Wed 05/20/2020 15:18 PM
Relevant Documents:
Earnings Release
Fourth-Quarter Presentation
Covid-19 Business Update Presentation
Investor Day Presentation 1 / Investor Day Presentation 2
March 20 Covid-19 Response

Department store operator Macy’s Inc. is facing significant challenges due to the Covid-19 pandemic in addition to longer-term digital and off-price clothing retail trends. CNBC has reported that Macy’s is weighing the possibility of raising as much as $5 billion of secured debt, citing sources that say the company could raise $3 billion with inventory serving as collateral and $1 billion to $2 billion with real estate serving as collateral. Macy’s 2.1-million-square-foot Herald Square location in New York City would not be pledged as collateral as part of the deal, according to the report. The company’s current capital structure consists entirely of unsecured debt.

During an April 30 investor meeting, CFO Paula Price said, “We're well into the financing process. We gave our relationship banks an early indication that we would be coming to market some time ago so that they would be expecting us and preparing for us. And so we've been engaged in this process for a while, thoughtfully evaluating our options to maximize flexibility not only in the short term but in the long term. And so what we're putting together is expected to position us well for our future needs as and if they arise. And so we've identified our lead banks, and we're all confident that we'll have a deal closed and funded well in advance of when we will have need for any additional liquidity.”

This potential financing follows the company drawing down its entire $1.5 billion unsecured revolving credit facility on March 19. The company’s credit agreement contains financial covenants consisting of a 3.75x maximum leverage ratio and a 3.25x minimum interest coverage ratio.

In response to the pandemic, the company temporarily closed its entire brick-and-mortar store fleet on March 18. Management said it expected to reopen the “majority” of company stores “over the next six to eight weeks,” in waves. The initial 68 store reopenings were scheduled for May 4, with an additional 50 stores planned to open on May 11.

After Macy’s removal from the S&P 500 in April and downgrades to junk by the three major ratings agencies in February and March, the company announced on April 24 that Price submitted her resignation as CFO effective May 31.

The company had 775 store locations on Feb. 1, including 551 Macy’s-branded locations, 51 Bloomingdales-branded locations and 171 bluemercury locations. Below is Macy’s recent financial performance:

The company has no debt maturities in 2020, and its $1.5 billion senior unsecured revolving credit facility is due in May 2021. Below is Macy’s capital structure:
(Click HERE to enlarge.)

Macy’s Covid-Related Commentary

In response to the Covid-19 pandemic, Macy’s closed all company stores on March 18. CEO Jeff Gennette, during an April 30 company investor meeting, said he anticipated the reopening of the “majority” of company stores “over the next six to eight weeks,” with the initial 68 store reopenings occurring on May 4. Management said it anticipated reopening groups of stores in waves, with an additional 50 stores planned to open on May 11. Macy’s provided the following store reopening graphical representation in the April 30 presentation:

Management said it expected initial sales at reopened stores to be at 15% to 20% of pre-pandemic levels, on the basis of international partner data and public information.

Macy’s said plans to rely on curbside pickup, which was expected to be ready at 100 locations on May 4, in addition to its At Your Service in-store service centers that provide online purchase pickups, returns and other services. Given the lower anticipated activity levels, Gennette commented, “When you think about what that would be a 20%, it may not make sense for us to open up the full building in the first couple of weeks, but that might make more sense later.”

Although Price did not provide the company’s specific weekly cash burn level during the shutdown period, in a response to a $40 million weekly burn rate estimate, she said that the weekly burn rate has “been below … [the] $40 million estimate … on average.” With the full shutdown beginning March 18 and store reopenings beginning May 4, the full shutdown lasted just under seven weeks. Price attributed the better-than-estimated cash burn rate to “quite strong” digital performance in April following weaker March sales and noted that the cash run rate “will change though in the coming months once the payment terms that we have extended come due. But importantly, we've been able to extend our cash runway, so that that gives us time to make the right financing decisions for the future of the company.”

For additional reference on industry shutdown performance, J.C. Penney disclosed in its first day bankruptcy filings that its April sales declined approximately 88% year over year and its store sales decreased to “nearly zero.” Macy’s digital sales represented 26% of fiscal 2019 net sales, compared with 14% at J.C. Penney during the same period.

Covid-19-related factors affecting Macy’s liquidity include:
  • Fixed cost cuts:
    • According to Gennette, “Essentially all of SG&A is variable to the extent possible.”
    • Store rent: Price said the company has “been able to delay rent payments in some cases.” Macy’s recorded $418 million of total real estate rent expense in fiscal year 2019, which included $364 million of minimum rent and $54 million of variable rent. The company reported $363 million in operating cash flows used from operating leases in fiscal year 2019.
    • Wages: Beginning April 1, Macy’s placed “a majority of its workforce on furlough.” These furloughed employees do not receive a salary or hourly wages but continue to receive health benefits if already enrolled. Pay for all employees at director level and above was reduced beginning April 1. Gennette and the board of directors will receive no cash compensation.
    • Marketing: According to Gennette, “Much of the marketing expenses has been dialed back with some expense remaining to support the ongoing e-commerce business.”
  • Capital spending: To preserve cash in its “cash preservation mode,” Macy’s “froze” its capital budget and said it plans to spend “about” half of the approximately $1 billion of 2020 capital expenditures guidance announced at the February investor day presentation.
  • Inventory liquidation and sizing future period purchases:
    • Inventory liquidation: After a “very strong” February, Gennette said, the company’s inventory was “very fresh and current” coming into the Covid-19 shutdowns. The CEO continued, saying that “a great chunk” of digital sales are being fulfilled directly from company stores rather than from distribution centers. This capability was expected to be available at 466 store locations as of May 4. Macy’s said it plans to work “really closely” with merchant and partner vendors on liquidation pricing along with vendor returns and seasonal inventory retention for 2021. Below is the company’s recent quarterly inventory days performance:
  • Back-to-school and holiday inventory build: Gennette said that although he continues to expect the holiday season to be Macy’s best quarter, he “definitely” expects smaller volumes and will plan “receipts accordingly.” He notes that management is “not planning as aggressively as we were once thinking about the holiday season.” Additionally, Gennette said, “We are being conservative. We do expect that the ramp back in brick and mortar is going to be gradual. So we don't want to get ahead of our skis in terms of over-ordering content.” He commented that Macy’s has “definitely made all the cutbacks” in the second and third quarters. Estimates of the company’s historic quarterly inventory purchases are below:
  • Additional pressure from permanent store closures: As described below, Macy’s is in the process of closing 30 stores, and it plans to close a total of 125 stores over the next three years as part of its Polaris cost savings strategy.
  • Vendor payment terms: The company was able to negotiate extended payment terms with its vendors, however Price commented that “[w]e know that that will change though in the coming months once the payment terms that we have extended come due.” As shown below, Macy’s quarterly days payables extended in 2019 compared with its four-year trailing average:

Performance by Product Category

Management noted that the following categories have performed well in the shutdown: home, beauty (“has been huge”), activewear (“extremely strong”), sleepwear, casual apparel, handbags, toys and games. In contrast, dress / career-driven apparel has performed poorly; Gennette said that specifically, men’s clothing, including dress shirts, has experienced “very low demand.” Below are Macy’s historical sales by category:

Capital Structure

As a “proactive measure” to address Covid-19 pandemic uncertainties, Macy’s fully drew down its $1.5 billion unsecured revolving credit facility on March 19. This draw followed Fitch, S&P and Moody’s downgrades of Macy’s long-term debt rating to junk on Feb. 6, Feb. 18 and March 5, respectively. During the company’s April 30 presentation, Price said that Macy’s is “well into the financing process” to address its Covid-related cash needs, emphasizing that management is “thoughtfully evaluating our options to maximize flexibility not only in the short term but in the long term.” The company said that it has “identified” lead banks and that management is “confident” it will secure funding “well in advance of when we will have need for any additional liquidity.” CNBC reported that Macy’s is contemplating raising as much as $5 billion of debt.

The company’s entire capital structure, including the $1.5 billion RCF and $4.14 billion of notes and debentures, is unsecured. With regard to a potential new-money financing transaction, Price said “we have substantial assets that can be used as collateral, most significantly inventory, but we also have real estate that is largely unencumbered” (emphasis added).

Macy’s finished fiscal year 2019 with 2.7x total leverage, according to its adjusted EBITDA definition. On its fourth-quarter 2019 earnings call, management stated that it continues to target an “adjusted debt-to-EBITDA multiple of 2.5 to 2.8x,” which the company views as in line with an investment-grade credit profile. Management views an investment-grade rating as an “important mechanism to indicate financial strength and prudent risk management” to its partners and its vendors.

A pro forma Feb. 1 capital structure, reflecting the RCF draw, is shown below:
(Click HERE to enlarge.)

Parent company Macy’s Inc. and subsidiary Macy’s Retail Holdings Inc. are co-borrowers under the credit agreement governing the company’s unsecured RCF. Macy’s Retail Holdings Inc. is the issuer of the company’s senior unsecured notes and debentures, and Macy’s Inc. serves as guarantor of the notes and debentures.
(Click HERE to enlarge.)

The condensed organizational chart above relies on 10-K disclosures and is not an exhaustive list of each of the company’s subsidiaries. The company’s subsidiaries are provided in list format in the Macy’s 10-K (Exhibit 21). According to Macy’s consolidating financial statements, significant company assets and operations exist both at issuer Macy’s Retail Holdings Inc. and at non-guarantor subsidiaries. Limited assets and no operations exist at holding company Macy’s Inc. Notably, issuer Macy’s Retail Holdings Inc. owes a total of $3.803 billion of intercompany payables to other Macy’s entities, with $2.675 billion and $1.128 billion owed to Macy’s Inc. and other non-Macy’s Retail Holding Inc. subsidiaries, respectively.

Macy’s historical intercompany balances show a shift of the receivables from the non-MRHI/Macy’s Inc. subs to Macy's Inc.
(Click HERE to enlarge.)

The company’s credit agreement includes a 3.75x maximum leverage ratio and 3.25x minimum interest coverage maintenance covenants. The agreement provides for an event of default if greater than $150 million of aggregate debt principal becomes due prior to its stated maturity date.

Prior to the dramatic business impact from Covid-19, Macy’s purchased approximately $2.266 billion of aggregate debt principal for $2.376 billion from 2017 to 2019 through tenders and open market purchases. A table of these purchases is below:

Below is the company’s annual debt maturity runway, including the $1.5 billion 2021 revolving credit facility maturity:

Company Background

Macy’s finished fiscal 2019 with 775 stores across 43 states, D.C., Puerto Rico and Guam. The company’s operations are conducted through Macy’s, Bloomingdale’s, Bloomingdale’s The Outlet, Macy’s Backstage and bluemercury. Below is Macy’s historical store count:

Below is a snapshot of Macy’s recent financial performance:

Macy’s-branded private-label brands represented “nearly 20%” of Macy’s-branded sales in 2018 and 2019. The company laid out plans during its investor day for “a more focused approach” to its “higher margin” private-label brands with a goal of building four $1 billion brands. On the fourth-quarter earnings call, management identified I-N-C as the company’s “biggest” and “most potent” private brand. The company offers the following private labels:

Other private labels include American Rag, Aqua, Belgique, Epic Threads, first impressions, Greg Norman for Tasso Elba, Holiday Lane, Home Design, Hudson Park, Ideology, jenni, Karen Scott, lune+aster, M-61, Maison Jules, Martha Stewart Collection, Material Girl, Oake, Sky, Sun + Stone, Sutton Studio, Tasso Elba, Thalia Sodi, The Cellar, Tools of the Trade and Wild Pair.

Similar to other department stores and retailers, Macy’s has faced years of margin pressure from online retailers and off-price retailers such as TJ Maxx. Digital represented 26% of fiscal 2019 net sales. According to management, mobile represents two-thirds of digital traffic and over half of digital sales mobile. has been contributing to operating profit for more than three years.

In response to off-price retailers, the company launched Macy’s Backstage in May 2015. The company had 218 Backstage stores, six freestanding and 212 inside Macy’s stores, on Feb. 1.

Polaris Cost Savings Initiative

To offset the margin compression from growth in its lower-margin digital channel and Backstage stores, Macy’s announced the initiation of its Polaris strategy targeting $1.5 billion in annualized cost savings at its Feb. 5 investor day. Macy’s planned to achieve gross annual savings of $600 million in 2020. As part of the strategy, Macy’s announced plans to close approximately 125 “of its least productive stores over the next three years, including approximately 30 stores that are in the process of closure now” (emphasis added). These “neighborhood” Macy’s stores targeted for closing account for approximately $1.4 billion in annual sales, according to the company. Price said the stores are “mainly in C and D malls or in markets where we have multiple stores in close proximity.” Although the stores are “cash positive,” they are expected “to decline at a more rapid pace over time.”

On April 30, Gennett commented on the Polaris strategy that “some aspects of the strategy that are more relevant today than ever” in light of the Covid-19 fallout, including “loyalty, digital, cost management and other aspects we will reassess as the business stabilizes.” He said the company is “debating” whether to expand or accelerate the strategy’s store closings.

To implement the strategies, Macy’s said it expects to incur approximately $230 million to $250 million of human resources-related cash expenditures and approximately $40 million of other restructuring-related cash expenditures. Management said it expected the Polaris implementation to be most disruptive in the first quarter of 2020 and expected “improvement thereafter.”

The $1.5 billion of annualized cost savings are summarized below:
  • $600 million gross margin improvement
    • $300 million supply chain
    • $100 million private brand sourcing
    • $100 million merchandising mix and pricing
    • $100 million marketing
  • $900 million SG&A improvement
    • $500 million corporate: “system modernization and consolidation”
    • $300 million marketing and stores: “optimizing media and production spend within marketing and in productivity enhancements like self-checkout and newer handhelds within our stores”
    • $120 million supply chain: “things like small parts of contracting, consolidating freight providers.”

Over the three-year Polaris strategy period, the company plans to reduce inventory by $200 million at cost and guided 2020 inventory levels down more than management’s guidance of -1.5% to -2.5% owned and licensed sales comparison.

The Polaris strategy includes applying Macy’s “growth treatment” to an additional 100 stores in 2020. This process involves “improvements to the physical store, as well as investments in merchandising strategies, technology improvements, talent and local marketing.” Prior to 2020, Macy’s applied this strategy to 150 stores representing approximately 50% of 2019 total stores’ sales.

Other Polaris-related initiatives include:
  • Expanding Backstage with 50 incremental store-within-store locations and seven incremental freestanding locations.
  • 9% net reduction in corporate and support function headcount
  • Campus consolidations
  • Testing a new store format, Market by Macy’s: The concept smaller off-mall targeted stores will “feature a mix of curated Macy’s merchandise and local goods, as well as local food and beverage options and a robust community events calendar.”

Real Estate

Over the past four years, Macy’s has sold 135 real estate assets for $1.6 billion of proceeds. At the company’s Feb. 5 investor day, management said it intends to generate $130 million of real estate sale proceeds in 2020 and expects to generate $100 million-plus of annual real estate proceeds going forward. Macy’s owns 342 stores, consisting of 69.342 million square feet, including its 2.185-million-square-foot Manhattan Herald Square flagship store. The company also holds 108 ground leases, representing 20.704 million square feet. These properties consist of standalone city properties and mall locations. Below is a snapshot of Macy’s 11 “flagship” locations:

Press reports on Macy’s potential $5 billion secured financing say that the flagship Herald Square store is not likely to be included in a collateral package, potentially providing the company with additional optionality for subsequent financing transactions. For context as a potential real estate valuation comp, the 660,000-square-foot 424 Fifth Avenue Lord & Taylor building sold in March 2020 for between $978 million and $1.15 billion, or between $1,482 and $1,742 per square foot.

Recent company property sales include:
  • The I. Magnin building in San Francisco’s Union Square: 250,000-square-foot building sold for $250 million cash proceeds in January 2019 to Sand Hill Property Co.
  • Downtown Seattle store: Sold in a series of 2015, 2017 and 2020 transactions for $183.7 million.
  • The top half, or floors eight through 14, of State Street Chicago store: Sold for $30 million in February 2018 to a Brookfield-sponsored private equity fund.
  • Top of Downtown Brooklyn store and nearby parking garage: Sold to Tishman Speyer for $270 million in January 2016.
  • Downtown Minneapolis store and a parking garage: Sold to 601W Companies for $59 million in March 2017.

Below is a summary of Macy’s real estate holdings as of Feb. 1:

Additionally, Macy’s owned 15 distribution centers with approximately 16.402 million square feet as of Feb. 1.

During the Macy’s Feb. 3 investor day, management outlined plans to develop outparcel land holdings with local joint venture partners. These JVs, intended to densify excess land holdings, average $100 million to $300 million of development costs. The company has 16 of these projects in “negotiation / pre-development.”

Credit Card Business

In 2005, Macy’s predecessors, Federated Department Stores Inc. and May Department Stores Co., sold a $6.6 billion credit card portfolio to Citigroup for a premium of approximately 11.5%. After the transaction, Citibank is the owner of “most” of Macy’s credit accounts and related receivables. The two companies are parties to a long-term marketing and servicing alliance whereby Macy’s and Citibank share in the economic performance of the portfolio. The income earned under the program is accounted for as credit card revenue. Macy’s program agreement with Citibank expires March 31, 2025.

Macy’s receives payments based on: 1) spending activity of the underlying accounts; 2) revenue associated with the establishment of new credit accounts and assisting in the receipt of payment for existing accounts; 3) Macy’s profit share related to the performance of the underlying portfolio; 4) finance charges, late fees and other items, net of fraud losses and expenses associated with the establishment of new accounts.

According to Price, “[B]ecause we don't own our receivables, our profit share, which is what fuels a good portion of our credit revenue, cannot go negative.” She continued, “The portfolio is impacted by consumer credit behavior, and this does include higher bad debt, which is one of the components of our profit share calculation.” Price said that credit revenue dropped to a low of $323 million in 2009.

FDS Bank is Macy’s bank subsidiary that provides credit processing, certain collections, customer service and credit marketing services with respect to all proprietary and non-proprietary credit card accounts that are part of the program and are owned either by Citibank subsidiary Department Stores National Bank or FDS Bank.

--Adam Rhodes CFA
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