Is This Dividend Safe?
When it comes to income investing, big yields come with big risk.
Case in point: Macy’s Inc. (NYSE:M). Amazon.com, Inc (NASDAQ:AMZN) has made road pizza out of brick-and-mortar retailers, crippling profits of traditional department stores.
Macy’s has responded by closing stores, trimming payrolls, and pawning off assets. Yet despite management’s best efforts, shares have plunged 40% in the past year. The stock now yields 7.2%, catching the attention of income hungry investors.
So can Macy’s keep those dividends rolling in? Maybe.
During the first nine months of 2017, the company generated $1.6 billion in free cash flow. Dividend payments, meanwhile, totaled $345.0 million over the same period. That comes out to a payout ratio of just 22%, leaving management plenty of wiggle room, even if profits continue to fall.
“M is highly profitable (18% return on investment) and has a lot of cash flow ($2.7 billion on a 12-month trailing EBITD),” Macy’s CFO Karen Hoguet noted in a June investor day presentation. (Source: “It’s Time for Some Retail Magic, and Macy’s Could Lead the Parade,” TheStreet, Inc., June 7, 2017.
And after getting in a little over its head with debt a couple of years ago, Macy’s has also repaired its balance sheet. Executives has whittled down its debt burden to $6.3 billion through a combination of scheduled payments and debt repurchases. Furthermore, the company has stockpiled a $783.0-million rainy day fund of cash and cash equivalents.
Macy’s still has too much debt for a retailer attempting a turnaround. Management, though, has proven they can shed liabilities quickly when needed. Head office will likely to continue to whittle down the debt load through the last quarter of the year, when the business will generate most of its cash flow for the year.
The projections look even better next year. Aside for trying to “Amazon-proof” their business, executives have also undertaken an aggressive campaign of closing down underperforming stores. Remaining locations represent the cream of the crop, generating plenty of cash.
Margins should look better better too. Last year’s numbers got clipped by warm winter weather, a strong dollar eating tourist cash, and a rash of retailer liquidations unloading inventory. This leaves the company with some easy comparables to beat in upcoming quarters.
Analysts expect big improvements to the bottom line. This year, the street projects free cash flow to remain flat. In 2018, it should inch up to $1.7 billion. The keyword here, of course, being “projects.” Even though earnings can sustain the distribution for now, online competition has eroded profits for years. We like to see a track record of growing income, not contracting.
Macy’s business is like a stalled airplane. You’re betting management will bring operations out of the dive before crashing into the ground. If they don’t, this thing will leave a charred wreckage of closed stores and shareholder retirements.
And judging by Macy’s most recent financial results, this business remains in freefall. Last quarter, the department store saw same-store-sales drop 2.4% year-over-year. Management still sees revenues plunging again, off between 3.2% and 4.3% in 2017.
Analyst Take: If profits start to improve next year, Macy’s could warrant a second look. For now, this big yield comes with big risk.