Source: Barron’s

Macy’s (M) reported quarterly revenue of $3.56 billion, non-GAAP EPS of -$0.81 and GAAP EPS of -$1.39. The company beat on revenue and earnings. I had the following takeaways on the quarter.

Digital Sales Demonstrated A Marked Improvement

Shelter-in-place policies have led to millions of Americans being stuck at home. It also drove a significant decline in store traffic and demand at Macy’s. The lion’s share of sales has occurred online, which has benefited retailers with a robust digital platform. Macy’s temporarily closed all of its stores in March. It began reopening stores in early May, and substantially all stores have been reopened since August. In conjunction with reopening stores, Macy’s reduced store hours, introduced social distancing policies and added curbside pickup.

The company’s $3.56 billion in revenue fell 36% Y/Y. This followed a 45% decline in the May quarter when management was disappointed by its online sales. Revenue was negatively impacted by the temporary store closings. However, the company’s digital platform performed much better, growing over 50%:

“However, in many of those areas, where the resurgence slowed the stores recovery, the digital business helped to partially offset the pressure. And overall, our digital business accelerated its strong performance coming out of the end of the first quarter and grew by 53% in the second quarter. Digital penetration across the company increased to 54%, up approximately 10 percentage points versus the first quarter.

However, with stores improving as the quarter progressed, digital stress moderated at the end of the quarter with July penetration coming in at 42% on digital growth of 25%. We expect this moderation to continue into the fall season as we discussed on our last call.”

Macy’s had to lean hard on its digital operations, and they delivered. The digital platform could help Macy’s keep pace with Target (TGT), Walmart (WMT) and Lululemon (LULU), which embraced online sales early on. It could also convince investors of the company’s long-term survival.

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On a product basis, Macy’s had strong performances in home, fine jewelry, fragrances, activewear and sleepwear. Men’s tailored clothing and dresses were laggards; they may continue to underperform while millions of Americans work from home. Apparel could create headwinds for Macy’s for the rest of 2020.

Margins Faltered

The decline in scale was bound to crimp margins. Gross margin was 23.6%, down from 38.8% in the year earlier period. Increased markdowns and higher delivery expense related to digital sales weighed. Gross profit on a dollar basis was $1.0 billion, down 57% Y/Y. SG&A expense was $1.4 billion, down 36%; the decrease reflects the decline in the business and expense management strategies. Despite deep cuts to SG&A, Macy’s reported an EBITDA loss of $153 million. On a dollar basis, EBITDA fell Y/Y by $539 million.

The company’s EBITDA could remain depressed until the economy fully reopens and the revenue slide subsides. As long as Macy’s reports operating losses, it could be difficult to make a bull case for the stock. Macy’s was struggling prior to the pandemic. The window of opportunity to rightsize the business could be closing.

Deteriorating Credit Metrics

Maintaining ample liquidity is paramount for retailers in this environment. Macy’s has $1.4 billion in cash, but it had to raise debt to shore up liquidity. Working capital was $777 million, down from $2.1 billion in the year earlier period. The good thing is that Macy’s pared inventory to $3.6 billion from $5.0 billion in the year earlier period. It is paramount that Macy’s continues to pare inventory to drive cash flow.

Free cash flow (“FCF”) for the first 26 weeks of the year was -$235 million, down from -$28 million in the year earlier period. Future EBITDA losses could amplify cash burn. Macy’s total debt load was $5.4 billion, up from $4.2 billion in February. The extra debt was being used to fund cash burn. It also came as the company’s revenue and EBITDA was shrinking. Debt-to-last 12 months (“LTM”) EBITDA is now 3.4x.

The company’s credit metrics have been slowly deteriorating, while Macy’s continues to wring costs out the business, close stores and attempt to build a viable digital platform. That said, the economy could be unkind to any turnaround efforts. U.S. Q2 GDP fell over 32%. There is no guarantee GDP will sustain long-term growth even after the economy reopens. Servicing its burgeoning debt load could become a challenge for Macy’s.


M is down over 50% Y/Y and could fall further. Sell the stock.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.