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A Look Into Macy's (NYSE:M) Valuation After the Latest Earnings

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This article first appeared on Simply Wall St News.

While still far below the all-time highs, Macy's, Inc. (NYSE: M) has rallied significantly from the 2020 lows. Yet, despite the improving fundamentals and reinstated dividend, the stock remains trading in a single-digit price-to-earnings (P/E) ratio.

See our latest analysis for Macy's

Q4 and FY 2021 results

  • Q4 Non-GAAP EPS: US$2.45 (beat by US$0.46)

  • Revenue: US$8.67b (beat by US$220m)

  • Revenue growth: +27.9% Y/Y

  • Full-year net income: US$1.43b

Other highlights

  • Q4 comparable sales: +28.3% Y/Y

  • Full-year comparable sales: +43% Y/Y

  • Full-year digital sales: +13% Y/Y

  • FY 2022 guidance sales: US$24.46b – US$24.7b

Speaking on the results, CEO Jeff Gennette stated that they wouldn't spin off the online business as activist investor Jana Partners called.

After reducing the debt and strengthening the balance sheet, he added that the company could start a new, US$2b strong share repurchase program. Additionally, the dividend will be raised by 5% to US$0.1575 / share (or a forward yield of 2.45%).

Looking into our database, we can indeed confirm that the debt-to-equity ratio has fallen from 196% to 114.2% over the past 5 years, and the debt is well covered by EBIT.

Meanwhile, Evercore ISI upgraded Macy's from In-Line to Outperform, as they believe the risk-reward profile is asymmetric. In layman's terms, they believe that the odds of the company outperforming in the long-term are good.

Estimating Macy's Valuation with the Discounted Cash Flow Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

The first stage is generally a higher growth period, heading towards the terminal value, captured in the second "steady growth" period. In the first stage, we need to estimate the cash flows to the business over the next ten years. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF ($, Millions)

US$1.63b

US$1.10b

US$856.7m

US$325.0m

US$733.0m

US$736.0m

US$742.2m

US$750.8m

US$761.3m

US$773.0m

Growth Rate Estimate Source

Analyst x5

Analyst x5

Analyst x3

Analyst x1

Analyst x1

Analyst x1

Est @ 0.84%

Est @ 1.16%

Est @ 1.39%

Est @ 1.55%

Present Value ($, Millions) Discounted @ 7.1%

US$1.5k

US$955

US$697

US$247

US$519

US$487

US$458

US$432

US$409

US$388

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$6.1b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For many reasons, a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case, we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way, as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.1%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$773m× (1 + 1.9%) ÷ (7.1%– 1.9%) = US$15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$15b÷ ( 1 + 7.1%)10= US$7.6b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$14b. In the final step, we divide the equity value by the number of shares outstanding.

Relative to the current share price of US$24.4, the company appears quite good value at a 48% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

Important assumptions

The most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. The DCF does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a full picture of a company's potential performance.

Given that we are looking at Macy's as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt. We've used 7.1% in this calculation, which is based on a levered beta of 1.231. Beta is a measure of a stock's volatility compared to the market as a whole.

Looking Ahead:

While the DCF model is not a perfect tool, our valuation calculation seems to align with institutional research. Meanwhile, we have to note that some institutions have been heavily buying the stock. For example, David Tepper of Appaloosa Management boosted his position by almost 50% and now owns the 4th largest stake.

Finally, we have to notice that the stock is still heavily shorted, with a short interest of just over 10%. Any positive news catalyst could trigger a minor rally based on the short squeeze factor.

If you want to explore the investment thesis deeper, we've put together three essential items you should assess:

  1. Risks: Be aware that Macy's is showing 4 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

  2. Future Earnings: How does M's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other Solid Businesses: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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