Shares of Macy's Inc. (M, Financial) experienced a substantial surge, soaring 20% to $20.80 per share in just one day following the announcement of a buyout offer.
The offer, valued at $5.8 billion or $21 per share, comes from Arkhouse Management and Brigade Capital Management, who are existing shareholders of the department store operator. Despite this impressive jump, the current price remains below the 52-week peak of nearly $24 per share and is well short of its five-year high of $31.30 per share. I think the offer undervalues Macy's.
High-value real estate portfolio
Macy's, a retail giant, operates through 722 stores spread across 43 states, Puerto Rico, Guam and the District of Columbia, covering 111 million square feet in total. The company's ownership of these stores is diverse: it wholly owns 316 locations, leases 361 and possesses 102 properties, where it owns the building but leases the land.
At the start of 2016, Starboard estimated Macy's entire real estate holdings to be worth approximately $21 billion. The crown jewel of Macy's properties is its flagship store, the historic Herald Square building in New York City, dating back to 1902. This iconic building, covering over 2.17 million square feet, was appraised by Starboard at nearly $1,830 per square foot, valuing it close to $4 billion. However, since then, its property ownership dynamics have shifted significantly, with a decreased number of owned stores and increased leased properties. If we apply a conservative 50% discount to Starboard's valuation, Macy's real estate portfolio is estimated to be around $10.5 billion. With approximately 278 million shares, the retailer's real estate portfolio alone could be worth $38 per share.
Source: Starboard's presentation
Overly punished for the declining operating performance
In the retail sector, physical stores face challenges while online shopping continues to experience significant growth. Macy's financial performance reflects this trend, with revenue and net income declining over the years. In 2014, the company achieved nearly $28 billion in revenue and a net income of approximately $1.49 billion. However, by 2022, these figures had dropped to $25.3 billion in revenue and just $1.18 billion in net income. The most challenging year was 2021, when revenue plummeted to $18.1 billion and the company suffered a substantial net loss of nearly $4 billion.
Despite the 2022 net income being only 20% lower than in 2014, Macy's market capitalization has suffered a drastic decline. It has plummeted by 70%, from $20 billion to just $5.7 billion, aligning closely with the recent buyout offer valuation proposed for the company.
Since 2014, Macy's was perceived as undervalued, a view that led Starboard Value to initiate a position in the company. Assuming the valuation in 2014 was accurate and reflective of the business's true worth, a proportional response to the 20% decrease in net income would suggest the market capitalization should have experienced a similar decline of 20%. This would result in a revised market capitalization of approximately $16 billion rather than the more dramatic drop that actually happened.
Source: YCharts
Macy's financials demonstrate a solid balance sheet. As of the third quarter, its total assets amounted to $18.1 billion, encompassing $4.14 billion in shareholders' equity. The company holds a significant debt profile, with nearly $3 billion in long-term debt, $160 million in short-term debt and about $3 billion in long-term lease liabilities. Nevertheless, the presence of $6 billion in inventory and $5.8 billion in property and equipment positions the company favorably in terms of financial stability.
Intrinsic value estimated to be $36 per share
Up until 2017, Macy's, Target (TGT, Financial) and Walmart (WMT, Financial) shared similar price-earnings multiples. However, since 2018, a divergence has occurred. Walmart's multiple soared, while Macy's experienced a gradual decline and Target maintained a middle ground.
Source: YCharts
The recent buyout offer values Macy's at just 8 times earnings, significantly lower than its peers. Walmart, with bigger size and stronger operational performance, commands the highest earnings multiple at 25. Target, meanwhile, is valued higher than Macy's but lower than Walmart at 17.3 times.
For the 2023 fiscal year, Macy's projects its revenue to be in the range of $22.9 billion to $23.2 billion, indicating a further decrease of 6% to 7% from 2022. The forecasted annual adjusted earnings per share range from $2.88 to $3.13. Should Macy's achieve earnings of $3 per share, applying a modest 12 times earnings multiple, which remains the lowest among these retail giants, would price its stock at around $36 per share.
The bottom line
I think the buyout offer for Macy's at $21 per share significantly undervalues its true worth. Despite facing challenges of the retail sector, such as the shift toward online shopping and fluctuating revenue figures, the company's assets and balance sheet remain strong.
The valuation disparity becomes more evident when comparing Macy's earnings multiples with its peers. Both the real estate portfolio valuation and the retail business operations suggest its intrinsic value is in the range of $36 to $38 per share. Therefore, shareholders and potential investors should consider the underlying value of the company, not just in its current market performance, but also in its intrinsic assets and future potential. While attractive at a glance, the current buyout offer may not fully capture the enduring value and resilience of this iconic retail institution.
