Prior to yesterday’s large price decline, Macy’s stock had jumped almost 50% since its March low. Contrary to popular belief, our analysis suggests it has more upside. It has accumulated hefty free cash flow suggesting it should be able to meet its debt obligations and maintain its dividend payments, a boon for investor confidence. The second highest revenue earner in the department store industry still has a positive ROE and boasts the third widest net profit margin in its group.
Meanwhile, the chart below demonstrates how Macy’s quarterly stock price momentum is inversely correlated with its quarterly inventory growth (inventory growth is shown inverted). This makes sense since leaner inventory levels imply that the firm is incurring less storage costs, and vise versa.
Note: Both Macy’s stock price and Macy’s inventories are shown as a quarterly rate-of-change.
*Inventory growth is shown inverted.
While we realize that inventory management is typically cyclical, we expect the firm to hold off from building inventories for the Spring/Summer seasons owing to the recession, suggesting that the recent stock price momentum still has legs.
The above analysis supports our Ranking System’s bottom-up Strong Buy recommendation.
A Roadblock To Positive Long-Term Performance?
With a price-to-book ratio of 0.42 it is likely that most of the economic woes, especially those related to consumer spending are already priced into Macy’s stock valuation. However, the long-term chart below illustrates how Macy’s stock is inversely correlated with the unemployment rate (shown inverted). Essentially, when jobs are plentiful consumers will shop, yet as unemployment rises consumers become frugal. The implication is that beyond the next three months, a sustainable rebound in Macy’s stock toward the $30 price range would require an improvement in employment conditions.
*The unemployment rate is shown inverted.
As a result, we recommend buying Macy’s stock at current prices, as the short-term run-up is not over. However, investors should look for signs of improving employment conditions and consumer spending activity before regarding this stock as a long-term holding.
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