumer trends.

With that said, certain areas of Macy’s business are beginning to show promise. The company’s previous investments into categories like women’s shows, fine jewelry, and furniture are growing and justifying the company’s previous commitment to these new product categories.

Further, Macy’s is continuing to see strong growth in its digital platforms. Though the company did not break out digital sales from the rest of its financial results, experience double-digit sales growth in 2016 and a similar rate of growth was likely present in the quarter.

By many measures, Macy’s operating business appears to be in decline. Fortunately for investors, the company has a tremendous value proposition right now based on its high-quality real estate assets alone.

Real Estate Value

In January of 2016, activist investment firm Starboard Value published a presentation called “Unlocking Value at Macy’s” where the firm outlined the surprising underlying value of Macy’s real estate.

At the time, the firm had held a ~$100 million stake in Macy’s since July 2015. Starboard’s thesis can be seen below.

M Starboard Value Executive Summary

Source: Starboard Value: Unlocking Value at Macy’s, slide 4

Starboard estimated that Macy’s real estate was estimated to be $21 billion at the time – more than both the company’s market capitalization and enterprise value.

Starboard’s recommended approach to unlocking this value was to break Macy’s real estate holdings into two (or more) “Joint Ventures” which would help attract the best rent tenants for Macy’s quality real estate assets. It would also result in a cash infusion for Macy’s operating business, as Macy’s would no longer own the real estate it occupies.

The two joint ventures recommended by Starboard are a ‘mall properties’ venture and an ‘iconic properties’ venture. The second entity would hold Macy’s largest and most recognizable locations – most notably, the company’s 2 million square feet Herald Square headquarters.

M Starboard Value Executive Summary Continued

Source: Starboard Value: Unlocking Value at Macy’s, slide 5

Looking at Macy’s portfolio (at the time) in more detail, we see that Macy’s was collecting $10 of net rent per square foot off of $166 in value per square foot. This represents a cap rate of 6% – which, accordingly to Fundrise, is a fairly typical cap rate for commercial properties.

M Starboard Value Macy's has the largest and most valuable real estate portfolio in the department store space

Source: Starboard Value: Unlocking Value at Macy’s, slide 8

Based on cap rate, Macy’s appears to be collecting adequate income from its real estate holdings.

However, there is the potential for much more value to be unlocked if the company sells its real estate.

Starboard modeled that at Macy’s then-valuation, the actual operating business was trading at a substantial ($10 billion) negative valuation.

M Starboard Value On a sum-of-the-parts basis, Macy's represents a compelling value story

Source: Starboard Value: Unlocking Value at Macy’s, slide 6

Despite Starboard’s robust investment thesis, the fund exited their position in Macy’s in March of this year. This begs the question – does Macy’s still have the same real estate value as when Starboard published their presentation?

Some research can help to answer this question.

First off, investors should note that Macy’s has been actively managing its real estate portfolio for some time. The company realized $673 million of real estate sales in 2016 alone.

These divestment efforts were helped along when Macy’s formed a strategic alliance with Brookfield Asset Management last November. Brookfield is a global alternative investment manager focused on real assets, and one of the only companies with the capital (~$250 billion of AUM) and operating capabilities to truly unlock the value of Macy’s real estate.

Here’s what the Macy’s CEO had to say about the company’s partnership with Brookfield:

“We have real estate assets with significant value creation opportunities, and we believe that partnering with a leading global real estate investor like Brookfield is the best way to unlock the potential of those assets. The Brookfield alliance strengthens our ability to improve the customer shopping experience by giving us greater flexibility to invest in our most productive and highest-potential locations, and to make the most of our real estate assets, or portions of them.” – Terry J. Lundgren, Macy’s Chairman & CEO

The Brookfield partnership tells investors that Macy’s will continue to be focused on optimizing the value of its real estate holdings. However, it does not help investors understand the underlying value of Macy’s current holdings.

More information about Macy’s real estate activities can be seen in the company’s first-quarter financial statements. Looking at the company’s consolidated balance sheet, we see that the carrying value of Macy’s properties is $6.9 billion.

Macy's Consolidated Balance Sheet

Source: Macy’s First Quarter Earnings Release

For context, Macy’s current market capitalization is $7.8 billion. Given that:

  1. Macy’s real estate has likely appreciated in value above its carrying value
  2. Macy’s has other assets (cash and inventory, most notably) beyond its real estate

Then it is highly likely that Macy’s is trading below its intrinsic value.

However, Macy’s has a large amount of debt, which partially offsets the per-share value of the underlying real estate. Macy’s reported $4.3 billion of shareholders’ equity and 306.9 million diluted shares outstanding at the end of the first quarter, which is good for a book value per common share of $14. Macy’s is currently trading for $25.80 – a surprising premium to its book value, given its low forward price-to-earnings ratio (7.7).

This can be explained by looking at the carrying cost of Macy’s real estate. As mentioned, the company reported real estate assets of $6.9 billion at the end of the quarter – though the company could likely sell these assets for substantially more than carrying value.

For example, in the quarter where Starboard Value estimated that Macy’s real estate was worth $21 billion, the carrying value of this real estate was only $7.5 billion. Starboard believed that Macy’s could sell its real estate for nearly three times carrying value, and a similar multiple is likely achievable today (more than a year later) although the carrying value has decreased slightly due to asset sales.

From a transaction basis, Macy’s continues to be highly active. The company announced real estate transaction proceeds of $96 million and booked $68 million of real estate gains in its first quarter. Most of these gains ($47 million) were related to the sale of Macy’s Downtown Minneapolis property.

Macy’s also announced that the company is under contract to divest two floors of its Downtown Seattle location. This comes after selling four floors of the building (floors five through eight) back in 2015. The transaction is expected to close in fall of 2017.

Altogether, the value of Macy’s real estate appears to be still intact and remains one of the biggest reasons why this stock is attractive. Management is intelligently focusing on selling assets above carrying value and using these transactions to unlock shareholder value.

Competitive Advantage & Recession Performance

Macy’s competitive advantage comes from its profitability in the highly competitive retail space.  While many of its competitors are bleeding cash, Macy’s generated $1.2 billion of free cash flow in 2016 with a return on invested capital of 18.5%.

Macy’s managed to remain profitable throughout the global financial crisis of 2008-2009, though it saw adjusted earnings-per-share decrease by 41% and cut its dividend by 38%. Macy’s saw a new level of peak profitability (and improved dividend income) three years later.

With that said, Macy’s current investment thesis is centered on value, not recession resiliency. Macy’s represents more of a ‘cigar butt’ investment (to borrow a term from Warren Buffett), not a hold-for-the-long-term investment like some Dividend Aristocrats or Dividend Kings.

Valuation & Expected Total Returns

Macy’s future shareholder returns will be driven by valuation changes, dividend payments, and growth in earnings-per-share.

Quantitatively, Macy’s is currently trading at a remarkably low valuation (7.7x the bottom of 2017’s expected earnings guidance band) based on fears that its business model will be permanently disrupted.  If Macy’s can improve its operations and return to growth, it is highly likely that Macy’s valuation will experience a significant upwards revision.

With regard to earnings growth, Macy’s compounded it’s adjusted earnings-per-share by 3.8% between 2006 and 2016. Looking ahead, there are two possible scenarios for Macy’s earnings growth.

In the first scenario, Macy’s returns to growth and earnings-per-share continue to grow at a similar 3%-5% clip.

In the second scenario, Macy’s cannot battle the competitive challenges posed by new market participants such as Amazon, and eventually, goes bankrupt. In this scenario, investors are likely to see permanent loss of capital.

Accordingly, Macy’s represents a ‘binary’ investment opportunity where the two possible outcomes are very, very different.

In either case, Macy’s total returns will be boosted by the company’s exceptionally high dividend yield. The company’s current quarterly dividend of $0.3775 is good for a yield of 5.9% based on today’s stock price of $25.80. For context, the S&P 500’s dividend yield is currently 1.9%, meaning that investor generates more than three times as much portfolio income from an investment in Macy’s than an investment in an S&P 500 index fund.

If the first scenario is realized, a best-case scenario would result in expected total returns of:

For expected total returns of 8.9%-10.9% before the effect of valuation changes. It is likely that Macy’s valuation would expand significantly in this scenario, and investors could potentially realize total returns in the mid-to-high double-digit range thanks to valuation expansion.

In the second scenario, investors would realize negative total returns. Macy’s high dividend would not make up for its declining earnings-per-share and plummeting stock price. With that said, it is likely that Macy’s would be able to harvest the underlying value of its real estate and return capital back to its shareholders in bankruptcy court if this unfortunate series of events were to occur.

Final Thoughts

Quantitatively, Macy’s appears to be a very attractive investment right now.

The company’s high dividend yield and low price-to-earnings ratio help it to rank very favorably using The 8 Rules of Dividend Investing.

With that said, Macy’s is not as safe as some of the companies analyzed on Sure Dividend. Macy’s is a binary investment opportunity right now – the company will either turn its operations around and investors will realize substantial upside, or it will slowly crumble into bankruptcy over the course of many years.

Investors should keep this in mind before initiating or adding to a position in this high yield, low valuation retail stock.

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