Macy’s (M): A Household Name with a High (but Risky) Dividend

Sporting a high 4.8% dividend yield and trading at its 5-year low, Macy’s (M) at first glance looks like it could be an attractive investment for investors living off dividends in retirement.

 

But many retailers, especially department stores like Macy’s, have suffered mightily over the past decade because of competition on the internet.

 

Can investors count on Macy’s to buck the trend? After all, Macy’s has been around longer than all of us, and the annual Macy’s Thanksgiving Day Parade in New York City has made Macy’s a household name.

 

Let’s take a closer look at the company for consideration in our Conservative Retirees dividend portfolio.

 

Business Overview

Founded in 1858, Macy’s and its subsidiary Bloomingdale’s sell merchandise, especially women’s accessories and apparel, at their department stores and through their online businesses.

 

Macy’s customers are mostly middle class Americans, while Bloomingdale’s attracts higher-end shoppers with luxury brands such Armani and Gucci.

 

Macy’s operates 732 departments stores, all located within the United States.

 

 

In 2015, Macy’s made over $27 billion in sales, placing them alongside Sears and TJ Maxx (TJX) as one of the U.S.’s largest department stores.

 

Over 60% of Macy’s sales come from women’s accessories and apparel, with the remainder from men’s and children’s merchandise, home furnishings, and other consumer goods.

 

 

Macy’s also sells its merchadise online and touts itself as one of the nation’s premier omnichannel retailers, referring to its dual physical and online presence. In April 2016, Fortune cited Macy’s as the sixth largest e-commerce company in the U.S.

 

Business Analysis

Macy’s greatest challenge is that online and discount retailers such as Amazon and TJ Maxx are eating away at sales of U.S. department stores.

 

In the 10-year span from 2005 to 2015, U.S. department store sales shrunk from $87 billion to $60 billion, a 31% drop.

 

The result is that Macy’s is barely eeking out sales growth (averaging 1.6% per year over the last 5 years) and its long-term growth potential is in question. In fact, Macy’s announced last August that it would close 100 stores that account for 4% of revenue.

 

To combat these trends, Macy’s is growing its online business and is revamping how and what it sells at its brick and mortar stores.

 

E-commerce sales in the U.S. is growing at a tremendous clip, and Macy’s is eager to grab a slice of the pie. Management reported that Macy’s two websites, macys.com and bloomingdales.com, saw double-digit growth in 2015.

 

Macy’s doesn’t break out sales by channel (online vs. in-store), but according to a Credit Suisse report 14% of revenue at major department stores was earned online in 2015 (double that of 2014). That’s a small portion of revenue today, but there’s no doubt Macy’s hopes its e-commerce business will grow to make up for lost sales elsewhere.

 

Outside the online world, Macy’s is also trying tactics to make its physical stores more appealing to shoppers.

 

Through its My Macy’s localization initiative, Macy’s invests in technology to custom curate what’s on the shelves at each of its department stores. Macy’s is betting that it can attract more shoppers by better identifying their specific needs.

 

Macy’s also invests in the training of its sales staff through its Magic Selling program. Done right, well-trained sales staff can make a customer’s shopping experience more valuable and enjoyable, improving the company’s bottom line and helping them earn return business.

 

A final point on Macy’s, and one that is easy to forget about, is that the company owns a ton of real estate in prime locations, such as its flagship Herald Square store in Manhattan.

 

 

Superb store locations means that Macy’s can remain a leader in retail if department stores nationwide see a turnaround. It also gives management options like selling unprofitable stores for a nice sum.

 

Department stores aren’t going to go away overnight, and Macy’s is well-positioned to continue its run of profitable business. But it also faces serious challenges, like entering the e-commerce world and reshaping the in-store experience, that make its future uncertain.

 

Key Risks

Macy’s needs to see its e-commerce business thrive and stop the bleeding at its stores. But neither of these are certain to happen.

 

Just because Macy’s has a website does not mean its website is profitable. Online sales is a notoriously low-margin business and requires enomormous investments in infrastructure like distribution facilities. There’s also the added expense of shipping, which is often offered for free to compete with Amazon and the like.

 

 

Macy’s doesn’t report the profitability of its online business, but retail competitor Kohl’s reported in 2015 an operating margin of 9% from online sales, well below the 14% margin enjoyed by its stores.

 

Even if Macy’s can make money online, there’s no guarantee their e-commerce business will ever be as prominent as their once-iconic department stores. Not only is online retail extremely competitive (with behemoth Amazon far ahead in the game), but it’s unclear what makes Macy’s unique amongst online retailers.

 

All said, the vast majority of Macy’s revenue still comes from its 700+ department stores. Sales have declined for the past 7 quarters, and there’s no guarantee management can turn things around.

 

If its decline continues, Macy’s will be left with unprofitable locations to close, dampening long-term growth prospects. And if profit margins from e-commerce sales turn out to be slim, or if sales at department stores drop faster than expected, the company could be faced with a cash crunch — a real problem for a company with a lot debt like Macy’s.

 

It’s hard to imagine a future without any brick and mortar stores, and some stores like Target and TJ Maxx continue to do well. But Macy’s place amongst them is in question.

 

Dividend Safety: Macy’s

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.

 

Macy’s has a Dividend Safety Score of 43, suggesting that a dividend cut is not imminent but that the stock should be approached with caution.

 

Macy’s earnings payout ratio, which measures the percentage of profits paid out as dividends, is on the rise. The higher a company’s payout ratio, the less wiggle room it has to pay its dividend and meet other obligations, such as debt.

 

 

In fact, the earnings payout ratio over the past 12 months sits at 71%, well above Macy’s historical average of about 20%.

 

This recent upward spike in Macy’s payout ratio is a result of declining sales, leaving the company with less cash to pay its dividend.

 

 

If sales don’t rebound, Macy’s may eventually be forced to cut its dividend in order to meet its debt obligations, which aren’t insignificant.

 

There’s no one metric that indicates whether a company is saddled with debt; instead, several numbers come together to tell a story.

 

One such metric is the Net Debt / EBIT ratio, which measures a company’s debt relative to how much it earns. The lower this number, the better. We prefer to see companies with Net Debt / EBIT ratios under 2.

 

Macy’s Net Debt / EBIT ratio is 4.9, far above what we consider safe.

 

Another way to ascertain a company’s level of debt is by measuring how much of earnings is spent on interest payments. This is known as the EBIT / Interest Expense ratio, and we prefer to see companies with a ratio above 6 (the higher, the better).

 

Macy’s EBIT / Interest Expense ratio is 3.8, well below what we feel comfortable with.

 

 

For these reasons, in 2016 Standard & Poor’s downgraded Macy’s credit rating to BBB, just one notch above “junk” status. If the company can’t turn things around, something will have to give, and first up will be the dividend.

 

Even if sales do rebound and Macy’s financial health improves, Macy’s products (clothing and accessories) are mostly non-essential items, making the business and the dividend vulnerable to recession (when consumers cut back on spending).

 

 

For example, in 2009 during the last recession, Macy’s earnings plunged and management cut the dividend by 63%.

 

No one knows when the next recession will hit, but when it does, Macy’s business and its dividend will almost certainly be impacted.

 

Dividend Growth

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Macy’s Dividend Growth Score is 50, which indicates that Macy’s long-term dividend growth potential is about average.

 

Macy’s has grown its dividend rapidly since 2009 when the company cut its dividend steeply because of the recession. The dividend has averaged annual growth of 33.7% over the past five years.

 

But the latest dividend increase was just 7.4%, and Macy’s 10-year average annual dividend growth is actually negative (-4.8%).

 

 

Unless sales pick back up, Macy’s can grow its dividend in the short-term only by cutting costs, whether through layoffs or store closures, or by drawing more from earnings to pay the dividend, a risky strategy considering Macy’s debt burden.

 

In the long-run, Macy’s ability to grow depends on the future of department stores in the U.S. and whether traditional retailers can compete online.

 

For now, Macy’s is not a stock that can be relied on for safe, growing income far into the future.

 

Valuation

Macy’s current dividend yield is 4.8% and near its all-time high. Of course, the high yield is driven by the company’s declining stock price, which has dropped by 21% over the past year.

 

The stock trades at a Price / Earnings (P/E) ratio of 15, which is actually above its five-year average of about 14. However, the stock’s forward P/E ratio (based on forecasted earnings) is closer to 10, meaning that investors don’t have particularly high expectations for Macy’s right now.

 

Macy’s owns a ton of real estate, and some analysts have valued the company’s real estate at $21 billion, far above the company’s current valuation of $10 billion in the stock market. This could make Macy’s an interesting investment, but there’s no saying whether the real estate valuation is accurate or whether Macy’s will sell its property.

 

All said, while Macy’s forward P/E suggests it is trading at a discount, it’s not an attractive investment for conservative dividend investors looking for consistent, growing income and capital preservation.

 

Conclusion

For over a hundred years Macy’s has been a prominent destination for shoppers in the U.S., and during that time the company has undoubtedly persevered through many challenges.

 

But with the meteoric rise of online shopping, this time could be different. The internet has already killed many a business (when’s the last time you rented a DVD?).

 

With a questionable future and a dividend that rates below average for safety, the bottom line is that — at least for now — Macy’s is not a sound investment for people seeking safe dividend income and peace of mind that they own a company that will outlast us all.

 

As seasoned income investors know, it’s often a dangerous game to chase yield. Investors can read about six other habits of effective dividend investors here.