Macy’s Navigating Tough Environment Reasonably Well; Stock Attractive

Macy’s Stock at a Glance

• Current Morningstar Fair Value Estimate: $27
• Macy’s Stock Star Rating: 4 stars
• Economic Moat Rating: None
• Moat Trend Rating: Negative

Macy’s Earnings Update

Macy’s M closed 2022 with fourth-quarter results that were in line with our expectations, a positive result given excess inventories across the apparel retail industry and softening consumer spending amid high inflation. No-moat Kohl’s, in contrast, posted an unexpected loss for the period due to large discounting. While Macy’s guidance for 2023 of a comparable sales decline of 2%-4% and EPS of $3.67-$4.11 is shy of our respective flat and $4.27 expectations, the shortfall is marginal given the state of the market. Indeed, Macy’s shares rallied by about 10% on the report, leaving them roughly 15% below our $27 fair value estimate, which we do not expect to change. Although we rate Macy’s as a no-moat firm in the challenged department store space, we also believe it has strengths, including its loyalty program of 30 million members, its partnerships with popular brands, and large e-commerce of about $8 billion per year (about one third of sales).

Against a tough comparison, Macy’s fourth-quarter owned same-store sales fell 3.3%, slightly better than our forecast of a 4.2% drop. More importantly, its gross margin on net sales was 34.1%, 60 basis points above our estimate. We think Macy’s did a better job of managing its inventory than competitors like Kohl’s and no-moat Gap in 2022, allowing it to limit discounting and putting it in better position for 2023. Macy’s expense control was also fair despite higher wages, leading to an 8.2% operating margin that bested our estimate by 80 basis points. In the long run, we project its yearly operating margins around 6%, comparable with prepandemic levels.

Macy’s shares trade at just 5 times its 2022 adjusted EPS of $4.48 due to its lack of sales growth and sizable debt, but we believe the latter is very manageable. Although it closed the year with debt of $3 billion, less than 10% of it matures in the next five years. In addition, it had $862 million in cash on hand after generating $457 million in free cash flow in 2022.