Macy's Stumbles From Grace

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On this episode of Market Foolery, host Mac Greer together with Motley Fool contributors Ron Gross and Andy Cross talk about some of the market's biggest updates today. Macy's (M -0.08%) tanked 18% after reporting a weak quarter. The guys break down the numbers to look at how bad this really is, what it could mean for Macy's and retail writ large, and how attractive the stock looks at this discounted price. Target (TGT 0.78%) also fell after reporting earnings, despite a pretty good report. Meanwhile, Bed Bath & Beyond (BBBY) popped some 12% on its report, but don't get too excited that the company might finally make a comeback. Tune in and find out more.

A full transcript follows the video.

This video was recorded on Jan. 10, 2019.

Mac Greer: It's Thursday, Jan. 10. Welcome to Market Foolery. I'm Mac Greer. Joining me in studio, we have Motley Fool analysts Andy Cross and Ron Gross. Guys, a belated Happy New Year! How are we doing?

Ron Gross: And a very Happy New Year to you, Mac! All is well. 

Andy Cross: Thanks, Mac! Happy New Year!

Greer: Thank you! We're going to be talking a lot of retail earnings, some good and some Macy's. And that's where we start. Shares of Macy's down around 18% at the time of our taping. Ron, weaker than expected holiday sales. 

Gross: You think?

Greer: Macy's cutting its earnings outlook. Now, you are a former Macy's employee. 

Gross: A proud one, yes.

Greer: We're going to get to that later in the show. But what about the earnings? 

Gross: What to say? They're bad. They're not 18% bad, I feel. You have anemic same-store sales growth, less than 1%. But you have growth. You don't have a contraction. But I think Wall Street is focusing on all of the lowered guidance. That's fair. You see net sales guidance coming down, earnings forecasts have been cut, the company has alluded to needing to be promotional to, as they say, "ensure a clean inventory." That's an interesting comment to me. That actually has implications for the wider retail segment. If Macy's is going to be promotional, that sometimes has a domino effect, and others then need to be promotional. People start cutting prices, that eats into margins, you have earnings impacts as a result of that. 

So, not great. But, again, some areas of positivity. Double-digit growth in the digital business. Certainly good to see there. And they did return to what they expected to see by the week of Christmas. Just some weakness right there in the middle of December, which is playing around with results. 

The stock is getting slammed -- 6.5 times earnings at this point. For those value investors out there, be careful, though. 5% yield at these levels, as well, could be a value trap, could be an amazing value investment. I'm not going to opine as to which at this moment.

Cross: It's almost the cheapest value stock we may talk about today. Ron's point about the inventory, watching the pricing and how aggressive they have to be to drop prices and discount, for a company whose profit margins a few years ago were in the mid-teens, now down in the 6% range. I think investors looking at that headline, I agree, 18% seems pretty aggressive. However, considering the retail environment that we are under, anytime companies are implying that they have to be aggressive on the pricing front that sends some shudders down investors spines. We're clearly seeing that today with Macy's.

Gross: And, exacerbated by the fact that I think everyone thought this holiday season was going to be really strong. I think that was the scuttlebutt. Even if it's a pocket of weakness or a week or two here of weakness, that makes everyone change course and sell stocks.

Cross: I mean, holiday comps at least were positive. That's a good sign.

Greer: Yeah, but when I hear Ron say "anemic... "

Cross: Exactly.

Gross: It's a good investing word.

Greer: Yeah, it's not a great term. Let's talk about the stock. When you look at the 52-week range, low of around $22, high of around $42 back in August. Today, shares on the earnings news trading in the mid-20s. So, it's close to its 52-week low. What do we think about Macy's stock going forward? 

Cross: You have a company that, as Ron pointed out, from a metric perspective, not expensive at all. Of course, the growth prospects are muted. It generates hefty cash flows that it uses to continue to pay out dividends, and their capital expenditures are run in a $500-$600 million range. So, when I look at this stock, I don't think it's attractive enough on the pricing front that I would go bottom-dwelling here. But I would certainly keep an eye on it. Anytime this kind of aggressive move happens, in my experiences, I let the market settle down a little bit to see where the price settles, and then take a little bit healthier look at what the company reports when it comes to the actual earnings and expectations for the year.

Gross: I may take the other side of that trade. I might nibble here. I would never have it be a big percentage of my portfolio. I would never have retail, probably, as a big percent, under most circumstances. I don't have the numbers in front of me, but I think they've shored up their balance sheet a bit over the last year or two. I like to see that. It's awfully cheap. They're still making money. I don't think things are as bad as they seem. Now, if we go into a recession, full-price retailers, it ain't gonna be pretty. But that's hard to predict. 

Greer: Ron, as I mentioned earlier, I think your perspective is unique because you are, in fact, a former Macy's employee. We have talked about your Macy's career, but for people who may have missed that conversation, how about a highlight and lowlight of your Macy's time? 

Gross: It was one of my first jobs ever. It was in high school. It was very exciting to be hired by a big company like Macy's. Actually, Bamberger is the one I worked at at the time, owned by Macy's. That was really exciting. I remember in my interview, when they asked me what book I had read recently, and quite frankly, I hadn't read a book recently. So, I said a Shakespeare book because we had recently read it in high school. And they were like, "Ooh, this guy is reading Shakespeare!" But, they gave me the job, and then they placed me in the bath shop, which was a big letdown. It was towels and bath rugs, and oh, boy, it wasn't pretty.

Cross: I don't have such experiences on the retail front, but I really wish I was shopping back then around when Ron was working to see what he was like as a salesperson on the bath floor. 

Gross: Not good.

Greer: I love that. We talked the show, and you confessed to -- is it fair to say you didn't really want to deal with the customers?

Gross: It was... [laughs] 

Cross: Were you on commission?

Gross: No. I'm dating myself here, but there was no such thing as barcodes or the fancy registers now. You had to type every little thing in manually. And God forbid someone had a return. Your head would explode. It was literally almost impossible.

Cross: Everyone paying by check.

Gross: So, I would kind of just hide in the corner and pretend to refold the little bath rugs over and over and over.

Cross: You become professional at that.

Greer: I love that!

Cross: I bet we go in your closet today, it's all nice and neatly folded.

Gross: I can fold a shirt, you bet I can.

Cross: You can compete with Gap there.

Greer: Let's stick with the retail theme. Bad news for Macy's not helping Target. Target reported a 5.7% increase in 2018 holiday same-stores sales. That's pretty good when you compare it to last year's 3.4% number. Target is maintaining its outlook. But, shares of Target down around 3%. Andy, what gives here?

Cross: I spent some money in Target over the holiday season! I'm contributing to this! This looked to be a fairly good news announcement from Target. They're looking at their comp growth of 5.7%, up from last year's 3.5%. Interesting, their store pickup, which is, you order online and pick it up in the store, was up 60%. Now, about a quarter of total digital sales are done with store pickup. I think that's a nice innovation they've had to compete with the likes of Walmart and some of their pickup initiatives. They're making lots of investments into the store. 

The stock is at $68 here now. It's going to earn maybe $5.50. That's an earnings multiple little bit higher than what we saw in Macy's, but I think it's a little bit of a better stock here, growing in the mid-single-digits line. Generates a lot of cash. So, Target to me is a little bit more attractive of an investment opportunity. That announcement was pretty good. I think it's just getting hit by the Macy's news today.

Gross: Agreed. On track to have its best full year of sales growth in 13 years. Not too shabby. They did announce, also, the CFO was retiring. I don't know if investors are reacting to that. Maybe a bit. Not too troublesome, though. A handful of other management changes, as well. Online sales grew 29%, as Andy said, driven by home delivery and the pickup hubs that they now have. 

I like what I see. A 4% yield, for those seeking a nice dividend. Continued to be quite profitable. As Andy said, only 12-13 times earnings. Not expensive. Doubled the earnings multiple of Macy's, but I think appropriately. I think they're doing fine.

Greer: OK, guys. Perhaps the most surprising news to me, Bed Bath & Beyond shares up 12% on earnings. Andy, I don't know if I was more surprised by the fact that the shares were up 12% or the fact that Bed Bath & Beyond is apparently still around. I want to read you a little piece from the earnings announcement. Bed Bath & Beyond said it's ahead of schedule in terms of slowing down the declines in operating profit. It also said that its fiscal 2019 earnings per share will be about the same as 2018. And investors just went wild.

Cross: The past few years, you've been just going down that hill. This is a business that had earnings per share in 2016 of around $5. Now, they're down to the $3 range. Operating margins have fallen from 12% down to about 4.5%. The interest coverage on the debt, Ron, has gone from 16 to 7. You just think about the metrics of that business, going down, down, down --

Greer: That's worse than anemic. That's bad.

Gross: [laughs] That's a tourniquet.

Cross: So, when they come out and say comp turns for the expected fourth quarter coming in at down 1%, and the earnings per share for the year about flat for next year, as they will be for this year, investors are saying, "Wow! At this price, this is a discount that I can't refuse to not be buying today off this low." Maybe they're trying to bottom-tick the stock price. Clearly the stock's moving on that news.

Gross: I have a feeling this is just a trade for many people. This is not a long-term holding. As we always say, it's all about expectations vs. reality. Here, things are a bit better than expected. The stock takes a pop. Some people will benefit from it, and then probably end up being short-term investors. 

Again, similar to Macy's, the stock is trading around 6.5 to 7. But I think they're in a bit more trouble here. This is a company that I would be very, very wary of. They continue to buy back stock. Is that a good capital allocation decision? Well, not if they're going to continue to go steadily down, it's not.

Greer: It's a lot cheaper these days, the stock down around 80% over the past five years. 

Cross: It sells at like seven-tenths book value now. All the other retailers sell at three, four times book value, which is down from what they used to be. As you mentioned, the earnings multiples totally contracted. 

The risk here I see is, the same management team has been in place running this for the last 10 years or so. This is a team that bought back loads of stock when the stock was in the $40-$60 range, up to $3 billion worth across that two-year period. I look at those investments and the other investments they've made as terrible uses of shareholder capital. To Ron's point, it's probably not one that I would be looking at over the next few years I'm holding on. I just don't see the story long-term playing out, either on the business or the management team.

Greer: I love the low bar here. We were talking before the show, and I was thinking of an analogy. For me, it's that I'm slightly ahead of schedule in terms of losing the weight I gained over the holidays.

Cross: Is that true?

Greer: It is true.

Cross: Congratulations, Mac!

Gross: That's good!

Cross: I'm trading Mac today. I'm buying Mac and selling next week.

Gross: You're healthier.

Cross: Maybe, from a trader perspective, Bed Bath & Beyond, a little healthier today than they were yesterday. 

Greer: We've talked a lot about bricks-and-mortar retailers. Over the years, especially in recent years, we've talked a lot about which retailers are most Amazon (AMZN 3.45%)-proof. I don't want to ask you that question again. We have talked about that a lot. But do we overstate Amazon and the threat that Amazon poses when we're talking about some of these more established retailers?

Gross: Overstate, yes. But it's a true problem for those brick-and-mortar retailers. We see it unfold, and it will continue to unfold. It's not going to destroy brick and mortar forever. It's not going to destroy all the malls. In fact, you see some online retailers actually moving toward the mall, whether it's a Warby Parker or an UNTUCKit. People with online presence actually want a brick and mortar presence, which is an interesting phenomenon. The malls will be around. Perhaps we grew too fast. Perhaps there are too many. Not all the anchor stores, a la J.C. Penney, will survive. It's unfortunate, but it's a natural consequence of the business cycle, especially when a company like Amazon comes in and disintermediates an industry. Things are overblown, but still, you can't overlook it. 

Cross: From the marginal sale, from the buying perspective, I looked at Macy's. The beginning of the holiday period was looking pretty good. But then it fell off the cliff in mid-December. That's where I think someone like Amazon and other exceptional online retailers have an advantage. Rather than having to go to a Macy's store, I can just sit on my couch and order from Amazon and have it the next day or two.

Greer: Love it!

Gross: That's my favorite part.

Cross: It's not just Amazon, though. I will say, cosmetics was a challenge for Macy's. Ulta is doing very well in cosmetics right now. Certainly, as Ron said, Amazon is playing a big part, but there are other factors going in. The buying habits of consumers are changing. A lot of those companies you mentioned are also pushing more of their online sales, it's just a higher hurdle when you're going against the likes of Amazon.

Greer: Dan Boyd, I want to bring you into this conversation. As a representative of the millennial generation, as a somewhat -- no, not somewhat -- as a younger man than my esteemed colleagues here... how about a bricks-and-mortar pick? If you're looking out over the next 10 years, we've talked about Target, Macy's, Bed Bath & Beyond. Do you have one bricks and mortar company that you think is most apt to succeed? 

Dan Boyd: You know, this conversation is very interesting to me. Out of the three stores that I actually enjoy going to, Macy's is one that I kind of enjoy going to. But it's clear that they're not killing it as a business right now. I absolutely detest going to Target, but out of the three, I think that one is probably the healthiest business and will be around the longest.

But I have a better answer. As far as brick-and-mortar stores go, I think that hardware and home improvement stuff is always going to be the kind of business that you go somewhere to get something. Stores like Lowe's or Home Depot are going to be your most resilient brick-and-mortar stores.

Greer: I like that. What about Tractor Supply? 

Boyd: Yeah, for sure. 

Greer: You're not buying deer corn --

Gross: I'm not. [laughs] 

Cross: Exceptionally smart, Dan, because Mastercard, the SpendingPulse report from the holidays had home improvement sales up 9%. Home improvement, doing quite well right now. 

Greer: As we wrap up here, I want to hit the desert-island question in a minute, but Ron, you mentioned malls earlier. Do you have a favorite mall store? 

Gross: A favorite mall store? Yeah, I've always been a fan of Nordstrom for their customer service, which I actually think has gone down recently. If you're listening, Nordstrom, get that set, get that right. That's what differentiates them. I think the merchandise as well, but the customer service you get at that large, bigger-box kind of department store is what differentiates them. That's where I like to go. 

Greer: Andy?

Cross: I'm a new shopper at Nespresso.

Greer: Say that again!

Cross: Nespresso.

Greer: Oh, that's a terrible name.

Cross: It's great! No! It's the Nestle home espresso-making machine.

Greer: And they just had to combine the terms. 

Cross: Their online experience is fantastic, Mac!

Greer: Nespresso.

Cross: Ordering, the app, the selection is great. They have what they call boutiques. They have one at Montgomery Mall. So, I go over there if I'm not ordering online. They serve you some coffee, you can buy your little pods.

Gross: Fancy.

Greer: Who are you?

Gross: I like Wetzel's Pretzels. 

Greer: That's funny, because you know what my favorite store is? I'm not even sure it's around anymore, but honestly, my favorite mall store, Orange Julius. 

Cross: Orange Julius! I knew you were going to say that, Mac!

Greer: Yes! I love Orange Julius! It's so good! And good for you, I think.

Gross: [laughs] The pulp.

Cross: My wife used to work there. She used to be, like, the local manager of an Orange Julius. I mean, do they have managers? I don't know. But she used to work --

Greer: [laughs] "Do they have managers?" 

Gross: Hysterical.

Cross: Orange Julius.

Greer: I'm not sure it's around anymore. I think it is. I think it's still around. I think someone bought them.

Cross: Bed Bath & Beyond bought them.

Greer: Exactly; that's the "Beyond." OK, so, the desert-island poll. We've got Macy's, we've got Target, and we have Bed Bath & Beyond. If you're going to own one of these stocks for the next five years, and you're going to be on a desert island -- and, again, the caveat, don't invest this way. It's just a silly way to end the show. Which stock are you going with?

Cross: I'm going Target.

Gross: I'd never go against my man, Dan, so Target it is.

Greer: Dan Boyd?

Boyd: Target, but, again, I'd rather go to Macy's than Target.

Greer: What are you buying at Macy's?

Boyd: A lot of times, for my mom's birthday or for Christmas or something, for her, I like to go around and find stuff that she would like and pick it out for her.

Gross: What a good son!

Greer: That's great!

Boyd: They sell Levi's at Macy's, too. That's usually where I go when I need a new pair of jeans.

Greer: You know where I went a few years ago for a pair of 501s? Sears. And it was great because I was the only one in the store. It was great! It was nice. I liked it. A little peace and quiet. 

Cross: You'll have to save Costco for another day, Mac. They had a good holiday period.

Greer: Oh, I know. 

Cross: Your favorite Costco.

Greer: Leave them wanting more.

Cross: That's right. Save it for a different day.

Greer: There you go. Andy, Dan, Ron, thanks for joining me! [email protected] is our email. If you want to share your favorite mall store, if you've got advice for the next Ron Gross, who may or may not be working at Macy's in the... what, the bed and bath shop?

Gross: [laughs] Bath shop, we called it, yes, thank you!

Greer: There you go. Questions, comments, [email protected]. As always, thanks for listening! People on the show may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! We'll see you tomorrow!