Macy's, Inc. Reports Weak Q4 Earnings, but Dillard's Earnings Were Even Worse

By Adam Levine-Weinberg Markets Fool.com

On Tuesday morning, Macy's (NYSE: M) and Dillard's (NYSE: DDS) kicked off earnings season for the department-store sector. As expected, Macy's reported fairly glum results for the final quarter of fiscal 2016 and gave a downbeat forecast for 2017.

Continue Reading Below

However, fourth-quarter results at Macy's looked good by comparison with the ugly earnings report from Dillard's. While Macy's is simply being hurt by falling mall traffic, Dillard's appears to be paying the price for its unwillingness to invest in its stores and e-commerce site.

Macy's meets low expectations

At the beginning of 2016, Macy's management forecast that earnings would stabilize after declining significantly in 2015. The company's initial guidance called for full-year 2016 EPS of $3.80-$3.90, compared with $3.77 in fiscal 2015.

Mall traffic trends, however, worsened as the year progressed. Uncooperative weather also stymied sales for much of 2016. Macy's was ultimately forced to reduce its guidance twice during the year. As of early January, the company projected that comparable-store sales (including licensed departments) would fall 2.5%-3% for the full year, leading to adjusted EPS of $2.95-$3.10.

Macy's had to cut its guidance twice during 2016. Image source: Macy's.

Continue Reading Below

In all, Macy's full-year comp sales declined 2.9%. In Q4 specifically, comp sales slipped 2.1% year over year. Nevertheless, adjusted EPS came in slightly ahead of Macy's updated guidance, at $3.11.

Dillard's wipes out -- again

Meanwhile, Dillard's reported yet another disappointing quarter. Comp sales plunged 6% in the fourth quarter and fell 5% for the full year. As a result, the company's profit margin continued to erode. Q4 adjusted EPS fell to $1.85 from $2.25 a year earlier. That was far below the average analyst estimate of $2.26.

Net income at Dillard's has now plummeted by nearly 50% since 2014. The negative impact on EPS has been only partially offset by share buybacks.

Bulls might take comfort in the fact that operating cash flow grew by double digits last year, rising from $450 million to $517 million. However, this cash flow growth was driven by a $156 million increase in accounts payable and accrued expenses. This increase isn't sustainable. (At some point, Dillard's has to pay its suppliers.) At best, accounts payable will remain flat in 2017, leading to much lower operating cash flow. At worst, the buildup in payables will be reversed, eviscerating cash flow this year.

The retail environment will remain challenging

As usual, Dillard's did not provide sales or earnings guidance for the coming year. Macy's did provide a forecast for 2017, and it wasn't pretty. The company expects comp sales to fall by another 2%-3%, because of a continuation of the weak trends experienced recently.

Macy's projects that adjusted EPS will rise to a range of $3.37-$3.62, ahead of the average analyst estimate of $3.20. However, that includes about $0.85 in asset sale gains. Excluding those gains, EPS would be down slightly year over year.

Given that sales trends have been significantly worse at Dillard's relative to Macy's, the 2017 outlook for Dillard's isn't very promising. Last month, Macy's announced a major restructuring program that is expected to reduce costs by $550 million this year, of which $250 million will be reinvested in growth initiatives. Unless Dillard's has similar cost-cutting opportunities, it could face another round of severe margin compression this year.

Is Dillard's falling into a death spiral?

For years, Dillard's has boosted its free cash flow by cutting capital investments to the bone. That strategy is now coming back to haunt it. In a market where all department stores are hurting, Dillard's is having the most trouble attracting customers. As a result, the company's profit margin is collapsing.

In 2016, the pre-tax margin at Dillard's was a little more than 4%, down from about 6% in 2015. This figure will decline further in 2017, barring a miraculous turnaround in its sales trajectory. Given that Dillard's has always kept a tight leash on spending, it may not have as much room as Macy's to offset sales declines with cost cuts.

Furthermore, Dillard's ended 2016 with inventory up about 2% year over year, compared with being down 2% at Macy's. With sales declining at a steady clip, department stores should be reducing their inventory. The inventory glut at Dillard's could put additional pressure on its profit margin.

The one advantage Dillard's has over Macy's is a stronger balance sheet. However, low debt isn't a solution if the problem is that Dillard's is losing relevance with consumers. Unless Dillard's can stabilize sales, its profit margin will continue sinking at a rapid rate -- and the company could fall into the red within a few years.

10 stocks we like better than Macy's
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Macy's wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of February 6, 2017

Adam Levine-Weinberg owns shares of Macy's. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.