After reviewing Macy's (M) earnings release, I am staying flexible and have taken a small long position. I now own a large long position in Dillard's (DDS) and a small to medium-sized position in Macy's.
The bad things suggested by the abysmal stock performance of Macy's clearly did not happen. The hurricane and warm weather took their toll, but that was it; unlike J.C. Penney (JCP) , no self-induced stupidity -- and now those factors should move into reverse.
The stock is well below any reasonable forecast of Private Market Value, its dividend provides a vastly above-average yield and is safe, and powerful seasonal factors are about to provide a significant tailwind.
Though I am negative on the market, I can see Macy's trading at over $22.50 over the near term (even by post-Christmas).
Key points that led me to the decision to re-establish a Macy's long include:
1. Nothing new on real estate but things are happening. Rumors are plentiful. Macy's has powerful real estate assets that are still "hidden." The only question is how high is up?
2. Merchandising management gets a high score. Like everyone else, Macy's competes against Amazon (AMZN) , which unlike Macy's is not required to sell stuff profitably. This has taken its toll on the multiple as well as sales.
3. The worst seems to be over. Merchandise gross margins are forecast to be flat and inventories (the source of most trouble in retailing) are in great shape relative to sales. Strong digital sales will now propel comps upward.
4. Seasonal factors will help, a lot more than the stock price suggests. In this market, most decisions are made by computers and computers have not been at this as long, nor do they have as much data, as some of us old-timers do! They play the over/under, and history favors the over.
5. This is a 53-week year. The extra week will add to earnings, helping the "over."
6. This year has an extra pre-Christmas selling day, with Christmas Day falling on Monday, the best of all possible worlds for a retailer.
7. At least for the next two weeks, selling weather in the weather-sensitive northern tier of the United States is forecast to be seasonally excellent. Management remarked that cold-weather goods were seeing good sales. Given the tight inventories, this means no unplanned markdowns.
8. Consumer economics are favorable. The stock market has helped wealth, real estate is fine, and employment is excellent. Because of President Trump, foreign visitation (a factor for this company) will be unexciting. Last quarter it was down 12%. That is the only visible negative outside of AMZN (not that AMZN isn't enough, but online is only about 12% of U.S. retail; there is plenty of offline share still out there and Sears (SHLD) is likely about to go extinct).
9. Valuation is extraordinary relative to the market (about 60% below on a P/E basis (Macy's 6x; market 18x) and relative to interest rates. (Borrow at 4% and buy stock at a 20% return or buy debt at higher than 4%.)
10. Macy's has an average interest cost of 5.5% and its first use of free cash flow will be to retire debt: Debt /EBITD is 2.3x.
This commentary was originally posted at 12:10 to Doug Kass' Daily Diary on Real Money Pro, our site for active traders. Click here to learn more about Doug's market blog and Real Money Pro.