Given Macy's focus on its balance sheet and improving fundamentals, we think it will continue to generate cash and use it to predominantly favor financial health over growth.
Jeremy Glaser: For morningstar.com, I'm Jeremy Glaser. Believe it or not, holiday shopping season is almost upon us again and a lot of shoppers may be heading to Macy's, but should investors be looking at their bonds? I am here today with securities analyst Joscelyn MacKay to take a deeper look. Joscelyn, thanks for joining me.
Joscelyn MacKay: Thanks for having me.
Glaser: So there's been a lot of talk about how Macy's has been struggling for a while after they re-branded all of the stores. How has that been going?
MacKay: We think the firm is definitely on its way to turnaround. After an ill-timed share repurchase as we headed into the downturn, Macy's balance sheet is in much more stable shape, thanks to this restructuring effort that they have been implementing. The firm eliminated jobs, cut operating expenses and rolled out a merchandising effort called My Macy's, which is focused on localization.
Glaser: How is that remerchandising effort going?
MacKay: We expect the merchandising effort to lead to modest top-line growth in 2010.
Glaser: So it's something that's really starting to move, but people obviously have a ton of different choices when they are shopping for apparel. Who is Macy's really competing with now? Is the shopper going to Wal-Mart or they are going someplace else?
MacKay: Macy's shopper isn't going to Wal-Mart, in our view. The main competitors are the usual suspects Kohl's and J.C. Penney, but Macy's also really competes with the mid-tier fast-fashion boutique shops.
Glaser: So places like H&M or Zara. How can Macy's really compete against those? Have they been successful competing against them?
MacKay: We think so. We think Macy's size and national presence should give the firm some advantage over these smaller store chains and niche players. Mall developers need those anchor stores to hold on to flagging traffic, which benefits this chain like Macy's.
Glaser: So, Macy's might be able to use their competitive advantage to try to gain even more traction. You mentioned that the balance sheet is stronger now than it had been before. What's the overall financial health picture for Macy's.
MacKay: We think Macy's financial health is getting better for sure. Thus far in 2010, the firm has proven its commitment to improving its balance sheet, using excess cash flow to pay down debt and abstaining from share repurchases. In addition, the firm reduced its pension liability by $325 million earlier this year.
Glaser: They seem to be moving in the right direction. Are there any credit opportunities, any bond opportunities that investors might want to take a closer look at?
MacKay: We think so. Given the company's focus on its balance sheet and improving fundamentals, we think Macy's will continue to generate cash and use it to predominantly favor financial health over growth. As such, we think its bonds trade much wider for a company with these improving fundamentals and expect spreads to tighten with this positive financial news.
Glaser: Are there any potential pitfalls that investors should look out for?
MacKay: With Macy's bonds in particular, a lot of them are structured very differently. Some have call protection, other don't. Call protection will be very important for an investor, thinking that the company might prepay some its notes, as Macy's has.
Another would be a change in control. In this environment where a lot of companies are being speculated as takeout candidates, I would look to some of Macy's bonds that maybe do have a change of control protection if that's what you are concerned about.
Glaser: So, there might not be a lot of chatter about Macy's right now.
MacKay: Sure.
Glaser: But you never know if that's going to pick up in the future.
MacKay: Sure.
Glaser: All right. Joscelyn, thanks for insights today.
MacKay: Thank you very much.
Glaser: For Morningstar.com, I'm Jeremy Glaser.
