Tuesday, January 28, 2020

Is Retail Worth the Risk? Evaluating the Financials of Macy’s, Target & Nordstrom

Do you like to go to the Mall?  I sure do!  Especially a swank mall like K11 in Hong Kong.
Is retail a smart investment?  

With malls shuttering and department stores downsizing across the US, it appears retail is a dying beast.  So many opt to shop online, where the Goliath, Amazon, usurps something like 60% of all sales!!!

However, we like to try clothes on in person.  At a store last night, my friend purchased two coats that sold for less online: "This way I know they fit," she reasoned.  And shopping is a fun weekend outing.  

I don’t think retail is going extinct.

So, I decided to evaluate the fundamentals of three stores; Macy’s, Target, and Nordstrom; to see if their financials look sound, and if they’d make a good investment.

These companies represent slightly different industries (the SEC lists Nordstrom as family clothing/retail, Target as retail/variety, and Macy’s as department), but they’re close enough they merit comparison.

My Prediction

Going in, I predict Target will be in the best financial health and make the best investment, and Macy’s the worst.  This is due to first-hand experience: in Portland, Oregon I've seen Target stores going up and thriving, and Macy’s stores shutting down.

Nordstrom is a head-scratcher: they’re giving brick and mortar a fighting chance with new luxe flagships stores in Vancouver, Toronto, and Manhattan.  Plus, their online service, which I’ve used domestically and internationally, is great.  And I can’t tell if their ultra-easy return policy is a boon--it makes for great customer service, but must cost tons of money.

Criteria for Analysis

In order to evaluate the financial health of these companies, I’ll look at several data and ratios from their financial statements over the past five years: income, income growth, debt to equity, income to gross margin, and return on assets.  

None of these companies have released their financial statements for the year of 2019 (only quarterly earnings) so I’ll be using the statements through 2018, which are posted at their websites (Macy’s, Nordstrom, & Target).  I crunched the numbers on several Excel file which is WAY too boring and lengthy to include in this post, so I'll just include the results.  

Next, I’ll look at stock criteria--P/E ratio and dividends--to see if a purchase makes sense.

Fundamental Ratios

Net Income
First of all, I glanced at net income over the past five years to see if any companies were in the red. 

Looks like only one year in the red--for Target.  Numbers are in millions.
As you can see, only Target reported negative income—for one year in 2014.  Negative income can be a sign of shaky financial health, or even bankruptcy.  Does this put Target out of the running?  Let’s keep digging.

Income Growth
Growth is certainly something that you want to see in a company.  Steady growth, around 3%, is a sign of good health.  Rapid growth, however, can be a sign of volatility.

MACY’S: -6%

Target is the clear winner here.  Perhaps 8% is a little rapid (they’ve opened about 50 new stores between 2014 and 18), but it’s more promising than the declining growth of Macy’s and Nordstrom.

Macy’s has a “store closing cost” expense listed on its income statement all six years.  Not good!  And Nordstrom decreased its Goodwill by $197 million in 2016 when it wrote down the value of Trunk Club (they'd purchased it for $350 million), which really took a bite out of net income that year.

Net Income to Gross Margin
A higher percentage of net income to gross margin means the company is thrifty and efficient with operating expenses.  I calculated these values yearly then averaged them for the past six years.

MACY’S: 12%

Look like Nordstrom narrowly wins!  Way to keep operating expenses DOWN.  These results are all pretty close, however, so I can't say this metric exactly pits one company against another.

Debt to Equity
This is a critical ratio as it demonstrates a company’s ability to pay off debts.  A company with lots of liabilities relative to equity may have to sell off assets or take on more debt during a bad year. 

I calculated the TOTAL debt to equity for each year, then found the average.  This is the average ratio of total liabilities to equity from 2013-18:

MACY’S: 2.9

Target is the winner here--it's doing the best job of keeping debts low, even as it expands and opens new stores.

And Nordstrom is the astronomical loser--its current (2018) ratio is in fact higher than the average; it now owes $8 for every $1 of equity.  A precarious position to be in. 

This isn't due to an increase in Nordstrom's liabilities, but rather a significant decrease in equity, caused by a negative balance in retained earnings (which is called accumulated deficit). 

Accumulated deficit is a sign of financial instability.  What may have triggered Nordstrom's drop in equity is that it decided to pay dividends during a low income year (2015-16), during same period it wrote down Trunk Club in the books.  In essence, it didn’t have the income to pay dividends, but paid them anyway.

A higher percentage of return on assets means a company is using assets efficiently and turning them into net income!  This is the average ROA for the past five years. 

TARGET: 5 cents (5%) 
MACY’S: 6 cents (6%) 
NORDSTROM: 6.86 cents (6.86%) 

And Nordstrom is the winner, again!  It’s earning an entire 6.86 cents in net income for every dollar in assets, narrowly out-beating Macy’s, who’s only earning a paltry six cents.  And Target loses with an abysmal five cents earned for every dollar in assets.   

Conclusion on Fundamental Ratios
Given that it’s demonstrating steady growth with a relatively low debt to equity ratio, Target wins the fundamentals round.  Its year in the red does give me pause, however.

Nordstrom has won in a few categories.  It’s been doing a good job keeping operating expenses LOW and creating income out of assets.  But these victories are marginal.  Its astronomical debt to equity ratio is a red flag.

Macy’s hasn’t done anything to recommend itself, really.  It has the lowest growth rate, and a pretty high debt to equity ratio.

Stock Price Analysis

So far, these equations have dealt with the financial health of the companies.  Now I’ll look at their stock prices and dividend payments, to see if they’d make a good purchase.

Trailing P/E Ratio
Comparing price-to-earnings ratios demonstrate how much value you receive for the share price.  As an analogy: Imagine your local hairdresser charges $80 for a blowout.  And the salon down street charges $60.  If the quality and service at each salon is equal, which receives your patronage?

Generally, a stock with a lower P/E ratio indicates the better buy.  A high P/E ratio mean the stock is selling for more than it’s worth, and that the price may fall as enthusiasm for the company wanes.

The equation for the P/E ratio is: share price / (earnings/# of shares outstanding).  I’ve taken a short-cut and found the ratios at the Yahoo Finance.  Here are the P/E ratios on January 23rd, 2020:

TARGET: 18.7
MACY’S: 5.7

Macy’s is the clear winner.  Its super-low P/E ratio makes it a real bargain.  

Maybe investors are looking at Macy's declining growth and high debt-to-equity and going, "meh, think I'll give it a pass." --Making it a bargain for the rest of us 😉.

As I mentioned in my white paper, "Unlocking the Stock Market", a lot of investors have an upper limit on a P/E ratio value, say around 15.  

By this gauge, Nordstrom's value of 11.6, though much higher than Macy's, would also indicate it's a "buy".  Purchasing Target stock, however, would be ix-nayed--with a P/E ratio of 18.7, the stock is overpriced.

Last but not least, the almighty dividend! 

It’s important to invest in a stock that pays a dividend.  If you hold onto the stock for 15 or more years and reinvest dividends, the initial investment grows by as much as 7-10%!!!  (Assuming the stock has steady growth.)  

I found these dividend values at Street Insider.  

TARGET 2019 Dividend payment: $2.64
% of stock price: 2.3%
MACY’S 2019 Dividend payment: $1.51
% of stock price: 8.8%
NORDSTROM 2019 Dividend payment: $1.48
% of stock price: 3.7%

Looks like Target wins for "biggest dividend payment", but since its stock price is so high (currently selling around $113), its dividend yield is actually the lowest.

Macy’s dividend yield, on the other hand, is quite high.  The stock price is selling at $17, and with a dividend of $1.51, the yield is 8.8%.  

This means if you purchased only 11 Macy's shares (less than $200), you could purchase ONE WHOLE SHARE at the end of the year with dividend payments.  Quite a bargain, really.  With Target, on the other hand, you'd need to purchase 43 shares ($4,800) to receive one share from dividend payments!  Kind of reminds me of purchasing Monopoly houses at, say, Park Place vs. Baltic Avenue.     

With respect to dividend growth (I didn’t do calculations for all of these), it’s reported that Nordstrom is a Dividend Rock Star-- meaning the dividend payment has steadily increased over the years.

This growth doesn't entirely entice me, as in paying increasingly higher dividends, Nordstrom has seriously impaired its ability to pay off debts.  Ultimately, this makes the business more precarious for investors.


To quote my favorite Winona Ryder character, Lelaina Pierce from Reality Bites, "The answer is......the answer is......I don't know."   

None of these companies look disastrous.  But do they merit investment?  Target’s financials are decent, but the stock is overpriced.  Nordstrom’s HIGH debt-to-equity almost puts it out of the running.  But then it DOES have great dividend growth, and the P/E ratio is reasonable.

If I HAD to pick something, I’d go with Macy’s.  Just because it’s only selling at $17/share, and such a bargain with a P/E ratio below 6, and a really high dividend yield.  And because nothing in its financials looked too horrible.

But “not too horrible” isn’t exactly a stellar recommendation. Macy’s seems like a gamble; with many stores closing, the company could go either.  So if I didn’t have a gun to my head, I’d pass on all three.  For the time being, anyway.  At least until Target's P/E ratio falls below 15.

And as for the industry itself, I'd say Target's high growth and overpriced stock indicates there's some lifeblood in retail yet.    

What are your thoughts?  If you were to invest in one of these companies, which would you select?

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