Macy’s Earnings: Lowered Outlook on Waning Spending Overshadows Positives; Shares Undervalued

Macy’s M missed sales expectations in its first quarter as weather and economic issues damped demand. Further, as consumer spending on apparel remains uneven and as discounting will be needed to move seasonal inventory, the firm reduced its 2023 outlook. Specifically, it now anticipates adjusted EPS of $2.70-$3.20, down from $3.67-$4.11 previously and our $3.87 estimate, with most of the shortfall coming in the second quarter. As we expect to adjust our forecast to be closer to the guidance, our $27 per share fair value estimate should fall by a mid-single-digit percentage. Even so, we view Macy’s shares, trading at a mid-single-digit P/E and offering a 5% dividend yield that we view as secure, as attractive. Although we rate it as a no-moat retailer given the challenges facing department stores, we think Macy’s valuation reflects a high level of pessimism as we anticipate annual free cash flow generation of nearly $1 billion after 2023.

Macy’s (owned) comparable sales dropped 8% in the first quarter, worse than our forecast of a 5% decline. Despite the sales miss, its gross margin was 40%, an increase of 40 basis points and 60 basis points above our estimate. The gross margin performance reflects the progress the firm has made in controlling its inventory and costs, although we think more work in this area is needed.

Due to the gross margin result, Macy’s 4.7% operating margin beat our forecast by 70 basis points, and its $0.56 in EPS was $0.08 better than our estimate. Current guidance is for second-quarter EPS of just $0.10-$0.15, but we anticipate stronger results in the second half of the year after excess inventory is sold and discounting moderates. In the long run, despite our forecast for negligible sales growth, we think Macy’s can achieve gross and operating margins of 38.5% and 6.5%, respectively. To achieve these marks, the firm will need to step up its efforts to upgrade its private-label offerings, improve its store operations, and cut costs.