Macy's: The Reasons We Are Remaining Bullish

Macy’s, Inc. (NYSE:M), an omni-channel retail organization, operates stores, Websites, and mobile applications. The company sells a range of merchandise, such as apparel and accessories for men, women, and children; cosmetics; home furnishings; and other consumer goods.

In today’s article, we will be focusing on the firm’s profitability and efficiency measures, and their developments over the past years. Our analysis will be primarily related to the company’s return on equity (ROE) measure, and its components, namely the net profit margin, the asset turnover, and the equity multiplier. We will be also discussing some macroeconomic trends, which are likely to have direct impact on M’s financial performance in the coming months.

We have already published an article on Macy’s in September 2022. Back then we have rated the company’s stock as “hold” for the following reasons:

• Low consumer confidence levels and the uncertain macroeconomic environment have been expected to negatively influence the firm in 2022.
• The stock appeared attractive from a value point of view, especially taking into account the share buyback program announced in 2022.

After this short recap, let us start with the analysis of the ROE.

Return on equity

ROE is an important measure of financial performance and it is often used to gauge the corporation’s profitability and its efficiency of generating profits.

Although M’s ROE has plummeted after the pandemic, it has already returned to its pre-pandemic levels, which is definitely a promising sign, considering that the macroeconomic environment has been especially challenging in 2022.

When comparing this measure, however, with other department store stocks, we can see that Macy’s has further room to improve.

Let us decompose this measure to understand what are the primary drivers of this development.

Net profit margin

Net profit margin measures how much net income or profit is generated as a percentage of revenue. In 2021, net profit margin has started to recover and eventually reached its pre-pandemic levels.

What we are especially impressed with is that the firm has managed to control its costs effectively, which is key during times of downturns. Cost of goods sold and SG&A expenses have essentially remained flat over the last 5 years.

Now that the macroeconomic environment is expected to improve, we believe that Macy’s profit margin is likely to further expand, starting from the second half of 2023.

The decreasing inflationary pressures, the decreasing energy prices and the increasing consumer confidence are all likely to positively impact the firm’s financial performance in the coming quarters.

When looking at retailers, we also often point out the inventory levels and its change over the past year, as many retailers have been struggling with inventory management issues, including obsolescence, leading to high promotional activity.

While M’s inventory levels have also increased, it is in line with the usual seasonal trend and it has not reached extraordinarily high levels.

At the same time, after the pandemic, M’s inventory turnover has substantially increased, which is also a positive sign, despite the pull back in 2022.

All in all, we believe that Macy’s is well situated to benefit from the improving macroeconomic environment and we expect its margins to improve, starting from the second half of 2023.

Asset turnover

The asset turnover ratio (or sometimes called asset utilization) measures the value of a company’s sales or revenues relative to the value of its assets. It indicates how effectively the company is using its assets to generate sales.

The company’s asset turnover has substantially increased after the pandemic, even above pre-pandemic levels. To put this figure into perspective, the industry’s asset turnover ratios range from 1.15 to 1.86. During this period, revenue has stayed relatively flat, along with the accounts receivable.

Equity multiplier

The last part of the three step decomposition of the ROE is the equity multiplier, which is simply the ratio of assets to shareholder equity. A higher ratio indicates more leverage.

While the equity multiplier is above pre-pandemic levels, it has been trending downwards since the end of 2020.

The reason for the substantial jump in 2020 can be explained by the change in long term liabilities, particularly by the capital leases line item.

At the same time, the firm has been successfully working on reducing its long term debt. While we definitely like this improvement, we would like to see it continue. The following table shows a comparison of a set of measures related to debt and liquidity.

Macy’s metrics do not appear to be concerning in this context.

Key takeaways

Macy’s return on equity has declined sharply in 2020, due to the Covid-19 pandemic. However, in 2021 and 2022 the measure has substantially improved and returned back to pre-pandemic levels. Currently, the firm’s return on equity is about in line with its peers from the industry.

Over the past year, unlike many other retailers, Macy’s has managed to control its costs and manage its inventory effectively. The company’s asset turnover has also improved. All in all, we believe that Macy’s is well-positioned to benefit from the improving macroeconomic environment.

Starting from 2019, the level of the equity multiplier has been elevated, due to a capital lease. The level has been, however, trending downwards. Compared to its peers, Macy’s does not appear to be over-leveraged and appears to have enough liquidity based on the current ratio and the interest coverage ratio.

For these reasons, we maintain our bullish view.