(Photo by Artificial Photography on Unsplash)

Macy’s (M) is the best bet in a struggling retail sector. Despite a prolonged downtrend in the share price, there remain reasons to be bullish. The stock appears to be trading at or near fair value and has an excellent dividend yield, so buying dips will be a profitable strategy going forward.

Retail hasn’t been doing so well. The number of store closures in 2019 has surpassed 8,200, beating the 2017 record of 8139. The number will likely be higher by year-end as the fourth quarter has only just begun.

There has been some debate about a “retail apocalypse.” Some commentators think it’s nothing out of the ordinary, some think it’s all because of Amazon and online sales, and others think it’s a sign of the US consumer struggling.

Given that 90% of all retail purchases happen at physical retail locations, we can rule out the possibility that online shopping has much to do with store closures. According to data from the US Census Bureau News provided by the Department of Commerce:

E-commerce sales in the second quarter of 2019 accounted for 10.1 percent of total sales.

Looking at the historic nature of store closures, i.e. that it surpasses even the depths of the 2008 financial crisis, we can also rule out the claim that “everything is fine.”

That leaves us at the third conclusion: the retail apocalypse is real. Consumer debt is at an all-time record high, so it’s not a stretch to say that people probably can’t afford to go on spending sprees these days.

All of this sounds like a nightmare and gives good reason to be short everything in the retail sector. In many instances, this has been true, as can be seen in the long and growing list of retailers that have gone bankrupt in recent years.

So why am I still a fan of Macy’s? For one, the dividend is great and has been growing. But there’s more to the story.

Macy’s is one of the most tried and true names in retail and even in America overall. The company turned 90 years old this year. And despite plenty of store closures, they still have a significant store presence.

Macy’s operates over 670 department stores throughout 43 states, Washington D.C., Guam and Puerto Rico. The stores include not only the traditional Macy’s name but also Bloomingdale’s The Outlet, Bluemercury, and Macy’s Backstage.

Let’s take a closer look at M.

Macy’s Fundamentals

Macy’s fundamentals have been doing well despite the declining share price, making now an opportune time to buy the dips. With a PE ratio of less than 5, M looks undervalued from the start.

Revenue growth and gross profit have both seen strong gains since bottoming out in late 2017.

M revenue and profit graph(chart via Zacks.com)

Shareholders’ equity and dividend yield have also been rising for the past two years.

M shareholder equity and dividend yield graph(chart via Zacks.com)

When looking at the share price, you might not guess that key data metrics like these have been doing well. That’s why buying the dips can be a good strategy here. Use the negative sentiment toward M and retail overall to acquire shares of a high dividend-yielding stock on the cheap.

Another fundamental reason to be long Macy’s is their focus on sustainability. The company maintains a commitment to energy conservation and waste reduction in all of its policies.

The company’s website states that they have a “deep sense of stewardship” for managing resources and maximizing positive social impact. Their sustainability principles guide their policies. Macy’s proactively engages on issues that underly all of their operations, including product responsibility and supply chain management, energy management, transparency, diversity and inclusion and striving to build in strong communities. The company states that operating according to these principles will allow them to “create value for shareholders while addressing the shared needs of society.”

We have a deep sense of stewardship for managing our resources and maximizing our positive social impact. Our sustainability principles guide these efforts. We proactively engage on issues that span the breadth of our operations – this includes transparency, product responsibility and supply chain management, energy management, diversity and inclusion and building resilient communities. We believe operating by these principles will enable us to create value for our shareholders while addressing the shared needs of society.

These policies are good for business, the environment, and public relations. This is a factor that puts Macy’s ahead of its competitors.

Macy’s Stock Valuation: the Dividend Discount Model

The biggest reason to buy M on the dips comes from its valuation according to its dividends.

Because Macy’s is a blue-chip company that pays a dividend, we can use the dividend discount model (DDM) as a valuation method. The DDM lies upon the theory that a stock’s price is equivalent to the sum of its future dividends when discounted back to their current value. Here I’m using the straightforward variation known as the Gordon growth model (GGM).

The GGM consists of a simple formula that divides the expected dividend per share by the cost of equity (or required rate of return) minus the dividend growth rate, or [ D / (r – g) ].

The needed variables are as follows:

  • M share price: $15
  • Dividends per share: 0.38
  • r: 17.7%
  • g: 15.2%

While the first two variables were taken from public market data, I show my work on the math for the other two below.

Calculating G and R

In Q1 2014, the quarterly dividend for M was $0.25 per share. Over the next four years, it grew accordingly:

Dividends per share for M:

2014: 0.25

2015: 0.31

2016: 0.36

2017: 0.38

2018: 0.38

Using these figures, calculating the rate of growth ( g ) goes as follows:

Growth rate calculations (excluding 2018, which saw no change from the previous year)

2014: 0.25

2015: 0.31/0.25 – 1 = 0.24

2016: 0.36/0.31 – 1 = 0.16

2017: 0.38/0.36 – 1 = 0.055

Averaging the growth rate of these three years arrives at the figure of:

15.2% = dividend growth rate ( g )

Now to find the cost of equity (aka required rate of return or RRR, expressed here as “r”). R is calculated as follows:

r = (dividend per share / share price)+ dividend growth rate. Therefore,

Cost of equity ( r ) = [(0.38 / 15 = 2.5%) + 15.2] = 17.7%

Now we can calculate the dividend discount model using the formula:

D / (r – g), which looks like:

0.38 / (17.7% – 15.2%), which equals:

15.20, or about 30 cents higher than M is trading at the time of writing.

We can conclude from this that the stock is just below its fair value assuming recent dividend trends. Of course, this is not the whole story.

Another factor worthy of consideration when using the (DDM) is the payout ratio. Payout ratio refers to the portion of profits a company pays out in dividends.

M has an average payout ratio of 36%, which is estimated to rise above 50% according to this year’s earnings estimates. If the payout ratio of M continues to rise, the dividend will become unsustainable. Earnings per share will have to rise in order to keep up with the increasing dividend, or else the company will wind up paying too much of its profits out to shareholders.

It’s possible that the historically high yield of 10% drops to 8% or less in the coming quarters. This is one of the only downside risks and exposes an inherent flaw in the dividend discount model: the assumption that dividend growth will remain constant. The DDM also ignores prevailing market conditions. Although the DDM is more likely to prove effective with a blue-chip company like Macy’s, uncertain times in retail and in general make all variables subject to change.

Macy’s Stock Chart

The stock has been trending lower for a very long time, so you won’t have to wait long to buy the dips. It’s difficult to say where the bottom is, so an effective strategy will be to get in whenever the price declines (with free trades now being offered by most online brokerages, this is a lot easier to do today than it was just a few weeks ago).

M chart 10-7-19(chart via Tradingview.com)

The RSI is signaling oversold conditions at just over 30.

The stock is hovering near multi-year lows despite having done better fundamentally. There could be a rally in the cards in the near future.

If long-term support is broken amid a sustained selloff, however, there might still be some pain before bottoming out. Closing below $15 for a few weeks in a row could signal decreased confidence in M. All things considered, a rally from the lows looks more likely, especially when looking at historical performance relative to the RSI. Over the last five years, trading has gone up or at least sideways whenever the RSI approached 30 or less.

Macy’s Competition is No Competition at All

One competitor of Macy’s that has the potential to outperform (and is far from filing bankruptcy, as many competitors already have) is Kohl’s (KSS). While Macy’s has been closing stores, Kohl’s has been building new, smaller stores while downsizing existing ones. They recently added a new fulfillment center that they claim will help deliver online orders faster.

Kohl’s has a dividend yield of 5.5%. The payout ratio is much lower than that of Macy’s at only 10.6%, so its dividend might be more sustainable although much lower. The share price is also higher at $48.40 at the time of writing.

But Macy’s specializes in a variety of higher-end merchandise that Kohl’s can’t compete with, including name-brand handbags, cosmetics, and jewelry.

Top-notch cosmetics and fragrance makers like Estee Lauder, Clinique, Shiseido, and Lancome all have booths with contract workers inside of most Macy’s retail locations. High-quality handbag creators like Michael Kors sell a lot of merchandise in M stores. And for men who want a decent suit, Macy’s is a great place to find brands like Calvin Klein, Kenneth Cole, and International Concepts.

To top things off, Macy’s has great brand awareness and excellent marketing, e.g., sponsoring the iHeart Radio Music Festival. If you doubt this, try scrolling through the Macy’s Twitter feed and compare it to the Kohl’s Twitter feed. One will keep you interested, the other will half bore you to death.

Conclusion

In short, Macy’s is a good long-term bet even amidst a declining retail sector overall. The company specializes in brands and merchandise that appeal to a broad range of customers. M has unrivaled brand recognition, being one of America’s longest lasting and most trusted brands.

I’m giving a neutral rating even though I’m bullish because the downward trend has been so strong for several years. It seems that the $15 support level should hold up, but if it doesn’t, there could be more room to the downside, even to $10.

If you’re going to invest in retail or just looking for a decent dividend-yielding stock, buying M on the dips is one of the best bets you can make.

Disclosure: I am/we are long M. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-10-09