At first glance, Macy's (NYSE: M) looks like a tempting income investment. It pays a forward yield of 7.8%, and it's raised that dividend annually for six straight years. That dividend seems sustainable, since it accounted for just 68% of the company's earnings and 49% of its free cash flow over the past 12 months, and the stock also looks cheap at 11 times earnings.
But before buying Macy's as a cheap income play, investors should realize that its yield was dramatically inflated by the stock's 50% decline over the past 12 months. Let's examine the headwinds blowing Macy's off course, and why its hefty dividend could trap unsuspecting investors.
What's wrong with Macy's?
Macy's annual revenue comparisons have fallen for ten straight quarters due to sluggish mall traffic and tough competition from superstores, fast fashion retailers, and e-commerce giants like Amazon. As a result, its oversized stores are now filled with excess inventory.
Last quarter, Macy's revenue fell 5.4% annually to $5.55 billion, with its total comparable store sales dropping 2.5%. Both figures notably beat Wall Street's low expectations, thanks to contributions from women's footwear, jewelry, and its new off-price Macy's Backstage stores. Its gross margin dipped 60 basis points annually to 40.3%, but that still beat expectations by 40 basis points.
However, Macy's EPS fell 11% annually during the quarter, which marked its tenth straight quarter of bottom line declines. Wall Street expects Macy's revenue to decline 4% this year, but for its earnings to improve 9% on cost cutting measures, real estate sales, and store closures.
What's Macy's turnaround plan?
Last year, Macy's announced that it would close about 100 stores. As of last quarter, it already closed 70 locations, and plans to close the remaining 30 locations in the near future. At its namesake stores, it's focusing more heavily on footwear, furniture, mattresses, jewelry, and fragrances, as cosmetics and houseware sales remain weak.
The company still operates over 700 Macy's and Bloomingdale's stores, as well as 150 specialty stores, including Bloomingdale's' The Outlet, Macy's Backstage, and Bluemercury, a chain of luxury beauty product stores and spas.
Macy has been opening more Bluemercury and Backstage stores while shuttering its full-price department stores, but its specialty stores still face tough competition from TJX Companies (NYSE: TJX) in the off-price market and Ulta Beauty (NASDAQ: ULTA) in beauty products. Analysts expect TJX and Ulta to respectively grow their revenues by 8% and 21% this year -- which could hurt the growth of Macy's specialty retailers.
Macy's digital sales rose annually for the 32nd straight quarter, but the company didn't disclose exact revenue figures. Like many other brick-and-mortar retailers, Macy's mobile app allows customers to scan items to see prices, availability, and product reviews, and it offers in-store pickup for online orders.
Could Macy's become the next Sears?
Macy's is also selling some of its high-value real estate, like its Union Square Men's Store in San Francisco, to boost its cash flows. It could also sell additional locations and lease the stores back.
Sears Holdings' (NASDAQ: SHLD) notably adopted a similar strategy before, which resulted in the spin-off of its real estate assets as an REIT called Seritage Growth Properties (NYSE: SRG). Activist investor Starboard pushed Macy's to monetize its real estate in a similar manner, but apparently gave up and sold its stake earlier this year.
But Macy's still plans to monetize its real estate, so it must tread carefully to avoid following Sears' self-destructive footsteps. Sears gained a short-lived boost from its real estate sales and Seritage spin-off, but those tailwinds quickly faded as the company failed to counter the real challenges of sluggish mall traffic, superstores, and e-commerce competitors.
The pain isn't over for Macy's
Macy's isn't a lost cause yet, but investors shouldn't underestimate the punishing headwinds. Its full-price Macy's and Bloomingdale's stores remain exposed to fast fashion, e-commerce, and superstore rivals, and its specialty stores face fierce competition in their respective markets. It's also a few missteps away from burning the furniture, as Sears did, for short-term gains.
Macy's massive dividend looks tempting, but it's also a red flag. It can keep supporting that payout for now, but those payments might not be enough to offset the stock's future declines.
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Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ulta Beauty, Inc.. The Motley Fool recommends The TJX Companies. The Motley Fool has a disclosure policy.