Store: Macy's in New York City.

Macy's reported a weak second quarter but will lift earnings by selling to Tishman Speyer a piece of its Brooklyn flagship which will be redeveloped.

After two tough quarters, Macy’s is looking to its real estate and new merchandising strategies at home and abroad to bolster the business.

On Wednesday, the company disclosed a 20 percent drop in second-quarter earnings per share to $0.64 amid sluggish sales impacted by international tourists spending less. Macy’s started feeling a slump in tourist spending last November and lost further ground last quarter by deciding to drop a friends and family event in hopes of seeming less promotional and compensating with improved sales via other events. Macy’s stock fell 5 percent, or $3.42, to $64.11 on Wednesday.

Along with the tourist setback, there was slowness in fashion jewelry, watches, petites, large sizes, men’s tailored clothing, housewares and tabletop, while handbags, fragrances, active, furniture and mattresses were strong. Macy’s and other retailers are seeing consumers spending more at restaurants, on recreational activities, healthcare and electronics rather than traditional general merchandise apparel and furnishings.

The West Coast ports had a lingering, albeit smaller effect and Macy’s is adjusting to its newly combined omnichannel merchandising, planning and marketing teams.

Despite the weak report card for the quarter, Macy’s sought to show progress, disclosing that its Brooklyn flagship would be redeveloped through a deal with Tishman Speyer, leading to a $250 million gain in the fourth quarter this year.

Macy’s also said that e-commerce will be conducted in China through a joint venture with Hong Kong-based Fung Retailing Limited.

The announcements on China and Brooklyn confirmed past WWD reports about the strategies.

The $28 billion retailer said that its net profit for the second quarter ended Aug. 1 declined to $217 million, from $292 million in the year-ago period. Sales fell 2.6 percent to $6.1 billion from $6.26 billion in the year-ago quarter, and comparable-store sales were down 1.5 percent.

Though clearly disappointed with the results, Terry J. Lundgren, Macy’s chairman and chief executive officer, told WWD, “In the end we will always fare well against our competitors. I think we are more impacted than most [from the decline in international tourist spending] not only because of having the largest store in the world but because of all the locations we have — Chicago, San Francisco, Las Vegas — everywhere tourists go there is a Macy’s and, in many cases, Bloomingdale’s.” On the bright side, “We will anniversary those difficult numbers around the holiday season. The dollar strength will continue for some period, but at least we are anniversary-ing those softer purchases.”

Lundgren also acknowledged that dropping a Macy’s “friends and family” event didn’t work out as expected.

Lundgren said he’s been to China four times in the last 20 months and many more times over the years, exploring both top-tier and second-tier cities and visiting homes with interpreters to learn about how the Chinese shop and what they want. “It’s something you just can’t avoid knowing that China would be the largest middle class market in the world,” Lundgren said. “Many people go to shopping malls because they like the air conditioning. It’s a break for the family, and the dining opportunities are superior to restaurants on the streets. They may have a very small apartment but the desire for brands, authentic brands, registers very high. This authenticity is extremely important to them.”

“We have a lot to learn there,” Lundgren added. “That’s why we are going to test and learn as we always do. We’ll find out what kind of demand there is for various products we offer. I do believe they will want many name brands.” With Macy’s private brands, much of which is produced in China, “They don’t have a major awareness. We think over time that will be very important.”

As far as planting stores in China, “We haven’t made that decision,” Lundgren said. “Five or ten years ago if we were going into China, that’s probably how we would have started.” The advent of omnichannel retailing has changed the perspective.

In China, Macy’s will begin selling on Alibaba Group’s Tmall Global in late 2015, through a joint venture with Hong Kong-based Fung Retailing Limited. Fung will assist Macy’s in merchandising its site on Tmall, and with logistics. Fung Retailing, which operates 1,000 stores in China and another 2,000 in other Asian countries, could also assist in launching a Macy’s store in China, if so decided.

The freestanding joint venture, which is 65 percent owned by Macy’s and 35 percent owned by Fung Retailing, will be based in Hong Kong and called Macy’s China Limited. Alipay will be a primary payment channel for Macy’s e-commerce in China. Kent Anderson, who launched macys.com and serves as its president, will be managing director of Macy’s China Limited. He has already moved to Hong Kong.

It’s hoped that as the Chinese get to know Macy’s in China better, when they live in or visit the U.S., they will be more inclined to shop Macy’s stores.

“Fung Retailing has deep experience and expertise in Chinese retailing, and the Macy’s-Fung partnership will be instrumental to helping set up and operate our test,” said Lundgren.

Peter Sachse, Macy’s, Inc. chief innovation and business development officer, said, “We have had initial success in partnering over the past year with Alibaba on various projects, including accepting Alipay on macys.com and conducting a special promotion during Black Friday 2014. We believe that, through the joint venture, Macy’s online presence on Tmall Global will give us insight that will serve us well in evaluating future international initiatives.”

Fung Retailing’s executive director Sabrina Fung, said, “There is demand for the quality and variety of power brands and authentic products associated with the world-famous name of Macy’s,” adding that many Chinese are attracted to the American lifestyle.

In 2011, Macy’s began selling to China and about 100 other countries with an edited assortment on macys.com. These goods are shipped to international customers from the U.S. However, Macy’s China Limited will ship to Chinese customers from inventories in Hong Kong, which is expected to improve speed, flexibility and pricing for the customer.

Macy’s anticipates about $50 million in e-commerce sales in China in 2016. Macy’s China Limited is expected to invest $25 million in the operations of the joint venture over the next 18 months, with Macy’s funding 65 percent. The venture will have no material impact on Macy’s earnings in fiscal 2015.

Privately held Fung Retailing Limited is totally separate from the publicly-listed company Li & Fung Limited.

On the home front, Lundgren said Macy’s has been working on a strategy for the downtown Brooklyn flagship for over a year. “This store is 150 years old. We changed the name from Abraham & Straus to Macy’s about 20 years ago.” He cited similarities to the Herald Square flagship — both being big and getting much-needed major upgrades. “There were lots of bidders and lots of interest,” in the Brooklyn site. “The neighborhood is going to be filled with new customers. Fulton Street is totally going to come alive.”

He also said the store will be full-line despite being downsized, and will attract a high percentage of Millennials.

In Manhattan, Lundgren confirmed that the lower level of the Herald Square flagship is being converted to a Millennial-oriented floor, as part of the multiyear, $450 million remake of the store nears completion.

Lundgren said the he expects to divulge before the end of this year additional real estate strategies at other major owned locations around the country.

As chief financial officer Karen Hoguet said during a conference call Wednesday, “Real estate values clearly are nearing all-time highs and so over the past few months, we have been intensely studying the subject again. We have brought on specialized real estate advisers as well as financial, legal and tax advisers to look at a wide range of alternatives from financing to structural that have the potential to create value.

“I think between real estate values being high and some interesting transactions, we are taking a deeper look at the subject,” Hoguet said. She was apparently referencing recent real estate deals by the Hudson’s Bay Co. monetizing and unlocking the value of much of its real estate, including the Saks Fifth Avenue flagship where, through mortgaging the ground underneath the flagship, the site was appraised at $3.7 billion. HBC is also funding its acquisition of Galeria Kaufhof in Germany by contributing much of the Kaufhof real estate to a joint venture with Simon Property Group.

Macy’s has been under some pressure from activist investor Starboard Value to unlock the value of its real estate and possibly create a real estate investment trust.
This year, Macy’s decided to close and sell off its Pittsburgh flagship. The company also said it would launch the first Macy outlets called Macy’s Backstage beginning this fall, and is believed to be developing a specialty store prototype to capture a younger audience.

In Brooklyn, Macy’s and Tishman Speyer signed a real estate agreement that enables Macy’s to still own and remodel 310,000 square feet over the lower and first four floors, and Tishman Speyer to own and convert 378,000 square feet on eight floors into office space. The project will start in spring 2016 and is scheduled to be completed in fall 2018. Tishman Speyer has also agreed to purchase Macy’s Hoyt Street parking facility, which could be used for a future mixed-use development. The store will remain open during the redevelopment.

Macy’s will receive $170 million in cash from Tishman Speyer for its Brooklyn real estate asset and an additional $100 million over the next three years to help fund the renovation.

Lundgren said the Brooklyn store, with fewer floors and less selling space will be more efficient. A portion of the interior will be reconstructed to level the floors, new elevators and escalators will be installed as part of a “top-to-bottom” remodel that will seek to project “cutting-edge style and a hip, urban attitude.” The main floor will house cosmetics, fragrances, shoes, handbags and accessories. Each floor will be leveled to create larger footprints and offer expanded assortments. Windows on the upper levels will be uncovered for more natural light. Macy’s said it’s keeping the store’s 490 associates. The Macy’s photo studio on the upper floors is being relocated to a leased building in Long Island City, N.Y.

The real estate transaction is expected to be completed in the fourth quarter.

Tishman Speyer’s assets include New York’s Rockefeller Center and Chrysler Center, São Paulo’s Torre Norte, Ventura Corporate Towers in Rio de Janeiro and OpernTurm in Frankfurt.

Among other growth initiatives, Macy’s Bluemercury division expects to open 10 more stores this year, bringing the count to 76. And this fall, four Bluemercury shops inside Macy’s stores will open, including one in the Union Square, San Francisco flagship.

Hoguet said that Plenti, the loyalty program shared by Macy’s and other companies, has over 7 million customers, and that Macy’s “top door” strategy is progressing with enhanced product offerings, upgraded shopping environments, incremental special events and additional sales associates with greater product knowledge. Macy’s has an “all things wedding” strategy which includes a partnership with Men’s Warehouse to open licensed tuxedo rental shops within 300 Macy’s stores beginning this fall.

Macy’s expects 1 percent comp-store sales growth this fall, and flattish total sales because of a reduction in selling private label goods to third parties. “Sales growth will be stronger in the fourth quarter than in the third as we begin to year round on the weakness in the international tourist sales,” Hoguet said.

“The overall economy didn’t do us any favors in the first half of the year,” Hoguet said. “We look forward to the effects of the stronger dollar beginning to year round in the fourth quarter and to consumers replenishing their closets as their wardrobes require updating heading into the fall and holidays.”

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