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Corporate Credit: Looking for tighter spreads in Macy’s
admin | August 17, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Macy’s posted another solid quarter of results as sales, gross margins, inventory and earnings all moved in good directions. The company bumped up guidance on sales and earnings and expects to keep trimming leverage. Spreads on Macy’s debt in general should grind tighter, with particularly good value in issues likely to benefit if the company extends the maturity of its revolving credit facility.
Background
Macy’s posted another solid quarter of results as same store sales beat Street estimates. Sales growth on an owned and licensed basis came in at 0.5%, beating the Street forecast of a 0.9% decline. Second quarter marks Macy’s third consecutive quarter of sales growth. The growth was impressive as the company shifted a large promotional friends-and-family event from the first quarter to the second. Adjusting for the shift, sales would have increased 2.9% in the second quarter compared to 2.3% in period a year ago. Management noted good growth across Macy’s, Bloomingdale’s and Bluemercury.
Gross margin was 40.4% in the quarter, up 80 bp year-over-year. Management noted that the growth reflected a much improved inventory position coupled with the strong sales performance. Macy’s ended the quarter with inventory down 40 bp on a comparable basis. The adjusted EBITDA margin was up 65 bp year-over-year to 9.65%. SG&A/sales was 38.8% in the quarter, up 40 bp year-over-year. The increase in the SG&A rate reflected investments in the business and increased support for the sales growth. Adjusted EPS of $0.70 beat Street estimates of $0.50.
Full year guidance raised
With the better than expected results, Macy’s increased full-year guidance. Sales on an owned and licensed basis are now expected to up in the 2.1%-2.5% range for the full year. This is up from previous guidance of 1.0%-2.0%. Macy’s noted that the company expects sales in the second half to be up in the 2.0%-2.5% range. Full year EPS was raised to the $3.95-$4.15 range, up from previous guidance of $3.75-$3.95. Full year gross margin is expected to be up slightly for the year, reflecting a decline in the second half of the year. The decline in the second half gross margin rate reflects a smaller increase in merchandise margins compared to the period a year ago, offset by higher delivery expense associated with the increase in online sales.
Debt reduction remains a priority
Management reiterated its lease-adjusted leverage target of 2.5x-2.8x and noted that the company still anticipates debt reduction to remain a priority for excess cash for the remainder of 2018. Macy’s reduced debt by $346 million in the quarter as the company executed a bunch of open market purchases across the capital structure (Exhibit 1). Given the debt reduction and the improved EBITDA, Macy’s looks like it ended the quarter with lease-adjusted leverage of roughly 2.7x, down sequentially from 2.8x.
Exhibit 1: Macy’s open market purchases in the second quarter
Source: Macy’s
Relative value
While further debt reduction should be a catalyst for Macy’s spreads to grind tighter, there is good current value in the M 3.875% 1/15/22 bonds, which are currently trading 35 bp (g-spread) behind the M 3.45% 1/15/21. The large trading differential seems due to a technical created by the current maturity on the company’s revolving credit facility, which matures on 5/6/21. Macy’s will likely look to extend the maturity of the bank line to a true 5-year at some point. If the line is extended, the 3.875% 1/15/22 bonds would then mature ahead of the facility and should make the differential between the 3.45% 2021 and the 3.875% 2022 bonds collapse. Furthermore, the BBB discretionary 2y/3y curve is currently worth 20 bp.
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