Macy’s Shares Plummet on Wednesday Despite Strong Earnings Report

Shares of Macy’s (M) plunged on Wednesday despite an earnings report that came in line with revenue expectations — and easily exceeded earnings per share estimates.

The Cincinnati-based retailer reported $0.27 in earnings per share for the third quarter, besting analyst estimates by $0.12 and hit dead on the $5.4 billion revenue bar set by Wall Street.

Margin pressures ahead of oncoming adverse factors like tariffs, supply chain cost increases and hiring surges appear to be clouding that result, especially as some experts anticipate an encroaching bear market.

Shares of the 160-year old retailer fell by 7.2% to $33.22 during Wednesday’s trading.

Scared of Shrinking

Investors seldom like to hear words like “downsizing” or “reducing.” That appears to be part of the problem for Macy’s shareholders as executives broke that cardinal rule in an earnings call on Wednesday morning..

CEO Jeff Gennette noted that the company is shifting more towards its “magnet” and “neighborhood” stores, which were described as being smaller than the “flagship” locations that occupy the largest amount of its real estate.

Unfortunately, part of that formula includes walling off sections of stores and leaving sections of shelf-space empty to reduce inventory costs.

The company’s initiative to “right-size” its stores in this way is making the market cautious, as it brings up thoughts of walled-off Sears (SHLD) stores that tried to hide the company’s contraction from its heyday.

Additionally, it makes modeling gains a bit difficult, as Real Money contributor David Butler pointed out.

“Macy’s Q3 results definitely benefited from real estate sales,” he wrote in his column. “It contributed $42 million to operating income, and $0.10 to earnings per diluted share. While selling off underperforming real estate is a perfectly acceptable exercise, it’s not a sustainable long-term trend.”

Thus, the blow-out earnings beat is a bit illusive given its one-time nature.

To be sure, many see the move as a rational and positive adaptation to the company’s needs.

“Macy’s has done a great job rationalizing its store space,” Jan Rogers Kniffen, president of J. Rogers Kniffen Worldwide Enterprises told Real Money. “How that can be bad news is a mystery to me.”

Stay Positive

Still there was a great deal in the quarter and yet to come that can spark some optimism.

The company reported strong same-store sales growth, up 3.3% against estimates of 2.8%, which helped raise its guidance figures on both earnings per share and same-store sales ahead of the holiday season.

“We are pleased with Macy’s, Inc. performance in the third quarter, marking our fourth consecutive quarter of comparable sales growth,” Gennette said in a statement. “Our strategic initiatives are gaining momentum and delivering results.”

Of particular note was the expansion in the company’s digital business, which reported strong growth quarter over quarter, bolstering sales while the company improves its brick-and-mortar base.

“Macy’s recipe for success is e-commerce,” Gennette said on an earnings conference call Wednesday morning. “Our e-commerce business just completed another consecutive quarter of double-digit growth, driven by continued improvement to our online offering and experience.”

He noted that the company’s mobile app in particular is a key driver of success, declaring that the app will be a driver of about $1 billion in sales for the 2018 fiscal year.

The digital business does carry over to the existing brick and mortar business as well, namely through in-store pickup options. A comparable trend becomes visible in most retailers that have been solid stock picks in recent years such as TJ Maxx (TJX) , Kohl’s (KSS) and Target (TGT) .

Still, questions remain on whether or not Amazon (AMZN) will simply continue to eat away at any gains that are made online.

Amazon controls about 50% of U.S. ecommerce retail in 2018, according to eMarketer. The report adds that this may only accelerate as 80% of growth in the ecommerce space is expected to head Amazon’s way in the next year. That poses a significant threat to growth for Macy’s.

Guiding Higher to the Holidays

Possibly pointing to a way further upward even amid some headwinds, Macy’s executives have raised guidance into the all-important fourth quarter.

“The holiday season is when Macy’s truly shines,” Genette explained. “We have the right merchandise, the right marketing and the right customer experiences in place to deliver a strong fourth quarter.”

As such, Gennette revised both net and comparable sales guidance upward on an annual basis.

Earnings per share guidance was likewise raised to a range of $4.10 to $4.30, up from a prior range of $3.95 to $4.15.

This too came with questions, as Credit Suisse analyst Michael Binetti pointed out that many investors are wondering whether the bar might be moved too far forward.

“The market is looking at this and saying ‘Is this as good as its gonna get?'” he told CNBC in an interview. “Do we start to slow down from here?”

As such he was worried that the bar being raised from prior guidance might be difficult to beat, possibly setting up the company for fourth quarter failure.

Analyst Action

Analysts overall do think that there is growth still ahead, per FactSet consensus figures.

The consensus price target of analyst research published in the last month stands at $39 per share and there are no analysts issuing a “Sell” rating. A run to the consensus would offer a double-digit premium to investors if accurate.

Most analysts are issuing “Hold” ratings, but the serious pullback today could offer a compelling buy thesis for bullish investors.

Cashing in on Consumer Strength

Recent macroeconomic numbers and sector action could add to that thesis for a retailer like Macy’s, given they reflect the ability to spend freely this holiday season on fewer options.

Earlier this month, jobs figures leapt by 250,000 and wages charted their biggest annual gain since 2009. The higher capital base of a more gainfully employed consumers bodes very well for the upcoming peak season.

The retail space is also far less crowded than it once was.

Notable among the departed are former holiday retail giants Sears, now in bankruptcy, and Toys R Us, which will offer some opportunity to a retailer like Macy’s looking to capture market share from its fallen contemporaries.

the liquidation of Bon-Ton (BONTQ) will offer yet another holiday tailwind to the company.

Gennette touched on just this topic in his assessment of the upcoming holiday shopping season.

“As you would’ve probably expected, we have very little customer overlap with Sears so I don’t see that affecting us much,” he told analysts. “When I look at something like Bon-Ton when that goes out of the Midwest, that definitely affected us.”

He noted that Bon Ton shoppers tend to look for products that Macy’s carries, at a similar price point and in nearby locations, which points to Macy’s being a recipient of the stranded shoppers.

“We’ve done a lot of outreach to those customers,” Gennette said, adding that Macy’s has also reached out to retail associates for its upcoming holiday seasons that will require a ramp-up in hiring

The only question that comes of the sector’s consolidation is whether that simply gets directed online. If so, Amazon is a winner yet again.

However, it would not appear that Amazon is going to gobble up share as it has in the past, especially since neither Sears nor Toys R Us were truly killed by Amazon and online shopping, but rather by ballooning debt and mismanagement.

These shoppers will likely remain on retail real estate, rather than online.

Macy’s stock is rising slightly post-market.