A few years ago, Macy's (NYSE: M) was returning huge sums of cash to shareholders via share buybacks. However, the retail downturn that began in 2015 caused the company's profitability to plunge, hurting its credit metrics. As a result, Macy's slowed the pace of its share repurchases in 2016 and stopped them altogether in 2017.
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For the past year, Macy's goal has been to achieve its leverage target: adjusted debt of 2.5-2.8 times its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Macy's is likely to reach that target in 2018, which could pave the way for a resumption of its share repurchase program.
Macy's has made significant progress on its debt
During fiscal 2017, Macy's made good on its promise to reduce its debt load. During the first three quarters of the year, Macy's paid down $552 million of its debt through a combination of scheduled repayments and debt repurchases.
Unfortunately, its leverage ratio remained steady at 3.2 times adjusted EBITDA during this period. Lower earnings fully offset the company's debt reduction efforts.
The fourth quarter appears to have been better in that regard. The company repurchased another $400 million of debt in December through a tender offer. Meanwhile, Macy's posted stronger-than-expected sales during the holiday season, leading it to boost its earnings guidance.
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The company's current outlook implies that pre-tax income will increase by about $80 million year over year in the fourth quarter. This would probably translate to an adjusted EBITDA improvement of roughly $50 million. Additionally, a recent rise in interest rates to a multiyear high may reduce its pension liabilities by increasing the discount rate Macy's uses to calculate them. That would further reduce the company's adjusted debt, bringing the leverage ratio below the 3.0 level.
More improvement ahead?
Macy's posted particularly poor sales and earnings results in the first quarter of 2017. Thus, if the company can maintain its recent sales momentum for the next few months, it has a good chance to achieve another increase in adjusted EBITDA in the upcoming quarter. That alone could get it close to the high end of its leverage target range.
Furthermore, the cash flow from its successful fourth quarter will give Macy's lots of firepower to continue repurchasing debt in the first half of fiscal 2018. The company also has a number of real-estate deals in the pipeline that could potentially generate hundreds of millions of dollars of proceeds.
Indeed, barring another downturn in Macy's core retail business, the company is virtually certain to reach its leverage target in 2018. Thus, the real question is whether Macy's will have any cash left over to resume its share repurchase program.
The big decision
The answer to this question may turn on what Macy's does with respect to its partnership with Brookfield Asset Management (NYSE: BAM). For the past year, Brookfield has been analyzing 50 of Macy's properties to investigate real estate development options, mainly using excess land.
Macy's CFO Karen Hoguet has indicated that Brookfield is likely to recommend proceeding with development on about two-thirds of the properties. In each case, Macy's will have the option to take an upfront cash settlement or contribute the property and some cash to a joint venture with Brookfield Asset Management.
By cashing out, Macy's could reap a significant windfall in 2018, allowing it to quickly ramp up its share buybacks. If the stock price remains depressed, this course of action might create the most shareholder value.
That said, there would be strategic benefits to Macy's maintaining joint control with Brookfield throughout the development process. After all, in most cases, it plans to continue operating the Macy's stores on these properties. Furthermore, the joint venture option would maintain the most upside exposure for the company. However, if Macy's goes this route, it will have to contribute cash to the joint ventures rather than receiving a payout this year. That might force it to wait until 2019 to resume its share repurchases.
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