Macy's Q2 results: Weak sales and credit card risks mean trouble (NYSE:M)

introduction

The department store Macy’s, Inc. (NYSE:M) Management may regret its decision to break off takeover talks with Arkhouse Management, which had offered to buy all outstanding shares for $24.80. Since the shares are now The share price is more than 35% below the offer value and has fallen a further 9% since the earnings results. The missed opportunity is obvious.

Although earnings numbers looked pretty good and earnings per share beat expectations, below-consensus revenue and a cut in guidance drove shares lower. In April, I recommended selling Macy's shares on concerns that rising credit card delinquencies could hurt Macy's prospects. So far, I've been right to avoid the stock, as it has lost 19% since then, significantly underperforming the S&P 500 (SPY), which returned 11%.

Despite the decline, I still rate the stock as sell. In this article, I want to provide an update on the stock, discuss the latest results, and explain the reasons why I think Macy's stock could fall even further.

Second quarter results

Macy's released its second quarter results on August 21^stwhich showed a mixed performance. Net sales were $4.9 billion, down 3.7% year over year and missing expectations by $110 million. This decline was due to continued weakness in sales of men's clothing, handbags and home goods, only slightly offset by stronger sales of fragrances. On a comparable store basis, own-store sales declined 4%.

Despite the revenue decline, the company reported adjusted EBITDA of $438 million and non-GAAP earnings per share of $0.53, beating estimates by $0.24. This came after gross margins increased 2.4% year over year to 40.5%.

Across Macy's three main brands, the namesake department store chain saw sales decline 4.4 percent. This came as Macy's continued to close stores, increasing the planned number of closures this year from 50 to 55. Despite Macy's goal of increasing its luxury sales through the expansion of its Bloomingdale's chain, net sales in this segment declined 0.4 percent year over year and -1.4 percent on a comparable store basis.

Credit card revenue was $125 million for the quarter, up slightly by 4.2% year over year. I've written before about the importance of this revenue to Macy's, as it is part of a profit-sharing arrangement.

Although this represents only 2.7% of net revenue, it is almost entirely profit because it is a profit-sharing arrangement with the partner bank, representing 46% of EBIT of $1.34 billion for the year ending February 2024. Any decline in this revenue, whether due to a cap on late fees or rising delinquencies, represents a significant revenue hit for Macy's, and I believe this profit risk is currently being overlooked by the markets.

Although credit card revenue increased in the quarter, Macy's expects third-quarter credit card revenue to decline to $110 million, a decline of over 22% year over year. With record levels of credit card debt and weakening consumer sentiment, rising credit card delinquencies and the possibility of a cap on late payment fees, although currently on hold, this particularly lucrative revenue stream could be at risk. Falling consumer sentiment and rising delinquencies point not only to lower credit card revenue, but also to a generally weaker consumer base, which could lead to a decline in Macy's revenue in the coming quarters.

In response to the weaker consumer outlook, Macy's lowered its guidance for the remainder of the fiscal year. Net sales are now expected to be in the range of $22.1 billion to $22.4 billion, compared to the previously forecast range of $22.3 billion to $22.9 billion. Adjusted diluted earnings per share remain at $2.55 to $2.90.

Overall, Macy's second-quarter results highlight the challenges the company is facing. While the quarter showed operational improvements with gross margin growth and earnings per share that were above expectations, continued sales declines and signs of a weaker consumer base highlight the difficulties Macy's is facing.

Turnaround plan

Like any company facing headwinds, Macy's has put together a turnaround plan called “A Bold New Chapter.” The plan calls for Macy's to close over 150 of its stores and focus on expanding its more upscale Bloomingdale's and Blue Mercury chains. Combined with investing in smaller locations and freeing up capital by selling off portions of its real estate portfolio, it's almost the standard retailer restructuring plan.

That won't work. Over the past five years, Macy's revenues have fallen from $28.1 billion in the year ending January 2015 to $23.9 billion in the year ending 2023. This decline is currently expected to continue in the coming years. Profits have also fallen. Net income was $110 million in 2023, the lowest since 2010, with the exception of 2020, when revenues were hit by the pandemic.

The problem is that Macy's faces the problems of a struggling department store business while also facing the challenges of any other retailer. There is strong online competition from companies such as Amazon.com, Inc. (AMZN) and Wayfair Inc. (W), as well as newer fast-fashion competitors such as Shein and Temu. These fast-fashion brands offer ultra-low prices and respond quickly to changing consumer preferences. They target not only low-income earners, but also Macy's traditionally higher-earning clientele. Those with annual incomes above $130,000 account for about 44% of Temu's sales. Combined with the challenge from traditional brick-and-mortar stores such as department stores Nordstrom, Inc. (JWN) and Kohl's Corporation (KSS), as well as other retailers such as The TJX Companies, Inc. (TJX), Macy's operates in an extremely competitive environment. Ultimately, the question is why consumers should shop at Macy's when they can get the products cheaper elsewhere.

In addition, Macy's physical stores are outdated and do not attract younger customers. While the company wants to expand its luxury sales, especially through its Bloomingdale's chain, those same luxury goods companies want to sell their products directly to consumers. If shoppers are looking for a luxury experience when shopping, would they prefer to shop at Macy's or the brand's own store?

While I applaud Macy's attempts to optimize its real estate portfolio, selling stores is not a panacea. While it may free up capital in the short term, it exposes Macy's to rising rent payments, which could limit its ability to invest in the future.

Evaluation

Macy's currently trades at a price-to-earnings ratio of 5.5, well below the overall market and slightly below its five-year historical average. This pricing suggests that the market is skeptical that Macy's can execute on its turnaround plan and grow earnings in the face of declining sales and intense competition. Analysts currently forecast further declines in sales and earnings over the next two years, with rising risks from competition, a weaker consumer, and a decline in lucrative credit card revenue. However, I believe earnings could decline even more than expected. Given the expected earnings decline and negative outlook, I assign a sell rating to the shares. Unless Macy's can demonstrate a clear path to stabilize and turnaround its business, the stock's valuation will likely remain under pressure.

Risks

Although I remain pessimistic about Macy's, as with any thesis, there are risks that could drive the stock price higher.

One risk is that Macy's remains a potential takeover target despite the company's difficulties. Arkhouse Management's $24.80 per share tender offer underscores the potential institutional investors believe Macy's and its assets have. With interest rates falling, financing a deal could become easier, making a takeover more likely.

Another risk to my thesis is the possibility that Macy's begins to leverage its real estate portfolio, which includes flagship locations such as Macy's Herald Square. If the company pursues a strategy to create value through sales, leaseback sales, or redevelopments, it could generate significant cash flow. This could be used to bolster the company's financial position and shareholder returns, or to reinvest in the business. With current commercial real estate prices well below their peak and many of Macy's buildings uniquely located, the true value of the properties is uncertain, but they could be a valuable asset for the company.

Diploma

In summary, Macy's faces several challenges in a rapidly changing retail landscape. Despite some improvements in gross margins and profits, ongoing store closures, weak sales, and risks to credit card revenue underscore the difficulties ahead.

Although Macy's has a turnaround plan, I do not believe it is sufficient to overcome the challenges the company is facing and the fierce competition in the retail sector. While there is upside potential from the realization of the company's real estate value or renewed takeover interest, these remain speculative. Given the challenges the company is facing, I am giving Macy's stock a sell rating and suggest prospective investors wait for clearer signs of a turnaround before considering investing.