M Stock: Is Macy’s, Inc. or J.C. Penney Company, Inc. a Better Investment?

M StockIs El Nino to Blame for Macy’s, Inc.’s Poor 3Q Results?

Macy’s, Inc. (NYSE:M), which also owns the Bloomingdale’s brand, has reduced its earnings forecast for the current financial year after an unexpected drop in same-store sales in the third quarter. The company noted that the strong dollar has discouraged visitors from spending, hurting Macy’s stock. However, despite a few more quarters of hardship, M stock has the legs to resume its rightful place in the retail sector.

More than sales, which have suffered because of lower-than-expected winter clothing sales due to the unusually warm fall season in the Northeastern states, Macy’s stock has suffered from investor disappointment. Investors weren’t overly happy with the retail chain’s decision not to spin off its real estate as a real estate investment trust (REIT), which represents a class of assets that money managers appreciate.

The warm weather that’s a result of El Nino, which tends to intensify around the winter holidays and is Spanish for “the child,” will bring gifts to consumers and coal to retailers this Christmas. Many have delayed purchases of boots, sweaters, jackets, and general winter apparel due to the unseasonable warmth. Weather observers expect El Nino to keep temperatures one to three degrees higher than normal throughout November. (Source: “Retail Could Get Crushed by Changing Consumer Habits,” The Street, November 9, 2015.)

Macy’s stock has dropped more than 29% since the start of 2015. The REIT would have facilitated the sale of Macy’s real estate assets. Indeed, Starboard Value, an activist investment fund, has urged Macy’s to sell its real estate assets. The investment fund believes the assets would fetch some $21.0 billion and the REIT would trade at a higher earnings multiple compared to M stock. (Source: “Macy’s cuts full-year forecast, sends shivers through retail,” Reuters, November 11, 2015.)

But Macy’s guidance has not given investors good news, either. Macy’s expects 1.8%–2.2% lower revenues for its fiscal year ending in late January. The third quarter, which ended in late October, saw same-store sales drop 3.6% in what was the third consecutive quarter of decline, defying analysts’ expectations of a 0.2% rebound, according to research firm Consensus Metrix. (Source: Ibid.)

JCPenney Learned All It Needed to Improve from Macy’s

Macy’s could explain its poor performance as a symptom of general spending malaise from consumers, which affected the overall retail sector. But this thesis contrasts sharply with the 6.4% comparable sales reported by competitor J. C. Penney Company, Inc. (NYSE:JCP), which hasn’t posted such strong results for more than nine years. Expectedly, shares of JCPenney surged; JCPenney stock has gained more than 30% year-to-date. (Recall that Macy’s has dropped 29% year-to-date.) (Source: “J.C. Penney settles false advertising class action lawsuit in California; 3rdQ sales increased 6.4%,” The Dallas Morning News, November 11, 2015.)

In fact, Wall Street has already lost faith in the 2015 Christmas shopping season and Macy’s may have sealed its case. The news may be good for shoppers, who can expect great deals in an attempt to bring about more sales, but Macy’s margins will be hurt. Macy’s serves as a barometer for the retail sector and most of its competitors saw lower-than-expected results, prompting retail stocks to tumble.

Given the overall retail discontent, the analytical problem is less what Macy’s has done poorly and more what JCPenney has done well. Ironically, just two years ago, as new management took over the reins of JCPenney, they looked to Macy’s as the example. Indeed, they looked very closely at everything Macy’s has done and they seem to have learned by example what not to do as well. (Source: “If JCPenney Wants A Model For Its Retail Turnaround, It Has One: Macy’s,” FierceRetail, April 10, 2013.)

Two years ago, Macy’s benefited from JCPenney’s problems. (Source: Ibid.) Macy’s aimed for a somewhat more “extravagant” customer, catering to this demographic’s needs by bringing in more luxury brands. Meanwhile, JCPenney, which had made its success as the ideal store for middleclass America, had to change to reflect the times. It seems this change has happened and Macy’s has already saturated its supply of former JCPenney customers. Perhaps JCPenney has learned too well from Macy’s, winning back its old customers along the way.

Macy’s saw its net income group share fall from 45.6% in the third quarter to $118.0 million, or $0.31 per share, in part because of an impairment charge related to store closures. Macy’s revenue dropped 5.2% to $5.87 billion, the third consecutive quarter of declines. Finally, Macy’s has revised its earnings-per-share (EPS) guidance downward. For the full year (ending January 31, 2016), Macy’s now expects an EPS range of $4.20 to $4.30, down from $4.70 to $4.80.

Macy’s Stock Is One to Follow Within the Retail Sector

Macy’s will need to come up with a strategy to reverse the current course.

The signing of a license agreement with the Italian eyewear manufacturer Luxottica Group, which makes Ray-Ban eyewear, among many other brands, will lead to the addition of LensCrafters locations stationed in 500 Macy’s stores over the next three years. (Source: “Macy’s and Luxottica Group Sign Exclusive Agreement To Open LensCrafters Licensed Departments In As Many As 500 Macy’s Stores Over Three Years,” BusinessWire, November 11, 2015.)

Macy’s may also refocus on predicting style and fashion trends, offering something different to shoppers who may not have noticed much in the way of new must-have fashions. (Source: “Retail Could Get Crushed by Changing Consumer Habits,” The Street, November 9, 2015.)

Nevertheless, the ability of Macy’s stock to thrive requires that the company examines the fundamental shifts in what consumers want. Years of economic slump, which was actually more of a recession for a vast majority of Americans, have changed buying habits, and this will force retailers to adapt to new consumer trends. Historic performance and the value of its assets continue to make Macy’s a compelling stock that investors should watch closely. If any retailer knows how to turn around and adapt to a trend, it’s Macy’s. I wouldn’t write off M stock yet.

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