S&P Global Ratings revised its debt rating outlook on Macy’s to positive from negative on encouraging signs that an accelerating economic recovery is emerging. S&P said it believes operating conditions for apparel retailers are “fast improving.”
Along with continued progress on the Polaris strategy, S&P said it believes macroeconomic tailwinds will support a more robust recovery than previously anticipated for Macy’s operating results and credit metrics.
S&P said its positive outlook reflects that the rating could be raised on Macy’s with consistent performance gains in the next 12 to 18 months, resulting in its expectation for adjusted leverage sustaining below 4x.
S&P said in its analysis, “Amid encouraging signs of economic recovery, we believe operating conditions for the apparel retail segment are improving faster than our expectations. We recently revised upwards our forecast of U.S. GDP growth to 6.5 percent in 2021 and 3.1 percent in 2022. An improving vaccination outlook, faster reopening schedule, and the $1.9 trillion stimulus “shot in the arm” have bolstered consumers’ confidence and financial health. The U.S. Census Bureau reported clothing and accessories sales at pre-pandemic levels in March. We believe pent-up demand following a year of suppressed social events and traveling, will be a tailwind for apparel spending as these activities resume.
“Macy’s fourth-quarter sales and profit declines were not as steep as we expected, with sequential improvement from the third quarter. Most recently, the company reported that the momentum of the fourth quarter of 2020 is continuing into the first quarter of 2021. While the boost from government stimulus will taper, we expect further vaccination progress, greater mobility, and improving consumer confidence to fuel increased spending at Macy’s and other apparel retailers.
“Accelerated growth toward online shopping and new customer acquisition present opportunities to regain sales and shares, while an industry headwind remains. We expect Macy’s will continue its fleet transformation, with a focus on rightsizing the number of stores, making omnichannel investments in remaining stores, expanding Backstage, and testing the potential of other smaller off-mall formats (i.e., Market by Macy’s). Macy’s accelerated online sales during 2020 by 24 percent, representing about 44 percent of total revenue for the year. The company boosted its omnichannel capabilities, including enhanced buy online, pick up in-store and curbside pickup, to support higher digital sales. As competitors such as J.C. Penney Co. Inc. and Belk Inc. filed for bankruptcy protection, Macy’s cited an influx of new customers (7 million in the fourth quarter) and an opportunity to capture market share, particularly in digital. In addition, Macy’s Backstage continues to be a growth opportunity in the favorable off-price segment, whose value proposition will continue to resonate with consumers.
“Still, our longer-term view is that changing consumer preferences will be difficult to navigate. Declining mall traffic, shifting category preferences, and online price transparency are persistent risks for Macy’s business. We think Macy’s could expedite or expand its previously announced plan to close 125 stores over the next three years (currently about 60 more to close). We envision the shift toward online purchases to continue, which could lead to lower traffic at brick & mortar locations even after they reopen. As such, we believe Macy’s will likely further invest in its digital business and prune its store footprint, especially considering the top performers in more favorable A and B malls representing at least 85 percent of total sales following the closure of the 125 stores.
“The Polaris strategy and additional cost savings implemented during the pandemic position Macy’s for margin recovery, though execution risk remains. Before the COVID-19 pandemic, Macy’s announced its three-year Polaris turnaround plan to boost performance by addressing fleet, cost position, merchandise offering, online capabilities, and other items. During fiscal 2020, the company accelerated key initiatives such as increasing digital capabilities and realigning its cost base, and paused others such as loyalty tactics and expanding its off-mall presence for Backstage. In June 2020, Macy’s announced a reduction in corporate and management headcount by approximately 3,900 and cut staffing across its store portfolio, supply chain, and customer support network. These actions saved approximately $900 million in cost on an annualized basis. It also generated greater full-price selling, improved inventory turnover, a healthy stock-to-sales ratio, lower selling, general, and administrative cost rate, and expense discipline.
“We believe continued successful execution of Polaris is essential in regaining profitability and counterbalancing a sustained reduction to its top line. Although we expect continued progress to its previously announced $2.1 billion of annual savings, which it expects to realize by year-end 2022, we believe adjusted EBITDA margin improvement to the more than 10 percent pre-pandemic level will be gradual as sales deleveraging and higher delivery fee related to digital sales continue to offset cost-cutting in the next two years. Key risks to our forecast include a lower-than-anticipated recovery in apparel spending, inventory and supply chain challenges, execution issues regarding Polaris strategies, and heightened competition.
“We anticipate improving cash flow generation in the next two years and liquidity to remain adequate. Macy’s debt issuances in the past 12 months and new asset-based lending (ABL) revolving credit facility bolstered its liquidity position. The company ended 2020 with approximately $1.7 billion cash and $3 billion of untapped ABL capacity. In June 2020, it raised approximately $4.5 billion in new financing through $1.3 billion 8.375 percent senior secured notes and a $3.15 billion ABL. This addressed imminent liquidity needs, including funding operations, inventory purchases, accrued payable obligations, and upcoming debt maturities in fiscals 2020 and 2021. Following the repayment of $530 million due in January 2021, Macy’s issued $500 million 5.875 percent senior notes due in 2029 in March to repay its tender offers for upcoming maturities due between 2022 and 2024. This further extends the company’s debt maturity profile and relieves near-term liquidity concerns.
“Macy’s free operating cash flow (FOCF) remained positive in fiscal 2020 despite a sharp revenue and earnings decline, owing to its efficient inventory management and sharp cost reduction. It also cut capital expenditure (Capex) significantly by more than half from $1.2 billion in 2019 to less than $500 million in 2020. We project rising investment requirements in inventory and CAPEX to more than offset earnings recovery in 2021, resulting in a moderate cash burn. We anticipate cash flow generation to improve in 2022, supported by continued recovery in earnings, cash inflow from a $500 million anticipated tax refund, and normalized inventory requirement, resulting in FOCF of about $550 million for the year.
“The positive outlook reflects the potential for an upgrade if Macy’s demonstrates sustained consistent performance gains, resulting in our expectations for adjusted leverage tracking to 4x or less on a sustained basis.”
Photo courtesy Macy’s