For the first time in a long, long while, retail stocks are on fire. Since I said it was time to go bottom-fishing for Macy’s Inc (NYSE:M) stock back on Nov. 17, M stock has rallied nearly 25%. The S&P 500 is up only 2.2% in that time frame. But this hasn’t been just a M stock rally. It has been a retail-wide rally.
Nordstrom, Inc. (NYSE:JWN) is up 10% in that time frame. Kohl’s Corporation (NYSE:KSS) is up 12% in that time frame. American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch Co. (NYSE:ANF) are both up about 13%, while Express, Inc. (NYSE:EXPR) is up a whopping 45%. The SPDR S&P Retail (ETF) (NYSEARCA:XRT) is up 7%.
Retail is back. And the catalysts fueling this comeback have longevity, meaning this rebound in retail could go on for a while. What is the takeaway for Macy’s stock? Stick with the rally.
Retail Is Rebounding On Solid Fundamentals
I’ve said several times before, and I’ll say it again: the death of retail has been greatly exaggerated. Not everyone is going to magically shop exclusively on Amazon.com, Inc. (NASDAQ:AMZN). Yes, it will continue to eat market share, but retailers aren’t dinosaurs who can’t adapt to changing dynamics.
They’re building out their digital footprints and successfully defending some of their market share. And that is just on the digital side of things. On the brick-and-mortar side, malls aren’t going to die. We are shifting to a world of omni-channel retail, not digital retail.
In other words, people will still shop in stores into the foreseeable future. Overall, then, the retail world ex-Amazon isn’t dying. It’s just shrinking. Investors who had sold off retail stocks as if mall retail was dying, are finally getting a dose of this reality.
By most estimates, Black Friday was pretty good for all retailers. Digital sales soared higher, while brick-and-mortar traffic declines moderated (some research firms even pointed to flat foot traffic year-over-year).
Supporting this broad data, Macy’s came out and said that they had a great start to the holiday season and that in-store traffic was so strong that they are hiring an additional 7,000 workers for the season.
That bullish report from Macy’s came amid a flurry of positive earnings reports from retail names like Express, American Eagle, and Abercrombie & Fitch, among others, all of whom sounded a bullish tone about Black Friday and holiday season sales.
Retailers are clearly having on their best holiday season in recent memory. That implies that this “shrinking” of mall retail may be nearing an end. If so, we should see a continuation of the current trend of sales improvement and margin stabilization.
Plus, tax reform is coming, and that is huge for full tax-paying retailers. Macy’s effective tax rate was above 35% last year). That combination should propel Macy’s stock, alongside other beaten-up retail stocks, markedly higher in the long-term.
Macy’s Stock Still Priced for Death Spiral
The attractive thing about Macy’s stock is that even amid this increasingly positive retail backdrop, the stock still trades at a hugely depressed valuation.
M stock trades at just 7.3x this year’s earnings estimate. The reason for the depressed current year earnings multiple is because the Street is modeling for earnings to have a wipe-out over the next two years. Earnings are expected to fall from $3.43 per share this year to $2.01 per share by 2019.
I don’t see that happening.
Comparable sales trends are improving. Comparable sales fell 2.5% in fiscal 2015, 2.9% in fiscal 2016, and 4.6% in the first quarter of this year. The full-year guide calls for comps to fall 2.5% this year. A 2.5% decline this year would illustrate sequential improvement in comps for the first time in a long while.
Margins are also starting to show signs of stabilizing. Operating margins actually improved 30 basis points last quarter. That is huge because the trend for many quarters has been margin compression. Operating margins compressed 90 basis points in Q2 and 70 basis points in Q1.
In fiscal 2016, operating margins fell 130 basis points, and that followed up a 170-basis-point decline in fiscal 2015. The last time margins expanded was in 2014, when they grew 40 basis points. What we are seeing, then, is that margins are stabilizing and actually growing for the first time since 2014.
With comparable sales trends improving and margins stabilizing, I really don’t see earnings falling more than 40% over the next 2 years. The consensus Street estimates seem far too pessimistic. Consequently, the valuation on Macy’s stock seems far too pessimistic.
Bottom Line on Macy’s Stock
Macy’s stock is in the middle of a 40%-plus rally over the past month. It may be tempting to sell on the bounce. But retail stocks are rallying on solid catalysts that have longevity.
I think M stock, alongside the rest of retail, will continue to rebound.
As of this writing, Luke Lango was long M, AEO, ANF, EXPR, KSS, and AMZN.