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Macy’s beats earnings, anticipates further debt reduction
admin | November 16, 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.
Benefiting from another solid quarter of earnings, Macy’s management plans to use excess cash to continue reducing debt. The lower leverage should serve as a catalyst for spreads to grind tighter, unlocking value in some short dated bonds if management uses the opportunity to extend the maturity of a existing revolver.
Earnings recap
Macy’s posted yet another solid quarter of results as same store sales (SSS) beat street estimates once again, with SSS growth on an owned and licensed basis of 3.3% in the quarter, well above the street forecast of 2.8%. Second quarter marks M’s fourth consecutive quarter of SSS growth. Management noted that they continue to see an improved trend in brick and mortar and witnessed good growth across Macy’s, Bloomingdale’s and Bluemercury. In particular, the Growth 50 stores (magnet stores) are performing above peers, so management plans to roll out the initiative to 100 more stores in 2019.
Gross margin was 40.3% in the quarter which was flat to the year ago period. While merchandise margins were better yoy due to stronger regular price selling, it was offset by increased transportation costs related to its loyalty program and growth in online sales. M ended the quarter with inventory up 50 bp on a comparable basis which was in line with expectations due to calendar shifts. Management is still forecasting inventory levels at year end to be down versus last year. The adjusted EBITDA margin was down 45 bp yoy to 7.65%. The decline primarily reflects the loss of EBITDA associated with certain asset sales.
Full year guidance raised again
With the better than expected results, M increased full year guidance once again. SSS on an owned and licensed basis are now expected to up in the 2.3%-2.5% range for the full year. This is up from previous guidance of 2.1%-2.5%. Net sales will be up in the 0.3%-0.7% range, up from flat to 0.7%. Full year EPS was raised to the $4.10-$4.30 range, up from previous guidance of $3.95-$4.15. Full year gross margin is still expected to be up slightly for the year, reflecting better merchandise margins offset by higher transportation costs.
Debt reduction remains a priority
Management reiterated its lease adjusted leverage target of 2.5x-2.8x and they still anticipate debt reduction to remain a priority for excess cash for the remainder of 2018. M noted that having a healthy balance sheet is key to maintaining both flexibility and durability. M has reduced $351 million of total debt year to date. Given the debt reduction and the improved EBITDA – $1.48 billion year to date versus $1.44 billion in the year ago period – we estimate that M ended the quarter with lease adjusted leverage of roughly 2.6x, down sequentially from 2.7x.
Relative value
Further debt reduction will be a catalyst for M spreads to grind tighter, unlocking value in the M 2.875% 2/15/23 bonds which are currently trading 50 bp (g-spread) behind the M 3.45% 1/15/21. The large trading differential is due to a technical created by the current maturity on the company’s revolving credit facility, which matures on 5/6/21. Given the improved results and better leverage, management will look to extend the maturity of the bank line to a true 5-year. If the line is extended, the 2.875% 2/15/23 bonds would then mature ahead of the facility and should make the differential between the 3.45% 2021 and the 2.875% 2023 bonds collapse. Furthermore, we note that BBB discretionary 2y/4y curve is currently worth 30 bp.
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