Holiday Central

Macy's has a huge opportunity this holiday

Why Macy's has 'huge opportunity' this holiday
Why Macy's has 'huge opportunity' this holiday

Investors seem to have forgotten just how bad last Christmas was for Macy's — and that's creating upside for the department store's shares heading into the critical fourth quarter.

Nearly one year after Macy's fire sale led to weaker gross margins than it recorded during the recession, Deutsche Bank analyst Paul Trussell said Wall Street is underestimating a potential recovery in that metric.

In a note to clients on Monday, Trussell upgraded Macy's stock to "buy" from "hold," saying the company should be able to sell more items at rational promotional levels this holiday. The easy comparison follows last year's unseasonably warm winter, which forced retailers to slash prices to clear through excess merchandise.

Yet even as Wall Street adopted a more optimistic tone for Macy's, analysts reiterated the structural challenges facing department stores, which are ceding share to online and off-price retailers.

Macy's shares rose 2 percent in early trading on Monday, to $36.46.

"We don't believe the market fully appreciates just how bad fourth quarter 2015 was, specifically on the gross margin line," Citi analyst Paul Lejuez echoed in a separate note to clients Monday.

Like Trussell, Lejuez upgraded Macy's stock to "buy" last month, saying the retailer was taking the right steps to alleviate the pressures on its business. Those include its decision to shutter 100 stores.

Trussell added a slight improvement in international tourism trends should also take some pressure off Macy's sales this holiday. International tourist spending was flat in August year over year, marking its best performance since February, Trussell noted. Because Macy's flagships are located in major cities, the retailer typically generates about 5 percent of its annual sales from international travelers.

Yet broader issues remain for Macy's and other brick-and-mortar players, which are losing share to online retailers. As fewer shoppers visit the mall, Cowen & Company predicts Amazon will surpass Macy's as the largest clothing retailer in the U.S. next year.

Department stores are also giving up sales to off-mall, off-price competitors such as T.J.Maxx. And they're suffering from a cultural shift toward spending on experiences over physical goods. Whereas retail sales increased 2.9 percent during the first nine months of the year, department store revenues slipped 4.8 percent.

Indeed, even as analysts made their case for Macy's stock, they predicted sales would continue to contract during the second half. Their forecasts for gross margin improvement also came with a caveat.

Lejuez noted that even if Macy's were to hit Citi's 39 percent forecast for this metric, that result would be slightly worse than its performance in fourth quarter 2008, when it came in at 39.3 percent.

Despite the stock's rise on Monday, Macy's shares are down nearly 30 percent over the past year. The retailer will report third-quarter earnings next month.