Sean O’Reilly: We’re going shopping for consumer goods dividends…
on this CG edition of Industry Focus.
Greetings Fools, I am Sean O’Reilly here
in studio at Fool headquarters in Alexandria Virginia. It is Tuesday, November 17th and
this week is dividend week on Industry Focus. Vincent Shen is out today and filling in for
him and joining us on the phone from the Windy City, Chicago Illinois, is Motley Fool contributor
Adam Levine-Weinberg. Morning, Adam and how’s it going?
Adam Levine-Weinberg: I’m doing well, how are you Sean?
O’Reilly: Not too shabby. I’ve got my coffee, got my water, ready to talk some dividends,
it’s all good. Levine-Weinberg: That sounds great.
O’Reilly: So Adam I talked to you a few days ago about today’s show, and once again
thanks for filling in for Vince. And you’re willing to dive right into the carnage of
the retail sector for some reason I’ll never understand.
You picked Macy’s for a great consumer sector dividend stock, which I happen to agree with
and we’ll get into the reasons why in a few. Before we get into the new gritty of
Macy’s as an income stock, can you just give listeners some perspective as to what’s
been going on in the retail sector? Because last week alone was a bloodbath.
Levine-Weinberg: Yeah that’s right, Sean. Retail stocks really got hit hard last week
and Macy’s was definitely one of the big reasons for that. Macy’s stock peaked in
mid-July at $73.61. But since then it’s fallen by nearly 50% and as of this morning
it’s below $39. So a lot of that drop has happened in just
the last week or two after its Q3 earnings; which were already expected to be pretty bad,
were even worse than that. And the company is seeing strong, big sales declines. But
the result of this is that the quarterly dividend is still $.36 and so the annual yield which
in the middle of July was a little under 2%, is now 3.7%. And that really makes Macy’s
an intriguing stock at least for dividend investors.
O’Reilly: Yeah that is just crazy. Because that’s more than a 30-year treasury right
now. I mean these are higher than bonds in the U.S. Government. So what’s going on
with the business? Because you and I did a, you were very gracious
enough to call in a number of months ago and we talked about Macy’s then as well. And
we both, I think were, I mean their returns on equity, their shift to doing the online
and the stores, it was all just awesome. They were clearly the strongest player especially
compared to a JCPenney or a Sears. What’s going on with the fundamentals? Because long-term
I think the story’s intact. Levine-Weinberg: Yeah so obviously you wouldn’t
want to invest in Macy’s just because of the high dividend yields if you really thought
that the business was in grave danger. Because sooner or later if you’re not making money,
have to cut the dividends and then as income year after year.
O’Reilly: Then game over. Levine-Weinberg: You’re out in the cold.
There’s no guarantees to dividend. The company can stop it at any time.
Though looking at Macy’s, last quarter their comparable store sales, so that’s sales
in stores that have been open for at least a year, declined 3.6% from the prior year
quarter. And Macy’s is expecting another decline on comparable sales for about 2% across
the full year. So that’s definitely not good and Macy’s
has definitely seen a trend in the past 2 to 3 years of slowing comparable store sales
gains. But this is the first time in quite a while, really since the Great Recession
that you’ve had a year-long […] decline in comp sales.
On a year-to-date basis, Macy’s EPS is $1.56 or $1.76 excluding some asset impairments
and that’s down year over year. Last year it was $2 and a penny. And Macy’s current
guidance fiscal year implies that you’ll see that some of its decline continued into
the 4th quarter. Again excluding any gain from asset sales or special items. But you
have to put this in the broader context because Macy’s has come out of a six-year streak
of double-digit EPS growth. So it’s not like this is a company like
you mentioned, Sears, JCPenney, where there’s been a lot of struggle. There, a few bad quarters
could be a really bad sign. For Macy’s, the company’s basically been doing well
until this year. And so it’s worth looking […] to see why it’s not doing well in
2015 and whether it might be able to recover. O’Reilly: Yeah, so they’ve got this shift
to where they’re trying to meet consumers in cyberspace as well. I mean, they built
that huge distribution facility which as I understand it and I’ve talked about it before,
they built it in Oklahoma and I’m pretty darn sure it rivals an Amazon warehouse. Like
it’s top of the line, it cost them $3-4 million and it was it. Is online sales balancing
these declines in physical stores at all? Levine-Weinberg: So Macy’s a couple of years
ago stopped reporting its online sales separately. And it had for a long time just reported the
gross numbers for online sales without necessarily breaking out the exact dollar amounts. But
as of a few years ago they were already at $2 billion and rising by at least 20% a year.
And a in a lot of years they’re rising like 40%. So they’re actually growing their online
business faster than Amazon for quite some time.
O’Reilly: That’s an achievement in itself I would think.
Levine-Weinberg: Yeah, and so that’s definitely a big business for them. But it’s still
smaller than the retail stores and the comp sales figures that I was discussing earlier,
that actually includes the online. So you can, that’s if the online is still
growing at a healthy clip and if the retail is declining even faster. And so that’s
creating some need to kind of rebalance and figure out a new strategy to get the most
value out of the stores that are in the network right now.
O’Reilly: So comps are dropping, they’re projecting decline in earnings for this year.
What are they doing to recover? Levine-Weinberg: So Macy’s is basically
going after this with a multi-prong strategy. So the first thing is they’re trying to
explore some new growth avenues beyond the traditional department store and even beyond
the online component of its traditional department store business. So one thing that they’re
doing is they bought the Bluemercury chain which is sort of luxury fashion or beauty
stores. More boutique size. So quite small compared to a department store.
And they are building more of those standalone Bluemercury stores and at the same time they’re
putting Bluemercury boutiques into existing Macy’s department stores to make better
use of space and to boost sales in the beauty department of each Macy’s store. They’re
also testing Macy’s Backstage which is a new off-price concept. So it’s like a T.J.
Maxx or a Nordstrom Rack. O’Reilly: I was about to say that’s reminiscent
of Nordstrom’s Nordstrom Rack and that’s been a huge success.
Levine-Weinberg: Yeah and Macy’s has already been in that business to some extent because
they also own the Bloomingdale’s chain which is upscale relative to Macy’s. And Bloomingdale’s
has a chain of outlet stores. So Macy’s is trying to sort of move that more into the
mass-market now. And it’s just a test at the moment, but they are really talking about
rolling that out more broadly over the next few years.
And Macy’s is even testing an e-commerce joint venture in China. So they have a bunch
of different things that they’re trying which will hopefully add more growth. At the
same time they also need to focus on getting costs down to be more in line with the sales
they’re seeing today. So the company announced last week as part
of its earnings report that they’re cutting their SG&A spending by about a half billion
dollars relative to their prior plan. And that will be implemented by 2018. So you’ll
see incremental improvements in their selling cost over the next few years. As part of that
they’re closing 35-40 stores in early 2016 and plan to continue closing stores that are
underperforming. O’Reilly: Now those are essentially, sorry
to interrupt, low traffic, unprofitable stores obviously not the big ones in urban areas.
Levine-Weinberg: Right. That’s true for the most part. There are some stores in urban
areas where they’re closing the store not because it’s unprofitable, but because the
real estate is so valuable that they can make more money by selling the building to someone
who wants to redevelop it. But in most cases yeah, the stores that are closing are the
ones that are in the lower performing malls where there’s just less traffic.
Maybe these are malls where JCPenney’s or Sears had a store which closed and so now
there’s fewer people coming to the mall. And you know there’s been a problem in the
U.S. for quite some time that there’s just too many malls relative to how many people
want to go to the mall these days. And so this is just a process that’s going to continue
for a while with paring down to a number of stores that’s more in line with today’s
reality, where you don’t actually need to go to the store for every single purchase.
Some things you might just want to buy online. O’Reilly: Got it. Well before we move on,
no go ahead. Levine-Weinberg: Go ahead.
theme, I wanted to point our listeners to a special article written by five industry
focus contributors detailing their top picks for dividend stocks. Just head to Dividends.Fool.com
to learn our picks for the best dividend stocks of 2016. Once again that’s Dividends.Fool.com.
So Adam, getting back to Macy’s, I was talking a little bit about the dividend sustainability
in the context of the cost cuts and everything, and actually their growth potential. Because
if they aren’t growing that dividend will not last for long.
Levine-Weinberg: Sure. So if you look at the annual payout, it’s now $1.44. And that’s
up from just $.20 during the Great Recession. So you can see that Macy’s really has been
increasing its dividends quite rapidly in the past few years. So $1.44 is about 40%
of Macy’s projected EPS for this year excluding any asset sale gains or special items. So
that’s a pretty good payout ratio. It means that you’re getting a good proportion
of the income but it’s not so high that you’d have to worry that a small blip in
earnings would make the dividend too high to afford for Macy’s.
On a cash basis Macy’s has generated operating cash flow of about $2.2 billion over the past
12 months. And the current dividend payout comes to roughly $450 million annually. So
this means that Macy’s has really plenty of cash to cover its planned capital expenditures
which it’s reducing to under $1 billion a year going forward. And still have a lot
of money left over for dividends and also for some share buybacks.
And just like if it were able to get its profit margins back to last year’s model, see who
could boost its cash flow, because if you look at its operating cash flow which is $2.2
billion in the past 12 months just a year ago it was $2.7 billion. So there’s definitely
some opportunity just in doing the retail basis a little bit better. And Macy’s is
also likely to bring in a lot of cash from selling off real estate. Either real estate
in stores where it doesn’t want to operate a store anymore, or in some cases it could
be really large stores in urban areas like New York, Chicago, and San Francisco where
the stores are so massive that you could sell off the upper floors of those stores, bring
in a lot of money, and still keep most of the sales because you’d have a lot of space
left. So Macy’s is actually working with a real
estate company to identify potential deals, both for these flagship stores in those three
cities I mentioned, as well as a few other stores. And while those proceeds might get
distributed through buybacks rather than dividends, the faster Macy’s can reduce its share count
the less it has to pay out in dividends for any given dividend rate. Which means it can
basically raise its payout faster. O’Reilly: Yeah, on a per share basis. Yeah.
Levine-Weinberg: Yeah, exactly. O’Reilly: So for Foolish investors you’ve
made a lot of great points. What’s the bottom line, the conclusion that Foolish investors
or just our listeners can go to check out, do their own research, but that you want them
to know? Levine-Weinberg: Yeah so I think the main
take away here is that Macy’s has suddenly become a high-yielding stock with a 3.7% dividend
yield. And the payout ratio remains quite modest. And beyond that Macy’s profitability
should improve going forward due to its cost cuts, attempts to sell off real estate, and
that leaves a lot of room for dividend growth in the future.
O’Reilly: Awesome. Well, thank you for your thoughts and I can’t thank you enough again
for filling in for Vince, Adam. Levine-Weinberg: You’re very welcome.
O’Reilly: Have a great day. That is it for us Fools. If you are a loyal listener and
have questions or comments we would love to hear from you. Just email us at IndustryFocus@Fool.com.
Again that’s IndustryFocus@Fool.com. As always people in this program may have
interests in the stocks they talk about and the Motley Fool may have formal recommendations
for or against those stocks. So don’t buy or sell anything based solely on what you
hear. For Adam Levine-Weinberg, I am Sean O’Reilly. Thanks for listening and Fool
on!