3 Reasons Why the Macy's Stock Sell-Off Makes No Sense

There's no doubt that Macy's (NYSE: M) is in the midst of a rough patch. Adjusted earnings per share peaked at $4.40 in 2014. By 2016, adjusted EPS had fallen to just $3.11 -- and would have been even lower, but for $209 million in asset sale gains. Adjusted EPS could fall even further this year.

This negative earnings trend has caused Macy's stock to plunge. The latest blow came last week, as steep declines in first-quarter sales and earnings at Macy's led to a nearly 20% drop in its share price on Thursday and Friday.

Macy's stock crashed last week after a disappointing earnings report. Image source: Macy's.

That said, Macy's stock has fallen to irrationally low levels. Here are three reasons why Macy's shares look very attractive right now.

Macy's has a turnaround plan

Today, investors are treating Macy's as if it is doomed. Following the most recent sell-off, Macy's stock trades for less than eight times earnings.

But Macy's isn't Sears. Many investors have short memories, but the company's sales woes only began about two years ago. It was certainly slow in reacting, but in the past year, Macy's has started to address its problems. It's just too early to tell if its turnaround plan will work.

One big initiative at Macy's is a proactive downsizing of its store base. The recent closure of more than five dozen stores actually hurt Macy's in the first quarter, as the lure of clearance sales at the locations that were closing drew traffic away from the remaining Macy's stores. By contrast, Macy's will get the full benefit of its store closures starting this quarter.

Macy's closed dozens of stores last quarter. Image source: Macy's.

Macy's is also doubling down on exclusive brands, which have been much more successful compared to widely distributed brands that often become commoditized. For example, in February 2018, Macy's will become the exclusive U.S. department store for sales of DKNY-branded women's apparel and accessories.

Additionally, Macy's is changing its operating model in several departments. For example, in its women's shoe departments, it is shifting to a curated assortment with deeper inventory of styles that are expected to sell well. It is also converting many of its shoe sections to an "open-sell" model, putting inventory on the selling floor rather than holding it in a stockroom. Today, most customers prefer this self-serve format, as evidenced by a double-digit jump in shoe sales at Macy's pilot stores.

Finally, Macy's plans to reset its marketing approach later this year, with a focus on promoting hot products rather than just big sales.

Thus, there are a lot of changes happening at Macy's. They probably won't all work -- but if some succeed, it will help Macy's stabilize its comp sales trends going forward.

Real estate value is still being ignored

Even if sales trends remain weak, owners of Macy's stock will have an opportunity to profit from the company's vast pool of real estate. Indeed, Macy's real estate assets have been valued at as much as $20 billion. Meanwhile, its enterprise value has fallen to less than $13 billion.

Macy's has been very transparent about the fact that it will take time to get full value for its excess real estate. Investors are frustrated with the slow pace of real estate sales, but Macy's has already brought in nearly $1 billion in asset sale proceeds since starting to focus on this area in 2015.

Right now, Macy's is actively marketing the upper floors of its Chicago flagship building for redevelopment as office space. It is also studying options for maximizing the value of its Manhattan flagship store and -- in concert with Brookfield Asset Management -- working to identify redevelopment opportunities elsewhere in its real estate portfolio.

Macy's is still studying how to get the most value out of its Manhattan flagship store. Image source: Macy's.

Most importantly, Macy's has been willing to sell stores where the real estate value exceeded the ongoing value of operating the store. This suggests that if Macy's turnaround efforts fall short (reducing the expected value of continuing to operate particular stores), the company will accelerate its real estate sales.

The dividend is a great incentive to be patient

One last reason why the recent sell-off in Macy's stock seems overdone is that the company offers a very attractive dividend. In fact, its yield reached 6.4% by the end of last week.

This wouldn't be much comfort if the dividend didn't seem sustainable. Fortunately, Macy's free cash flow has been quite stable, compared to the big swings in its accounting earnings. Free cash flow is what ultimately pays for dividends, and right now, Macy's is generating about twice as much as it needs to support its current payout.

Macy's stock price may remain depressed until the company shows tangible progress either in its retail turnaround or in its real estate monetization efforts. It's not possible to be sure when the outlook will brighten for Macy's, but the generous dividend represents a good reason for investors to stay patient.

10 stocks we like better than Macy'sWhen 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 May 1, 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.