Why Macy's Plan to Close 100 Stores Is Brilliant

By Markets Fool.com

Image Source: Getty.

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[...] it is not the most intellectual of the species that survives; it is not the strongest that survives; but the species that survives is the one that is able best to adapt and adjust to the changing environment in which it finds itself. -- Leon C. Megginson on Charles Darwin's "The Origin of Species"

It's not every day that a brick-and-mortar retailer announces a drop in both earnings and revenues, gives questionable guidance, and details a large wave of store closures, only to be rewarded with a share price pop of over 17%. Yet that is exactly what we have been privy to as department store operator Macy's (NYSE: M) reported its second-quarter results on August 11, 2016.

Image source: Derek Jensen via Wikimedia Commons.

Make no mistake: This was no ordinary scheduled earnings release. Not only did management host its usual conference call and file an 8-K, but investors were provided with a second press release titled: "Macy's, Inc. Outlines Moves to Drive Profitable Growth and Enhance Shareholder Value."

Those who have been around the "investing block" more than once know that anytime management speaks of plans to "enhance shareholder value" while plotting to shutter some 16% of the company's full-line locations, it's highly likely there's trouble brewing behind the scenes.

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Fortunately for Macy's shareholders, that's not the case here. As I've detailed in the past, Macy's is uniquely positioned to profitably adapt to a world where e-commerce and physical store locations work hand in hand.Make no mistake, this is no ordinary situation, this is no ordinary retailer, and its announcement to close some 100 locations (no matter how painful for the many lives that will be affected) is absolutely the right decision.

Here's why.

Key details

Macy's second-quarter earnings were, in the eyes of anyone but Wall Street analysts and Macy's management, nothing to brag about. The bottom line may have beaten analyst estimates, and management may very well have been "encouraged by the distinct improvement in our sales and earnings trend in the second quarter," but both of these views ignore the simple truth that both sales and profits fell year over year.

Total sales slipped to $5.866 billion, a modest 3.8% from Q2 of FY 2016, and non-GAAP earnings per share fell 16.3% year over year to $0.54. Including the costs associated with the soon-to-be-implemented store closures, EPS came in at $0.03.

Management is putting on a good face in spite of strong headwinds -- not entirely unexpected in corporate America. What's far more interesting, and unique, is that they have a plan to set Macy's up for future success.

This leads us to Macy's second press release of the day. In it, management broadcasted two classes of information. Its plans for the future, and the thinking that led to these decisions.

Betting it all on omni-channel

In order to succeed in an increasingly competitive retail landscape, one plagued with competition everywhere, Macy's intends to:

  • Decrease its store count in order to focus capital and talent on better-performing locations in prime markets.
  • Specifically, beginning in early 2017, 100 of Macy's full-line stores out of a total 675 will be shuttered.
  • Customers used to shopping at closed locations will remain a priority through remaining locations, its website, and its mobile app.
  • Those associates displaced by store closures may be offered roles at alternate, nearby locations when possible. Also, Macy's associates who meet the eligibility requirements for severance benefits who get laid off by the planned closures will be properly compensated.

To see a retailer that is arguably the envy of its peers and still solidly profitable making bold moves like this is not an everyday occurrence. All the more interesting is the managerial thinking that led to these store closures.

Current Chairman and CEO Jeff Gennette stated:

The announcements we are making today represent an advancement in our thinking on the role of stores, the quality of the shopping experience we will deliver, and how and where we reinvest in our business for growth. In the short term, our company's topline sales will be somewhat smaller, but the changes being made will position us to grow comparable sales more quickly and generate a level of profitability that stands out among retailers.

Jeff Gennette, the current president of Macy's and decided heir to CEO Terry J. Lundgren noted in the release that:

Nearly all of the stores to be closed are cash flow positive today, but their volume and profitability in most cases have been declining steadily in recent years. We recognize that these locations do not yield an adequate return on investment and often do not represent a customer shopping experience that reflects our aspirations for the Macy's brand. We decided to close a larger number of stores proactively so we can invest in a winning customer experience in our most productive and highest-potential locations, as well as invest in growth sooner and more aggressively in digital and mobile.

That's right folks, not only are the stores likely to be shuttered currently cash-flow positive, but management is going all-in on offering shoppers a comprehensive, 21st-century experience. You have to give them credit; as one surveys the current status of peers likeSears HoldingsandJ.C. Penney, one can't help but think this is exactly what a retailer should be doing in 2016 (or perhaps 10 years ago, for the more far-sighted). One also realizes Sears probably wishes it had the luxury of being able to shutter cash-flow positive locations.

Why it had to be done

Cautionary tales aside, Macy's has seen a noticeable shift in its business over the last five years. These trends, coupled with the rise of its online success as well as meteoric rise of websites like Amazon.com (NASDAQ: AMZN), which cater to consumers' every whim, made bold action all the more necessary.

Metric FY 2011 FY 2012 FY 2013 FY 2014 FY 2015
Store count* 842 841 840 823 870
Comparable-store sales growth 5.3% 3.7% 1.9% 0.7% (3%)
Total sales $26.4 billion $27.7 billion $27.93 billion $28.1 billion $27.08 billion
Net income $1.26 billion $1.34 billion $1.49 billion $1.53 billion $1.07 billion

Data source: Macy's FY 2013 and 2015 Annual Reports. *Includes non-full line stores.

The bottom line for investors

The truth of the matter is that this major step put into action by Macy's has been in the works for years. The buzzword "omni-channel" has rolled off of management's tongues in conference calls and in SEC filings in every year of recent memory. Macy's has built massive, state-of-the-art distribution facilities in order to more effectively compete with Amazon.com's inroads into selling clothing. Macy's even described itself as "an omnichannel retail organization operating stores, websites and mobile applications under three brands (Macy's, Bloomingdale's and Bluemercury)..." in its latest annual report.

Current shareholders should be thanking their lucky stars they own a company whose management is adapting to the world as it is rather than what they would like it to be. To those on the sidelines right now, in addition to all that has been said in this article, it should also be noted that Macy's currently trades for just 12.6 times the low end of reiterated, normalized earnings for this year, and it is obviously making a strong go of adapting to a world where shoppers don't need to go to the mall to get what they want.

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Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.