Macy’s buy-out signals deep value in the retail sector

Key Points

• Macy's buy-out offer points to deep values in the retail sector. 
• Macy's bid implies a minimum 20% upside and it could be lifted soon. 
• Other stocks in the retail sector offer similar value and high yields for income investors. 

The retail sector has struggled over the past few years due to the COVID bubble bursting and the shift in consumer habits that have discretionary items out of favor compared to dailies and health and beauty products. Today's takeaway is that the heavily beaten-down sector provides some profound value opportunities that private equity capital has begun to scoop up. Macy’s NYSE: M is the first major retailer to get such an offer, but others are waiting in the wings that are incredibly buyable, if not buy-out candidates. 

Macy’s received an offer to take the company private that values it at $21.20 per share or about 22% above Friday’s closing price. The offer comes from a partnership including Arkhouse Management and Brigade Capital Management, which views the company as undervalued. Trading at the bottom of the historical range with a P/E of only 5.8X earnings, this 3.8% yielding stock is certainly attractive. The pair says they are prepared to up their bid provided due diligence suggests the stock is still incredibly undervalued. The board hasn’t issued any statements yet but has the offer under consideration. 

Macy’s has brand strength and a solid omnichannel presence

What does Macy’s have that other retailers don’t? Macy’s is a good example of what it takes for a retailer to succeed in today’s environment because of its solid branding and omnichannel presence. 

Smaller brands like Williams-Sonoma NYSE: WSM have been able to sustain business above the prepandemic period because of it, providing stable cash flow for capital returns. It trades at a low 14X earnings and pays nearly 2% in yield. Macy’s capital return program is centered on its dividend, only 22% of the earnings outlook, with a positive outlook for distribution growth. At this level, the company has ample cash flow to continue paying and growing the distribution (assuming no takeover) or redirect it into business improvements should the takeover move forward. 

Analysts are likely happy with the news. They have the stock pegged at Reduce with a price target that implied a double-digit downside before the takeover announcement was released. Now, the stock is trading above the analysts’ highest target, providing a significant selling opportunity for them and their following. 

Analysts aim for Target’s 3.25% dividend yield

Target NYSE: TGT is the poster child for retailers struggling in the new environment. Its product mix and semi-chic appeal have consumers turning toward Walmart and off-price retail, leaving its sales declining compared to last year. The takeaway from the latest earnings release is that the margin outlook is clearing up, and analysts have noted. Regarding the value, Target trades at roughly 16X earnings compared to 23X for Walmart NYSE: WMT and TJX Companies NYSE: TJX, and both of them are trading at lower valuations than they have in recent years. 

Target stock is still rated at Hold, and the post-Q3 release activity was mixed but included upgrades and price target increases that view the stock as undervalued. The recent targets suggest a $10 to $20 upside for the market plus the dividend. The dividend may not grow substantially over the next year or so, but it is solid and reliable at 3.25%. 

Kohl’s: deep-value and high yield in off-price retail

Kohl’s NYSE: KSS is another deep value in the retail sector with a solid dividend. This company pays over 8% with shares trading at 9X earnings and is a committed payer. Some recent shifts in operations have helped free up the earnings and cash flow outlook, helping solidify the dividend outlook and keep the analysts' interest piqued. Takeaways from the last earnings report include a better-than-expected margin aided by a 13% reduction in inventory. Looking forward, the company expects the holiday quarter to be weak compared to last year, but earnings that led analysts to raise their estimates. 

The price action in Kohl’s stock shows a bottom with a high potential to complete a reversal. The pre-market action has it up more than 3% on the Macy’s news, and it could go higher given the technical picture. The next targets for resistance are near $29.50 and $33.75 and could be reached soon.