Macy’s: Retail or Real Estate investment?
It hasn’t been an easy time to be a USA retailer, especially a big box, or department store, retailer. Aging demography, declining store traffic, poor wage growth, and inexorable and crushing competition from internet based companies have put business models and share prices under pressure.
See the below table for just how difficult it has been to be a traditional big box retailer.
Only one retail trade? Or is this a real estate investment
There has only been one trade to have. Buy Amazon; sell everything else including Walmart the prior behemoth of retailing which is itself now under pressure. Are big box retailers toast or can they fight back? Is there anything to stop Amazon and other internet and warehouse companies from continuing to take market share of the consumer dollar? We invested in Macy’s recently so we believe there is life yet in the “clicks and bricks” strategy. We also assert that the big box retailers, or some of them, will enjoy a renaissance as destination centres for more than shopping.
Many of these stores are centrally located in growing cities and will become ‘3rd places’ where people will gather to shop, eat and drink. At some point people will want more of an experience than to buy stuff to have it delivered in brown boxes, all the while with no human interaction. The concept of the 3rd place is worth understanding and is clearly a necessity in civic life. We discuss a little more below and provide some reading for those who are interested. Effectively we believe that the faceless and anonymous retailing model has peaked and will give way to more consumption through specialised and targeted interaction between human beings.
Omni Channel Model:
Old department store business models may well be dead, but a new omni channel model which drives online sales to stores and vice versa, is going to give Amazon a run for its money. Add in significant property redevelopment potential, reduction in store count to improve asset turns and return on equity, and a cheap valuation and it’s a compelling proposition on a 3 year view. At this stage it doesn’t matter what Macy’s average same store sales are. As they seek to discount unwanted and slow moving retail stock, and as they shut down some stores, it is inevitable that revenue will fall. We think the market is wrong to focus on revenue or same store sales. What matters more now is the success of the online strategy, the speed with which it can reduce store count and working capital, and shrink to grow its bottom line and reinvest to grow the top line.
Return on capital has been solid for Macy’s as has free cash flow generation. What the market hasn’t liked is the lack of revenue growth and reinvestment to get there. New management is going to reduce the amount of property capital in the business and reinvest in an omni channel strategy – online and in store with local tweaks rather than a national ‘one size fits all’ approach.
It doesn’t have a lot of time since activist shareholders are circling. In November management announced a joint venture with Brookfield, the property manager, to unlock value from approximately 100 stores. There is definitely a catalyst to unlock the value from this change of strategy. We are contented currently to invest for the turnaround and a new era in retailing.
The Third Place
As for the 3rd place and why we think that a physical connection on the high street is irreplaceable it is worthwhile delving into the subject. The 3rd place is not the office and not the home. It used to be the pub or club, and in Australia it still is, but the USA has lost a lot of those spaces. They can be recreated on the high street through a retail experience which involves talking to human beings and doing more than waiting alone for a box to arrive at the front door.
There are two authors to consider:
In the book The Great Good Place, Ray Oldenburg (1989, 1991) argues that third places are important for civil society, democracy, civic engagement, and establishing feelings of a sense of place.
Robert Putnam addressed issues related to third place in Bowling Alone: America’s Declining Social Capital(1995, 2000).
Same store sales are poor but we believe this is not the reason to own Macy’s. New management is attempting to unlock the asset value and shrink the asset base by redeveloping superfluous stores. There is also an attempt to produce an online strategy with distinctive product offerings between Macy’s (mid-market) and Bloomingdales (up-market). This is an attractive exposure to a retail turnaround with significant real estate development potential. The company has recently announced a tie up with Brookfield Asset Management to unlock value from its ‘vast property holdings’. Sell side analysts are still focussing on the same store sales which are poor but the company is still trading on less than 1x sales. Activist investors have been pushing the company for change and we are inclined to back them.