Macy’s Inc. sent a cold autumn wind of reality through the retail sector on Tuesday.
The nation’s largest department store retailer saw its share price drop by 14 percent to $40.44 after it issued weaker-than-expected third-quarter results and, worse, revised its outlook for the fourth quarter and year sharply downward. The reaction from Wall Street was swift, sending Macy’s shares down to a 52-week low of $39.75 before they eventually recovered slightly. Trading volume was heavy at 37.8 million, which compares to its three-month average trading volume of 5.6 million. The decline in the stock represents a $2.2 billion loss in the company’s market capitalization.
Macy’s stock drop weighed down other retailers in the sector. J.C. Penney & Co. shed 1.9 percent to $8.51 while Kohl’s Corp. fell 5.3 percent to $43.17. Dillard’s Inc. plummeted 8.3 percent to $81.80 and Bon-Ton Stores, a mall-based operator that is seen by analysts at more vulnerable to consumer spending slumps, fell 8.9 percent to $2.67. The S&P Retailing Industry Group Index closed the day down 0.7 percent to 1,283.
Terry J. Lundgren, Macy’s chairman and chief executive officer, tried to calm investors’ fears by listing a slew of initiatives the company plans to take to return to the growth path. He did so even as the company revealed it had no plans to develop a real estate investment trust, or REIT, for its properties, as some investors had pressured it to do. “The board of directors has concluded that a REIT does not offer sufficient upside potential for value creation. To the extent that circumstances change, we may revisit this alternative in the future,” Macy’s said.
But while it isn’t pushing forward with a REIT, Macy’s is moving rapidly to try to maximize the value of its real estate assets — including its Herald Square flagship in Manhattan. For the first time, the retailer revealed it is exploring joint ventures or other tie-ups to redevelop portions of its major stores — which in addition to New York include the flagships in San Francisco, Chicago and Minnesota — to bring in other uses while keeping a significant retail presence.
Amid a challenging consumer spending environment that includes an erosion of tourist spending due to a strong dollar, Macy’s Inc. delivered third-quarter results that were weaker than expected.
Lundgren’s plan also includes the stepped-up expansion of the Macy’s Backstage off-price format, with the goal of opening 50 freestanding units over the next two years while also piloting using the nameplate within 10 existing Macy’s locations. The retailer also said it would open 40 additional Bluemercury freestanding stores by the end of 2017, which would bring the number of those beauty stores to 115.
For the third quarter, Macy’s said net sales declined 5.2 percent to $5.87 billion while net income (attributable to shareholders) dropped 45.6 percent to $118 million, or 36 cents a share, compared with net income of $217 million, or 61 cents a share, in the quarter a year ago. The steep decline was due to a $111 million impairment charge that relates to store closures, the company said. Excluding those charges, earnings were 56 cents a share. Same-store sales in the quarter declined 3.6 percent, which was below analysts’ consensus estimates.
“We are disappointed that the pace of sales did not improve in the third quarter, as we had expected. Spending by domestic customers remained tepid, especially in key apparel and accessory categories. Simultaneously, the slowdown in buying by international visitors continued to significantly impact Macy’s and Bloomingdale’s stores in tourist centers, which are some of our company’s largest-volume and most profitable locations,” Lundgren said.
By way of guidance, the retailer said full-year earnings will be in the range of $4.20 to $4.30 a share, which would exclude “asset impairment charges associated primarily with previously revealed store closings.” This is a steep revision down from prior guidance of $4.70 to $4.80 a share. “Earnings guidance for 2015 includes gains from asset sales, including approximately $60 million from the sale of real estate in Seattle and an expected $250 million gain on the sale of real estate in downtown Brooklyn,” the company said.
Regarding its store base, Macy’s said it was on track to close 35 to 40 of its Macy’s and Bloomingdale’s stores — as previously announced — beginning in early 2016. But the company also said it “expects it will continue to reduce the number of stores over time.”
And the retailer reiterated that it would be “concentrating its resources in top stores in the best locations so each store is a more compelling magnet for customer activity and uses its selling space more productively.” Macy’s earlier this year said it planned to focus more of its resources on its top 150 stores out of its 880-store fleet.
On Wednesday, the retailer said the best stores “will see intensified merchandise assortments in key destination departments such as jewelry and watches, strategically selected licensed departments, strengthened visual presentation, enhanced staffing and more local marketing.”
Also on deck is a goal to cut annual selling, general and administrative expenses by $500 million — net of growth initiatives — from “previously planned levels by 2018, with incremental progress in 2016 and 2017 toward that goal.” Also, the retailer will slash capital spending “to less than $1 billion in 2016 from the $1.2 billion expected in 2015.”
Macy’s said, due to the success it had with the Brooklyn store redevelopment, it has now partnered with Tishman Speyer “in an expanded relationship to advise and support the company’s senior management team in identifying and advancing potential store redevelopment projects nationwide.”
Additionally, the company has “begun a process to explore joint ventures or other deal structures with third parties to redevelop Macy’s flagship real estate assets in Manhattan (Herald Square), San Francisco (Union Square), Chicago (State Street) and Minneapolis (downtown Nicollet Mall) in a manner that maintains a robust Macy’s retail store presence while also bringing alternative use into those buildings.”
Regarding the expansion of Backstage, which the company described as an “exciting new dimension in retailing across America,” the retailer will test putting Backstage within 10 existing stores thereby “creating a new hybrid store — the first in retailing — that offers the latest fashions, outstanding service and major brands for which Macy’s is known, along with the thrill of the hunt associated with the finds and bargains at Backstage.”
When asked if the Backstage nameplate — which is also emblazoned with the Macy’s logo — had more brand cache compared to other competitors in the off-price sector, Lundgren told WWD, “Yes, we’d like to think so.
“We think the opportunity to attract a new customer is very real,” the ceo said. “We offer a great deal of value, credibility and fairness.”
Regarding incorporating Backstage into existing stores, Lundgren said the genesis of that idea came out of looking closely at department-level sales productivity — from a sales per square foot perspective. With the success of Bluemercury, “we then asked, ‘What if we did the same thing with Backstage?’” Lundgren said.
Driving the Backstage initiative are some broader, economic realities that have been around for some time, Lundgren said — notably “a challenging apparel market.” But with the expansion of Backstage and Bluemercury — inside the store and as freestanding units — Lundgren expects the efforts to “generate excitement for shoppers,” which will drive up sales productivity.
Analysts’ reactions to Macy’s results and longer-term strategies were mixed. Citi analyst Paul Lejuez noted that the retailer is saddled with higher inventory levels, “implying potential margin pressure.”
“And while the company is looking into ‘strategic redevelopment’ of some of its key assets, it also stated outright that it does not plan to execute a large-scale REIT transaction,” Lejuez said in his research note. “We continue to believe that consensus forecasts for next year are too high and not considering the 56 cents per share of gains from asset sales helping 2015.”
“Despite the relatively low expectations, we still expect the stock to trade-off given the significant guidance revision and the confirmation that the company will not be doing a large-scale REIT transaction [as some had hoped],” Lejuez said adding that he expects Macy’s to “kick up promotions in [the fourth quarter] to attract its fair share of holiday spending. This is an incremental negative for anyone that competes with them in the mall.”
Craig R. Johnson, president of Customer Growth Partners, said the retailer’s strategic efforts were on the right track.
“The parallel initiatives to ramp up Macy’s Backstage — including repurposing some of the ground floor real estate…makes huge sense,” Johnson said. “And, the steps to expand the 2016 store closures from the previously announced 30 to 40 pace is also spot-on. Together the three initiatives are three legs of a new strategic tripod that can help Macy’s reposition itself for this still new century, by monetizing underutilized assets, improving the productivity of the core retail assets, and realigning its fleet to better reflect the way today’s consumers like to live and shop.”
For the short term, there are other headwinds to deal with, notably an overall retail environment that has consumers spending more on bigger-ticket items such as autos and home appliances as well as on experiences, which include dining out and taking long vacations, instead of on buying clothes. Then there’s the weather, which is expected to remain warmer than normal this month.
“An unseasonably warm autumn is leading our credit default swap [CDS] spreads for Macy’s Inc. to levels not seen since 2012,” said Fitch Solutions in its latest CDS case study report. “Five-year CDS on Macy’s widened out 16 percent over the past week and are now trading 140 percent wider than they were at the start of the year. As a result, the cost of credit protection on Macy’s debt is at its widest levels since July 2012.”
Fitch analysts went on to note that “after pricing consistently in [the] BBB+ space for much of the past year, CDS on Macy’s are now treading in below investment grade territory.” Fitch Solutions director Diana Allmendinger said in addition to the unseasonably warm weather “slowing down winter clothing sales, souring market sentiment for Macy’s is likely coming from weaker foot traffic at department stores.”
In the quarterly report, Lundgren told investors that the company is keenly focused on accelerating efforts aimed at responding to “changing customer shopping preferences” and getting earnings and sales where they need to be.
“This includes building on our strength as a leading omnichannel innovator with consistent growth in online sales,” Lundgren said in the report. “No other retailer has our track record of mastering change and creating shareholder value with a model of customer centricity.”
The ceo reminded investors that since the beginning of fiscal 2009, “we have returned nearly $9 billion to shareholders. Our Total Shareholder Return has been 540 percent during that period, compared with a 121 percent increase in the Dow Jones Industrial Average.”