Why Macy's and Kohl's Shares Tanked on Better-Than-Expected Reports

Markets Motley Fool

In this MarketFoolery segment, host Mac Greer, David Kretzmann of Supernova and Rule Breakers, and Ron Gross of Motley Fool Total Income consider the latest news from the retail sector, with Macy's (NYSE: M) and Kohl's (NYSE: KSS) turning in second-quarter reports that were less bad than analysts feared. But even though these department stores are doing what they need to do to adapt to the rise of e-commerce, the market apparently wasn't buying their upbeat spin. The question retail investors may be asking themselves is whether these stocks are priced right for adding to their portfolios right now.

Continue Reading Below

A full transcript follows the video.

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 August 1, 2017

Continue Reading Below

This video was recorded on Aug. 10, 2017.

Mac Greer: Ron, shares of Macy's and Kohl's both down big on Thursday. Now I hesitate to call this a good news, bad news story. It feels more like a less bad news, bad news story.

Ron Gross: That's fair. Everything's relative.

Greer: Both retailers reported better-than-expected earnings, and same-store sales were down for both, but they weren't down quite as much as expected. So that seems relatively not bad. But investors are not buying it. Shares are down. What's going on?

Gross: It's interesting that that's how you put it. Relatively not bad. If you had asked me to make a bet pre-market, I would have bet the stocks would have been fine to up, because I think the expectations are pretty lousy. And the fact that the results, specifically the same-store-sales results, for both companies were not really as bad as expected, I would have thought investors would have responded favorably. Shows you what I know. ?The stocks are getting slapped.

It's interesting, though. It's kind of a "we're not dead yet" moment, it feels to me. "We're Macy's and we're Kohl's, and we're around, and we've been around, and we're not going anywhere. In the age of Amazon, there's still a need for both of us. And we're getting our shop in order, and we're taking the necessary steps in order to make sure that we can get growth back into our business and improve profitability." Easier said than done.

I do like some of the steps they're taking, especially Macy's. They're closing the stores they need to close. They're cutting costs pretty dramatically. They're focusing on their backstage discount line, which is kind of like a Nordstrom Rack, if you will. Their Bluemercury, a relatively recent acquisition, is pretty strong for them as well. So they're doing what they need to do. They're saying a lot of the right things. It's a wait-and-see-what-happens kind of moment for me, because it's too early.

Retail is notoriously a tough business. Even the best of these companies basically file bankruptcy at some point during their life. Bloomingdale's, which is part of Macy's, has had its ups and its downs. Macy's has had its ups and downs. Dillard's has struggled. J.C. Penney we talk about ad nauseam, which is a tough one. This is a tough, tough business, made even tougher by the internet and Amazon in particular. So I'm still on a wait-and-see mode. But at least they're taking the steps necessary to right-size the business.

Greer: I'm going to call you cautiously pessimistic. [laughs]

Gross: [laughs] That's fair. I wouldn't be a J.C. Penney buyer, for example, even though, as a value investor, you could say maybe it's been beaten down so bad at various points that you would want to dip your toe into that water. But that business in particular, I don't think it's strong enough for me or will be strong enough in the future. Macy's I feel a little bit differently about. And Kohl's, differently, but a little less.

David Kretzmann: For me, just looking at both of these companies, when you have companies like these that are going through difficult times or facing a lot of headwinds in many different areas, when they have such a high debt count, that really ties your hands with what you can do. Macy's has $5.5 billion in net debt. Kohl's has $4 billion in net debt. This, for me, reinforces why, in general, I like to find companies that have minimal debt or even no debt. It really opens up your options to be flexible when you do hit hard times. You're not trying to figure out how you're going to make that next interest payment, or whatever it might be. So to me, that's another yellow flag with both of these companies. If one of them didn't have debt, that might make it a little bit more appealing to me. But at this point, when you have a fairly weak balance sheet and a lot of headwinds, it's hard to see this as a strong turnaround candidate.

Gross: I think that's actually a fantastic point. It could be a point that you can take for any industry, and that's a great lesson to teach, that balance sheets are important. You can't just look at same-store sales and earnings and cash flow. You need to look at the balance sheet. Now, back to the retail in particular -- that's why you have some of these companies that have been forced to restructure in bankruptcy proceedings in the past, because of that debt load during times when business was really weak. So, really important lesson.

Greer: Ron, you're our resident value guy. So, what gets you interested? What makes these stocks more appealing for you?

Gross: So typically, when I look at a beaten-down company or a beaten-down industry, there's always a reason, right? And if you believe the market is somewhat efficient, the stocks are selling of for a reason. So at what point, then, do you say, "Well, I'm going to think like a contrarian and I'm going to be a buyer when everyone else is a seller?" When you find a stock that is troubled, you have to believe in some sort of turnaround, and you have to believe in the management to execute on that turnaround.

So for Macy's, as I said earlier, I like some of the things they're doing. They're reducing their footprint. They're focusing on areas of their business that I think will do well. I think management is saying a lot of the right things. I'm not there yet. But you can't just look at valuation in a vacuum, because even though these stocks are 10, 11, 12 times earnings, which, in a vacuum, is theoretically cheap when the market is 25 times, there's a reason these stocks are, in quotes, cheap. Because they're troubled. So you need to be careful, you need to look at each company on a case-by-case basis and believe in the strategy and be willing to put your money where your mouth is and invest alongside that management team in the belief that they can turn the business.

Greer: Ron, you made the mistake of telling me before today's taping that you worked at Macy's.

Kretzmann: Juicy details.

Gross: As a high schooler.

Greer: As we wrap up this story, how about one highlight, one lowlight from your Macy's career?

Gross: At the time it was Bamberger's, which was owned by Macy's, and eventually that particular store I worked at changed its name to Macy's. I was in high school. Definitely the low point was when one day they came to me during the Christmas season and said, "Could you go to the gift-wrap department? We're swamped." I had never wrapped a gift in my entire life. I'm still not good at it. You make that triangle and you fold. Not a thing.

Greer: Hate the triangle.

Gross: Origami and me do not mix. So I was really stressed out, actually. It's funny to think about it now, but sometimes I think I still dream about it. The high point was definitely when I resigned and moved on to bigger and better things.

David Kretzmann owns shares of Amazon. Mac Greer owns shares of Amazon. Ron Gross owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.