investing

A Change in Business Strategy Proves Profitable for Macy's

The department store chain has thrived in a tough climate for retailers that cater to middle-income consumers.

In 2007, Michael Dervos, then regional director of Macy's New York-area stores, walked past a clearance sale in the shoe department of the store in Flushing, Queens. He noticed that all the shoes were size 9 and above -- even though many of the store's customers were Asian-Americans, who tend to have smaller feet. Meanwhile, on the clearance rack at a Brooklyn Macy's, which had customers who tended to have average-size feet, the shoe sizes were 7 and below. Dervos swapped the inventories of the two stores, and the shoes sold quickly.

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It was this incident that led Macy's (symbol: M) in 2009 to adopt a new strategy called My Macy's. The strategy has enabled the chain to double earnings over the past three years – a period during which most retailers serving the middle class have struggled. At J.C. Penney (JCP), for instance, earnings plunged 32% for the period, and at Kohl's (KSS) earnings rose just 13%. Over that same period Macy's stock climbed more than fivefold, to $39.70 (prices and related data are as of March 16).

My Macy's boosts sales by tailoring the merchandise in each store to its clientele. The Cincinnati-based company has hired merchandising specialists who visit Macy's stores every day in 69 U.S. cities. These specialists tailor goods to customers' needs by walking through stores, talking to salespeople and customers, and even visiting competitors' stores. Among the things that are customized are brands, sizes, fabrics and color preferences. Customizing merchandise to local markets not only boosts sales, it also helps Macy's better control inventory -- and therefore helps to reduce markdowns, which translates to fatter profits.

At the same time, Macy's has simplified its operations by centralizing functions, such as marketing and planning, that had been split among the company's four regions. For instance, only one office now buys merchandise for 840 stores, but that office is now informed by the 69 regional merchandising specialists.

The company, which owns Bloomingdale's stores as well, has also made a bigger push into exclusive private-label brands. In 2010, Macy’s started selling a clothing line, called Material Girl, designed by singer Madonna exclusively for Macy's teen-clothing departments. In addition, last fall Macy's rolled out "Impulse Beauty," which sells boutique beauty brands.

Another bright spot for Macy's: growing sales on the Web -- which also help drive customers into stores. Online sales from Macys.com and Bloomingdales.com jumped 40% last year, to $962 million, according to an estimate by Morningstar, and are expected to grow to $2 billion this year.

All these strategies have helped Macy's gain market share and show that it can perform well in a so-so economy. Macy's has had to be resourceful because, as a retailer that primarily serves the middle class, it can't raise prices the way a Saks Fifth Avenue and a Nordstrom (which have wealthier clientele) can.

The numbers tell Macy's success story best. In the fiscal year that ended in January, sales increased 5.6%, to $26.4 billion, while earnings per share jumped 36%, to $2.88. Earnings have bounced back nicely after nearly getting sliced in half during the recession. For the year ending January 2013, Macy's forecasts that sales at existing stores will increase 3.5%, on the heels of a 5.3% increase last year. Analysts on average forecast that total sales will rise 4.6%, to $27.6 billion, and that earnings will jump 15%, to $3.32 per share.

The firm's ability to generate cash is impressive. In January, Macy's board authorized a doubling of its quarterly dividend, to 20 cents per share. That’s well above the 13-cents-a-share dividend Macy's paid before it started cutting the payout in 2009, during the last recession (the stock currently yields 2.0%). The board also increased the company's stock-buyback cache by $1 billion, increasing the total money available to buy shares to $1.6 billion.

And despite this good news, Macy's is still a cheap stock. It trades at 12 times estimated earnings for the current fiscal year, compared with 21 times for the average department-store stock. If gasoline prices continue to move higher, sales could drop. But Brian Sozzi, chief stock analyst for NBG Productions, an independent research firm, says Macy's low price-earnings ratio cushions the stock price from a big hit. "It's not like Macy's is trading at 17 or 18 times earnings," he says. Sozzi thinks the stock could increase 10% over the next 12 months. And the stock could do far better if the economy picks up steam, as it appears to be doing.

Follow Jennifer on Twitter and Facebook.

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