Barron's
By Jack Willoughby
Here's a Mother's Day gift idea: Buy her a nice selection of Macy's shares before prices go up.
After a huge acquisition that racked up enormous debt, intense competition from Internet retailers and a recession that reached into its customers' wallets, the 153-year old retailer finally has begun to regain some former glory. Sales and earnings are up, and the company has started to free itself of a suffocating $9 billion debt load. A new sales-and-distribution strategy holds the promise of more good news to come.
If the improvements continue, the company could jump up a notch to recapture a long-lost investment-grade rating. "I believe it will happen," says Terry Lundgren, the 59-year-old CEO who's credited with overseeing Macy's turnaround. "It's just a question of when. We're doing the right things with our balance sheet."
Investors have already returned to Macy's aisles. Robert Olstein, founder of the Olstein Strategic Opportunities and Olstein All Cap Value Value funds, has purchased a large block of Macy's shares for both, impressed by the retailer's ability to generate $3 a share in free cash flow and the speed with which it is paying down debt. He says the shares, trading last week around $24, are worth 40, based on cash flow, other financial metrics and the quality of management.
Similarly impressed is Leah Hartman, an analyst with CRT Capital Group, who has a Buy on the stock with a one-year price target of 32. Macy's paid down $1.2 billion in debt in 2010, and Hartman expects it to continue to whittle it down. Another promising sign: The company reported a 4.6% increase in same-store sales for 2010, the first rise in four years and the biggest gain in over a decade.
Although the shares have bounced way off their bottom of 5.07 back in 2008, they're still reasonably priced. At last week's level, they trade at just 10 times forward earnings of $2.33 a share for the fiscal year ending January of 2012, well below the current market multiple of 13.7. Macy's is also attractive compared with its peers, which trade on average at 13.5 times earnings. "Macy's continues to be the cheapest name in the space," says Morgan Stanley analyst Michelle L. Clark. Although some analysts believe this is as good as it gets for the company, "I believe they're still in the early stages" of their turnaround, she says.
IT'S BEEN A PAINFUL PROCESS. In 2005, Macy's bought May Department Stores for $11.5 billion in cash and stock and assumed $5.8 billion in debt. It was a bold move to give a company with a quintessential New York-brand name a bigger national presence. The deal brought in regional merchandisers Filene's, Foley's, Kaufmann's, J.W. Robinson's, Meier & Frank and Marshall Field's, among others. The transaction helped push the retailer, which also includes 42 Bloomingdale's stores, toward its mammoth size of 850 stores. The following year, notes Lundgren, was the first in which the retailer actually qualified as a national advertiser on the TV broadcast of its Thanksgiving Day Parade in New York.
But sitting on some $9 billion in debt made Macy's vulnerable to the miserable financial and economic conditions of 2008 and early 2009. Revenue dropped from $26 billion in 2007 to $24.9 billion in 2008 and then to $23.5 billion in 2009. Following earnings per share from operations of $2.15 in 2007, the company posted $1.29 in 2008 and $1.41 in 2009. Last year the figure rebounded to $2.09 a share.
"You have to remember how serious things became back in 2008," says Lundgren in an interview with Barron's at Macy's famous Herald Square store. "Consumers were questioning their net worth. The world seemed to be coming to an end," he recalls.
So, as Lundgren puts it: "It was clear then that it was time to make the necessary changes. We couldn't afford to waste a recession."
His reorganization started in the spring of 2008, with two initiatives, OneMacy's and MyMacy's. OneMacy's encompassed the unification of core functions such as buying, marketing, merchandizing and planning in New York, and support functions such as human resources and finance in Cincinnati. Macy's cut the number of regional divisions, whose chiefs operated with a lot of autonomy and separate hierarchies, to four from seven the first year. It got rid of them entirely in 2009. In all, 7,000 jobs were eliminated and Macy's estimates it saves about $500 million a year overall from the reorganization.
In the regional units' place came MyMacy's, designed to provide a faster, clearer picture of what customers wanted and to improve response time by opening up communications between New York and 69 newly created individual districts. The idea, says Lundgren, is to be more responsive to customer needs. He put experienced buyers and managers out in the 69 districts, which included 10 to 12 stores each, rather than as many as 23 stores in the old system. The idea is to increase the flow of information between the head office and individual stores so they can adapt to changing demand more quickly. It also lets the company leverage the buying power that tens of billions of dollars in revenue and hundreds of stores afford.
Previously, all of Macy's major suppliers had to deal separately with the seven regional chiefs and their staffs. CFO Karen Hoguet notes that prior to the Beijing Summer Olympics in 2008, Macy's was about to make a major deal with Ralph Lauren to design some of its wares around the games. But the transaction fell apart because not all the seven regional heads would sign on. More recently, for the Vancouver Winter Olympics in 2010, a Ralph Lauren deal was struck with one telephone call. Says Hoguet: "We speak with a new, uniform voice."
Sometimes, this system has to cope with mysteries. Mike Dervos, senior vice president regional director in charge of Macy's upper Midwest region, recalled that one store found that it couldn't keep pace with demand for women's size 11 shoes. Macy's rounded up more of the shoes; it even created separate displays for them and then worked with suppliers to create new styles of bigger women's footwear. It followed up with queries to other Macy's stories in the same district to see if they had noted a similar trend. Today, 300 Macy's stores carry size 11s for women and suppliers have responded with more styles. No one knows for sure why this size has become more popular, only that Macy's responded quickly to one store's needs. "These days there's no such thing as rolling it out in every store, says Dervos. "Trends move from the local to regional to cross country," he says.
Suppliers seem to like the change and are adapting their own systems."With MyMacy's we meet with one buyer and have one discussion, instead of seven discussions with seven plans not necessarily reflecting customer desires," says Fabrizio Freda, CEO of cosmetics specialist Estee Lauder. "Now we can talk with local representatives who call on each store to help personalize the customer's experience and focus on the right assortment."
"In many ways, we've returned to the system that I was familiar with back when I was starting—where buyers really knew the stores they were overseeing and visited them regularly," says Lundgren, who's seen his own career come full circle at Macy's. In 1988, he was the president of Los Angeles' specialty-retailer Bullocks Wilshire, a Federated Department Stores unit that was sold off to Macy's. Lundgren found out from a reporter's query that he was being replaced by Macy's. He landed on his feet as head of Neiman Marcus and rejoined Federated in 1994 as chief of merchandising. Shortly thereafter, Federated bought Macy's and he became Macy's CEO in 2003.
Ultimately, Lundgren envisions Macy's operating like a kind of living organism that's constantly adapting to customer needs. He'd like to see all its stores' inventory linked, to better deal with the ebbs and flows of demand. "The idea is to employ all the resources available to satisfy customer demand. It's one thing to put an order in through a fulfillment center, quite another to put it through to another store and have the item delivered. That's what we're aiming for—floor to store," he says.
Macy's surely has a lot more firepower than any old-time retailer. "There's no way you can duplicate or even buy the level of experience or the nationwide reach of the network we've created," says Lundgren. "It functions much the way the old local retailers did back in the early days but with the power of a nationwide buyers. Our purchasing clout gives us access to the best brands at reasonable prices. More than 40% of our sales come from exclusive and limited distribution brands only sold at Macy's. We want to raise that number." Among them: the Martha Stewart Collection of housewares and home textiles designed exclusively for Macy's, and Tommy Hilfiger's family apparel and accessories.
IT'S A LITTLE EARLY FOR A FIREWORKS display.
Long-term debt remains high at 55% of total capital. Although Standard & Poor's recently raised its view of Macy's debt to positive from stable, it says it still wants "additional clarity" about the retailer's financial plans before making any changes (it rates Macy's debt BB+). David Kuntz, a director at S&P, says the company has at times been "fairly aggressive" in the use of its balance sheet, though it more recently has "worked to deleverage." Adds Kuntz: "Still we need a deeper understanding of their financial policy upon the achievement of an investment-grade rating for it to occur."
More important, the economy's course—and consumers' wealth—remains iffy.
"People are crazy if they think that retail is separate from the economy," says money manager Olstein. "There's a chance [of a second dip in the economy], but we don't think so." Rising food and gas prices are the latest threats.
While these are real risks, Macy's has some "margin of safety," says Nathan Snyder, portfolio manager with $3.7 billion-in-assets Snow Capital Management. The retailer has lots of room for improvement, says the value specialist. By his calculation, Macy's generated $152 per square foot in 2009, compared with Kohl's $190 per square foot and Target's $279. "There's lots of room ahead for meaningful upside, regardless of overall growth in sales," says Snyder.
Although many analysts are wary of old-line retailers like Macy's that are anchor tenants for shopping malls, Lundgren thinks they can excel if they do things right. "We are responsible for the big traffic. People don't come to the malls, because the Gap is there. We need to create a reason to go there," he says. "That's our responsibility." Special events—like the national flower show—or local visits by celebrities can create traffic. And, in addition to well-trained sales people, retailers need to use the Internet and current media both to attract and keep customers. Macy's, for instance, has been using video at its counters that includes features like interviews with popular make-up artist and cosmetician Bobbi Brown to personalize the buying experience.
It's up to retailers like Macy's to figure out how to get teenagers, who still gravitate to malls, into their stores.
Surprisingly, for the first time in more than two decades, the department-store share of the retail dollar is rising—ever so slightly. In 2010, it hit 2.5%, up from 2.4%, in 2009. To put that into perspective, 25 years ago the figure was 9%.
Small as it is, the increase has made consultants, like Craig Johnson of Customer Growth Partners, more enthusiastic about Macy's. "Macy's had the best spring quarter since the recession. And most of the benefits are in front of it," says Johnson. It "used to be your grandmother's store. Now it's appealing to a new generation of young shoppers," he adds. Just in time for Mother's Day.
