Executive Summary:
(Macy’s Inc.)
Investment Recommendation: Overvalued, Sell (Nov. 1, 2007)
M- NYSE(11/1/07):
52 Week Range:
Revenue:
Market Capitalization:
Shares Outstanding:
3 month avg. daily trading volume
Percent Institutional
Ownership:
Book Value per Share:
ROE:
ROA:
$31.54
$27.18 - $46.70
$26.88 billion
$13.51 billion
$433 million
6,089,440
92.4%
$21.80
8.16%
4.54%
Cost of Capital Est.
Estimated:
3 month
1 year
2 years
5 years
7 years
10 years
R2
Beta
Ke
0.088
0.087
0.086
0.085
0.084
0.084
1.26
1.25
1.25
1.24
1.24
1.23
14.72%
14.64%
14.64%
14.55%
14.55%
14.47%
Published Beta:
Kd(AT):
WACC(BT):
1.03
6.22%
10.26%
WACC(AT):
Altman Z-Score
2002
2003
2.65
3.14
2004
3.18
Valuation Estimates
Actual Price (11/1/07):
$31.54
2005
2.8
Financial Based Valuations
Trailing P/E:
$23.01
Forward P/E:
$60.69
P.E.G.:
$74.82
P/B:
$75.96
P/EBITDA:
$61.12
P/FCF:
N/A
EV/EBITDA:
$2.46
Intrinsic Valuations
Discount Dividend:
Free Cash Flow:
Residual Income:
LR ROE:
AEG:
$4.99
$67.86
$17.65
$15.07
$15.01
9.11%
1
2006
2.21
Industry Analysis
In 1858, Mr. Rowland Hussey Macy established the first Macy's
department store in New York City under the name R. H. Macy & Company.
Today, Macy's is a chain of mid-range American department stores with its
flagship store in Herald Square, New York City. This store’s one million square
feet of selling space has been dubbed as the "world's largest store,"
(Wikipedia.com). As of July 2007, Macy's operates 876 stores in 45 states, Puerto
Rico, and Guam. In addition to the physical locations, customers can now shop
Macy's via Internet or through one their mail order catalogs.
Direct competitors for Macy's are Nordstrom, Saks 5th Avenue, and
Dillard's. Ultimately, competition among existing firms is based upon price and
customer loyalty. Therefore, economies of scale and tight cost controls are the
frontline in the battle for market share. This practice makes it extremely difficult
for new firms to enter into the market, nearly alleviating the threat of new
entrants. Furthermore, since competing firms sell much of the same
merchandise, switching costs for the consumer are low and the threat of
substitute products is high. This forces firms to compete on customer service in a
big way.
Marketing strategies that attempt to differentiate are also crucial in the
competition for market share. Existing companies try to differentiate themselves
through exclusive contracts with big name brands to lure in customers. However,
the bigger the name, the more bargaining power the supplier has over the firm.
For the most part though, bargaining power of the suppliers remains relatively
low in this industry.
In the high-end retail industry, there are a handful of competitive factors
that are key tools in gaining market share and a competitive advantage. These
key factors are economies of scale, low input costs, and investment in brand
image. Excellence in these key factors will provide a dominating edge against the
competition in the fight for market share.
2
Accounting Analysis
The ability to match key accounting policies with key success factors is
what determines profitability. Under the flexibility allowed by GAAP and
aggressive accounting styles, window-dressing is an ever-growing concern for
investors. Therefore, accounting analysis is a key tool in finding any irregularities
in a firm's financial statements and determining the transparency of the
information presented.
One of Macy's key accounting principles is the way it presents its liabilities
for operating and capital leases. Like most of its competitors, Macy's uses a
majority of operating leases. However, using an operating lease poses a problem
because it grants the firm some flexibility in reporting expenses. To head this
problem, Macy's discloses the future operating and capital lease obligations for
the next five years, with the remaining obligation after five years appearing in
the footnotes of the financial statements. Pension funds are another area of
flexibility. Depending on the chosen discount rate, a firm may be able to reduce
the present value if its pension liabilities. However, Macy's maintains its
transparency by listing all discount rates, changes in discount rates, and any
additional changes. For example, in 2006 Macy's raised its pension discount rate
by .15%, lowering the line item pension expense. But, it also made "voluntary"
contributions to the pension plans in 2005 and 2006 of $136 and $100 million,
respectively.
Upon our conclusion of the accounting analysis, we found that any "red
flags" we had discovered were easily explained and in fact, normal. This further
demonstrates that Macy's does well in disclosing plenty of transparent
information in its 10-K.
3
Financial Analysis, Forecast Financial, and Cost of Capital Estimation
In order to better forecast a firm’s financials, analysts use a series of
financial ratios that evaluate a firm’s liquidity, profitability, and capital structure.
When computed correctly, these ratios provide analysts with data that is used to
compare a firm to its competitors and forecast the firm’s financial statements.
After this is done, a regression table is made to estimate a Beta for the firm.
Also, the cost of debt, cost of equity, and weighted average cost of capital are
computed.
We found that Macy’s liquidity, when compared to their competitors, is
disappointing. Macy’s liquidity ratios such as: current ratio, quick asset ratio, and
working capital turnover were either below the industrial average or in decline.
However, after computing Macy’s profitability ratios, we discovered that they are
extremely productive. When compared to their competitors, Macy’s gross profit
margin, operating profit margin, net profit margin, return on assets, and return
on equity dominate the industry. The only exception is their asset turnover,
which is dismal compared to their competitors. This could be explained by their
high profit margins, but is still a concerning matter for top management. Finally,
Macy’s capital structure ratios were promising. When compared to the industry,
they’re times interest earned ratio was at the top. Also, their debt to equity ratio
is right in line with the industry average. However, Macy’s does have a poor debt
service margin, indicating they may be having some trouble covering their longterm debt. From this, we can conclude that Macy’s strength lies in keeping its
interest expenses low, while increasing its cash flows.
Using growth rates and the ratios previously discussed, we
forecasted Macy’s financial statements for the next ten years. The processes that
we took to forecast the financial statements varied for each statement. To
forecast the income statement, we first computed the common sized income
statement, which stated each item as a percentage of net sales. Then, we
calculated a personalized growth rate for each account. We used these growth
rates to forecast the income statement items for the upcoming years. Next, we
4
used the liquidity, profitability, and capital structure ratios that we computed to
forecast the balance sheet. The statement of cash flows was the most difficult to
forecast because there were inconsistencies which caused us to make a few
assumptions during this process. Due to the uncertainty, we find the cash flows
forecast to be the least reliable of our forecasts.
Valuations
We use valuations to estimate Macy’s share price. Then, we compare our
estimations to the observed share price as of November 1, 2007, to illustrate
whether Macy’s is over or undervalued. We started our valuations with the
methods of comparables, which include: P/B, P/E (trailing and forward), PEG
ratio, P/EBITDA, and EV/EBITDA. When we calculated Macy’s share price based
on these methods, we found that Macy’s observed share price is undervalued.
On the other hand, when we used the intrinsic valuations, we discovered Macy’s
is in fact overvalued.
The intrinsic valuation methods that we used to further explore Macy’s
share price were Discounted Dividend, Free Cash Flow, Residual Income,
Residual Income Perpetuity, and the Abnormal Earnings Growth rate models. To
use these models, we used our forecasted financial statements, Ke, WACC
(before tax), and growth rate.
Under the discount dividend model, we found that Macy’s is overvalued.
In addition, the residual income, residual income perpetuity, and AEG models all
concluded that Macy’s is overvalued. However, the free cash flow model
demonstrated that Macy’s is undervalued. After all of our research and
evaluations, we feel the calculations that produced overvalued results for Macy’s
are the most accurate. Therefore, we believe that Macy’s is overvalued and our
stock advice is to sell.
5
Business & Industry Analysis
Company Overview
The first Macy’s (M) was created by Rowland Hussey Macy in 1858. They
are now based in Cincinnati, Ohio. Over the last 150 years, Macy’s Inc. (formerly
known as Federated Department Stores, Inc.) has built itself into a giant in the
“high-end” retail industry. “As of February 3, 2007, the company operated more
than 850 retail stores in 45 states, the District of Columbia, Guam and Puerto
Rico under the names Macy’s and Bloomingdale’s” (Macy’s 2007 10-k). These
stores sell a variety of merchandise to their consumers. Some of these items
include clothing for all ages and genders, cosmetics, home furnishings, and other
accessories.
Macy’s Five-Year History
2006
2005
2004
2003
2002
Total Assets*
29,550,000
33,168,000
14,885,000
14,550,000
14,441,000
Net Sales*
26,390,000
22,390,000
15,630,000
15,264,000
15,435,000
30.35%
36.65%
(2.32%)
(2.9%)
1.76%
Comparable
Sales Growth
*in thousands
Macy’s main competitors in the “high-end” retail industry include Dillard’s,
Saks, and Nordstrom. Though Nordstrom’s Market Cap is comparable to Macy’s,
Macy’s has supremacy over the entire industry. Macy’s revenues more than triple
6
its nearest competitors last year. The acquisition of a group of stores explains
the leap in comparable assets for Macy’s in 2005. This merger made Macy’s an
even more dominant force in the high-end retail industry. Macy’s stock reached a
five year peak of 45.05 in March of 2007. However, the price history for this
market shows a slightly different story from the 2007 10-Ks. Nordstrom’s has
clearly been the “hot” stock in this industry for the past few years. Macy’s is still
far too large to be worried by Nordstrom’s recent market boom, but it is
definitely something to be monitored in the near future.
http://moneycentral.msn.com/
Industry Overview
The high-end department store retail industry is an intensely
competitive market. Most of the products sold in this industry are the same from
store to store. This puts a lot of pressure on each company to create a loyal
following, since it is easy for unsatisfied customers to go to other stores.
Consumers in this industry are looking for the highest quality, name-brand
merchandise. Price of the products is a secondary priority to these buyers. It is
difficult for new entrants to take away business in this industry because all of
these firms are well-set in the market. For instance, Nordstrom was founded in
7
1901; Saks was founded in 1919, and Dillard’s in 1938. Smaller, ‘flavor-of-theweek’ companies may have come and gone in that time period, but these big
three have been competing with Macy’s for over 70 years. Nordstrom “derives its
revenues from sales of high-quality apparel, shoes, cosmetics and accessories”
(Nordstrom 10-K). They have 155 stores throughout the United States and also
have businesses in 45 other countries. Saks Inc. consists of Saks 5th Avenue, Off
Fifth, and Club Libby Lu. Of these stores, Saks 5th Avenue is the only one
competing in Macy’s industry offering a “wide assortment of distinctive luxury
fashion apparel, shoes, accessories, jewelry, cosmetics, and gifts” (Saks 10-K).
Saks Inc. owns 190 stores, 54 of which are Saks 5th Avenues. These 54 stores
are a very small portion of market share in comparison to Macy’s 850,
Nordstrom’s 155, and Dillard’s 328. Dillard’s Inc. is based out of Little Rock,
Arkansas. They “rank among the nation’s largest apparel and home furnishing
retailers. Dillard’s stores offer a wide selection of merchandise including fashion
apparel for women, men and children, accessories, cosmetics, home furnishings
and other consumer goods” (Dillard’s 10-K). As stated above, these 10-K reports
show that creating a loyal customer base is crucial for success in this industry.
With all of these firms selling the exact same types of merchandise,
differentiation is extremely important in this market.
8
Five Forces Model
The five force model is a useful tool used to help analyze the industry in
which firms compete. This model helps to give the general feel of the industry
and give a better understanding of how a firm can be profitable. It is, however,
just a single tool in a large systematic analysis of an industry. Also, the five force
model includes five major topics: rivalry among existing firms, threat of new
entrants, threat of substitute products, bargaining power of buyers and
bargaining power of suppliers. These major topics are then broken down into
smaller subtopics and generally discussed to help us see exactly what a firm
needs to do, in order to be successful in the industry.
After going through the five force model, a value chain analysis will then
be formulated. This will explain how Macy’s has not only been able to stay alive,
but continue to be a successful powerhouse in the high-end retail department
industry.
HIGH – END RETAIL INDUSTRY
Rivalry among existing firms
VERY HIGH
Threat of new entrants
LOW
Threat of substitute products
HIGH
Bargaining power of buyers
HIGH
Bargaining power of suppliers
LOW
Rivalry among Existing Firms
The high-end retail industry is a highly saturated industry thus very
competitive, and this leads to firms being forced to fight for market share.
Ultimately competition is based on price and customer loyalty. Even though the
high-end retail industry is characterized by high prices, firms need to be careful.
9
Setting prices too high may scare new customers back to the open arms of its
competitors and possibly chase away loyal customers. Firms in this industry are
forced to fight for market share by striving to differentiate their products or offer
incentives that appeal to customers. Late store hours for convenient shopping
and better customer service with excellent exchange and return polices are a few
existing examples in this industry.
Industry Growth
Percentage Growth of Sales
0.500
0.400
0.300
0.200
0.100
Macy's
0.000
Dillard's
Saks
-0.100
Nordstrom
-0.200
-0.300
-0.400
-0.500
-0.600
2002
2003
2004
2005
2006
2007
Growth in the high-end retail industry is very slow. This discourages new
entrants and forces firms in this industry to be innovative in order to grow. As
shown in the diagram above growth is very slow, if at all. Nordstrom however,
has been growing steadily over the last five years, and Macy’s sales were low
until 2005 when their sales shot up. Therefore, just because the industry in
general shows slow growth a firm can be innovative and still show growth. Most
firms grow by acquiring new stores or diversifying into other areas or businesses.
Some firms in this industry spend lots of money in advertising to attract new
10
customers. Other firms offer high limit store credit cards which lure people to
shop even when they do not have the money to do so. And the store is able to
make money on interest on the credit cards, thus increasing revenue.
Concentration
An industry with a lot of players or firms is considered to have high
concentration and this creates a lot of price wars. The high-end retail industry
falls in this category and thus they are forced to either acquire aggressive
merchandising or reduce prices to attract and keep the customers they have.
Industry Market Share
2002
2003
2004
2005
2006
Macy's
49.04%
48.32%
47.48%
55.36%
58.49%
Dillard's
24.90%
23.81%
22.73%
18.67%
16.56%
Saks
7.34%
7.66%
8.33%
6.87%
6.38%
Nordstrom
18.72%
20.22%
21.46%
19.10%
18.57%
Market Share
60.00%
50.00%
40.00%
Macy's
Dillard's
30.00%
Saks
20.00%
Nordstrom
10.00%
0.00%
2002
2003
2004
2005
2006
11
Market share is a percentage of industry sales. The above bar graph
shows how market share is distributed among the main firms in this industry. As
the graph shows, relative market share throughout the industry has remained
fairly constant. Macy’s has dominated the market for the last five years thus
creating high concentration in the industry. This leads to price wars, but in the
high-end retail industry, quality plays a big role because customers want high
quality and are willing to pay a higher price for it.
Differentiation & Switching Costs
The ability of a firm to differentiate its products from the other
competitors reduces competition in the industry. However, it is hard to
differentiate products in the high-end retail industry largely because many firms
in the industry share some of the same suppliers. This causes the same brand
name items to be sold in all the stores. Therefore, most firms strive to focus on
quality of customer service and sell name brand designer label items to justify
their high prices. Excellent customer service and long store hours influence
customers’ decisions to shop at a particular store. Switching costs in this industry
are low because it would be very expensive to liquidate the current inventory in
a particular store and start something else; meaning most firms are in it for the
long run.
Economies of Scale
In the high-end sector of the retail industry, firm size plays a key role in
success and the level of competition. Larger firms enjoy economies of scale,
giving them purchasing power with their suppliers and the ability to reduce
operating costs by spreading fixed costs over a larger base. The unique
relationship firms share with their suppliers allows them to make long term
contracts to buy in bulk. This process locks in large discounts for the firm that
can be passed on to the consumer and therefore attracting more customers.
Purchasing power also shields firms from the threat of new entrants seeking
12
mutual suppliers. The table below shows that Macy’s dominates a large portion
of the market in the high-end sector of the retail industry.
Industry Sales
2002
2003
2004
2005
2006
Macy's
15,571,000
15,412,000
15,776,000
22,390,000
26,970,000
Dillard's
7,906,646
7,594,460
7,552,060
7,551,697
7,636,056
Saks
2,331,659
2,441,989
2,766,977
2,778,333
2,940,003
Nordstrom
5,944,656
6,448,678
7,131,388
7,722,860
8,560,698
Total Industry
31,753,961
31,897,127
33,226,425
40,442,890
46,106,757
*in thousands
Fixed Costs to Variable Costs
A firm’s ratio of fixed costs to variable costs is also a key determinant
when measuring its level of competition. In the high-end retail industry, it is not
uncommon for firms to have a low ratio of fixed costs to variable costs. This
means that for every dollar of variable costs the firm expends, they only spend a
fraction of a dollar in fixed costs. This gives the firm leverage to liquidate
inventory that’s not selling and shift their focus to new products. However, a
high ratio of fixed costs to variable costs indicates that the firm has a great
amount invested in its particular industry and is restricted in its actions.
Fixed Costs to Variable Costs Ratio
2002
2003
2004
2005
2006
Macy’s
.6788
.6892
.6785
.6473
.9076
Nordstrom’s
.4676
.4436
.4092
.3905
.3629
Saks
.5674
.5731
.5530
.5123
.3583
Dillard’s
.6274
.6415
.6184
.6339
.6300
*Ratios derived from the financial statements of Macy’s Inc., Nordstrom’s Inc., Saks Inc., &
Dillard’s Inc.
13
Excess Capacity
Excess capacity occurs when a firm’s supply exceeds demand. In the retail
industry, this tends to happen towards the end of peak seasons. When it
happens, retailers discount their merchandise to make way for the next season’s
inventory. If the firm enjoys economies of scale, it is able to compete at a higher
level during excess capacity due to its purchasing power and cost control.
Same Store Operations
2002
2003
2004
2005
2006
Macy’s
(14.9%)
(1.3%)
(1.1%)
2.4%
43.3%
Nordstrom’s
1.9%
6.1%
8.6%
9.9%
8.3%
Saks
(7.8%)
(2.6%)
2.4%
6.3%
(7.5%)
Dillard’s
(4.8%)
(2.9%)
(3.9%)
0.0%
0.0%
* Percentages derived from the financial statements Macy’s Inc., Nordstrom’s Inc., Saks Inc., &
Dillard’s Inc.
Same store operations are a way for firms to measure the productivity of
all their different stores. The table above shows the same store operations for
this industry. It is helpful to see the efficiency for all of the stores of each
company. These numbers allow each firm to evaluate how sales are compared
from store to store. For example, Macy’s stores down in Texas will most likely
have different sales than the stores in New York. The northern stores will find
higher sales volumes for the cold weather clothing, while the southern stores will
favor warmer attire. Therefore, it would be beneficial for the southern stores to
remove their cold weather inventory and ship them north, where their stock will
be more useful. The same concept applies for the northern stores sending their
warm weather inventories down south, thus, making all stores more efficient.
14
Exit Barriers
Exit barriers are any obstacles that prevent a firm from leaving its
industry. Firms in the high-end retail industry have invested a lot of capital and
have a large amount off fixed assets that are not easily converted into liquid
cash, should they decide to leave the industry. If a company decided to leave the
market, it would be forced to liquidate large amounts of inventory.
Conclusion
In the high-end retail industry competition is intense. This is due to high
market concentration and an inability to differentiate products. Therefore, firms
seek economies of scale so they can maintain price control. Factors such as slow
growth, low switching costs, and few exit barriers also play key roles in the
highly competitive nature of this industry.
Threat of New Entrants
The threat of new entrants isn’t going to be very common because of the
magnitude of the operation. On average, a single Macy’s store is approximately
200,000 square feet. It would be very difficult for a new business to jump into
the industry and instantly become competitive. The stores are extremely large
and require a great deal of capital to begin operating. The small “mom and pop”
outfits throughout the country steal tiny portions of the market from Macy’s.
Large department stores will usually always have a cost advantage over smaller
stores due to the bulk of the purchases. This combination makes it hard for large
entrants to join the industry and small entrants are rarely effective in the overall
market share.
Learning Curve
A learning curve is low because the large department stores are already
established and the only threat of new entrants is rival companies merging and
acquiring stores of their competitors. Brand identities do exist to some degree.
15
Though the DS only carry merchandise from other manufactures, I have to look
at brand identity as loyalty. Macy’s, Saks, Foley’s, etc., all carry just about the
same items, brand identity can be associated with customer service which then
really leads into differentiation, another subject all together.
Economies of Scale
Economies of scale plays a part in the large DS because they can
purchase more products from individual manufactures that, over a period of
time, drives the price down and the profits up. The threat of a brand new
company setting up and taking business away from the existing DS is highly
unlikely.
Distribution Access
The access to distribution channels is extremely easy for the large DS
because they have been doing business with one another for many years. This
has created a loyalty between the existing firms and suppliers that makes it very
difficult for a new DS chain to come and succeed. Suppliers would not want to
take a risk on a new company when they already have a strong relationship with
an older, reliable firm.
Conclusion
The difficult boundaries for any company thinking about joining the highend retail industry make in nearly impossible to join and compete. The large
companies that currently exist already have relationships with suppliers and are
able to get large quantities of merchandise for low prices. These relationships
make it nearly impossible for a new company to enter the industry and compete
on price. Smaller, new companies will have to find creative ways to differentiate
themselves from the existing competition in this industry.
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Threat of Substitute Products
In the high-end DS industry, the threat of substitutes will always be
present. This plays a big role because all department stores carry the same kind
of merchandise in each department. Therefore, the cost to the customer to
switch from one store to another is relatively low. Companies must compete on
other factors such as customer service and quality of goods sold.
Relative Price & Performance
Value has always been associated with price. Since you most likely will be
able to find similar items in different stores, Macy’s must justify its price with
superior service and quality. The price must always reflect the amount of value
perceived for that product and what you might get based on the price you pay.
Customers will find somewhere else to spend their money if they do not receive
exceptional service at a “high-end” store.
Buyers’ Willingness to Switch
The threat of substitutes will be just about the biggest factor in the retail
clothing industry. Companies must rely on differentiating themselves through the
service they offer their customers or by the particular brands they carry. A
customer is very likely to switch stores if they do not receive the satisfaction they
deserve or if they find similar products at other stores at a very competitive
price. Retailers must always take into consideration the extremely low cost for
consumers to switch stores. A strong customer base is what drives this industry.
Knowing this, retailers are required to cater to every need that their customers
desire.
Conclusion
Substitutes are the biggest threat in this industry, and because customers
can move so easily from one store to another, the companies focus on other
aspects they deliver in addition to their products to validate premium prices. That
17
is why it is so important for a company to offer easy help, quick check-outs,
clean stores, friendly employees, and other “extras” to create a loyal customer
base as well as entice new customers to come to the store.
Bargaining Power of Customers
The bargaining power of customers plays a crucial role in the way a highend retail company forms its business model. A retail department store will
develop a pricing strategy, marketing strategy, and customer service department
based on the role that consumers have in their industry. The higher the
bargaining power a customer has over a firm, the bigger role pricing will play in
that firm’s business strategy.
Price Sensitivity
The high-end retail industry is a very price sensitive market. The
switching cost of customers in the high-end retail department stores is relatively
low. Switching costs are the costs that consumers will incur to change products
or suppliers in the marketplace. Most of the department stores generally carry
the same items and brands. For the most part, they are also located in the same
areas, such as malls or strip centers. This allows the customers to easily switch
between retailers based on price or other factors that they feel are important at
little to no extra costs to them. Clients have no obligation to shop at one specific
department store, so it is very easy for them to buy their products else ware.
The majority of products sold in retail department stores are relatively the
same from one store to the next. This makes it difficult for department stores to
differentiate themselves with their products. However, some retail stores can
separate from others by offering products that are higher quality or specialty
items. Companies like Macy’s, Dillard’s, and Nordstrom differentiate themselves
from large category killers like Wal-Mart by offering higher-end products that
they charge a premium for. Unfortunately, they still struggle to differentiate
themselves from each other, which force them to attract customers in other
18
ways. Ultimately, this will come down to quality of customer service. If all of the
higher-end retail department stores are offering similar products, the consumer
will search for the retailer who offers the best shopping experience to add value
to their dollar. This is how these stores justify the higher prices that they charge.
High-End Retail Industry
38.50%
38.00%
37.50%
37.00%
36.50%
Gross Profit Margin
36.00%
35.50%
35.00%
34.50%
34.00%
2002
2003
2004
2005
2006
As shown in the graph, companies in the high-end retail industry have
begun steadily increasing their gross profit margin by increasing sales and
decreasing the cost of goods sold. Buying in bulk from their suppliers makes this
possible for these firms to accomplish. The more they buy at once, the lower the
cost. Then they continue to sell these large stocks of products, thus, increasing
sales.
Relative Bargaining Power
The high-end retail department store business is a very competitive
industry, and is driven solely by its customer base. The number of buyers in this
market is extremely large because of the vast number of products being offered.
However, the purchase volume per customer is relatively small, so the cost of
19
losing one customer is not that significant on a monetary level. This limits
bargaining power of customers to a small extent, but not enough to outweigh
the low switching cost of the customers and the lack of differentiation in the
industry. Therefore, the buyers (or customers) in the high-end retail industry
have a high level of bargaining power.
Conclusion
The bargaining power of buyers will play such a major role in the way a
high-end retail company forms its business model. Firms competing in this
industry must accurately assess the price sensitivity and relative bargaining
power of its customers. The low switching costs for customers and minimal
differentiation between competing firms creates high price sensitivity and a high
bargaining power of buyers in this industry.
Bargaining Power of Suppliers
In the departmental retail industry, suppliers have minimal bargaining
power. This is mainly due to the fact that department stores use a wide variety
of suppliers. This allows retail companies to be more selective and provides them
with a greater amount of control involving the prices of products.
Price Sensitivity
In a particular industry where suppliers have a great amount of bargaining
power, prices will usually increase for both the firms and potential customers.
However, this is not the case for most retail department stores. If a supplier of
one of these stores does not agree to a specific condition regarding the time of
delivery or price, they can easily be removed as a supplier of the company.
20
Relative Bargaining Power
In addition, suppliers of major retail department stores are aware that
there are a limited number of these stores that will sell their product to many
people at a profitable price. Therefore, this reduces the bargaining power of
suppliers. However, many suppliers of these high-end retail department stores
offer many respectable name brand products that are in high demand by both
the company and customers. In some cases where the particular brand is highly
valued, these suppliers may have slightly more bargaining power than other
suppliers.
The relationship between the firm and suppliers is important to the
success of both companies. Having a strong relationship helps to increase
efficiency and reduce the prices of products. However, it is important that a firm
does not depend on one particular supplier. In 2006, Macy’s did not order more
than 5% of it inventory from one supplier. Having this diversity among suppliers
allows the company to have more bargaining power.
Conclusion
The bargaining power of suppliers plays an important role in any retail
industry. The lower the bargaining power of the suppliers, the more beneficial it
is for the company purchasing the products for resale. In addition, many firms in
the departmental retail industry provide similar products. Therefore, the
switching costs are relatively low. As one can see, the bargaining power of
suppliers in this particular industry is low due to the wide selection of suppliers
offering similar products.
21
Value Chain Analysis
“The profitability of a firm is influenced not only by its industry structure
but also by the strategic choices it makes in positioning itself in the industry,”
(Palepu and Healy). The value chain analysis tells us exactly what the firm is
doing in order to stay ahead of the competition.
The value chain analysis will show what strategies the firm in the high-end
retail industry is taking in order to be efficient in producing and distributing its
products. We will then use the strategies from the value chain analysis to see
how Macy’s stacks up to the competition.
Economies of Scale & Scope
Economies of scale and scope play a major role in the high-end retail
industry because most firms in this industry are large in size. Size is important
because it enables companies to cut costs through quantity discounts. It would
therefore be advantageous for a company to sell the same merchandise in all
locations, in order to take advantage of the quantity discounts. Most of the
companies in the high-end retail industry are taking advantage of this by using
the internet to make products available to any customer, from any location in the
world. Economies of scope, on the other hand, “refer to the reduction of per unit
costs through the production of a wider variety of goods and services,” (Street
authority). This is usually achieved by producing small batches of many items.
Instead of just having one line of products, firms achieve economies of scale by
providing a variety of products and increase sales. The fact that existing firms
already have relationships with their suppliers discourages new entrants to the
industry. It would be hard for a new comer in the industry to achieve the same
success.
22
Low Input Costs
Low input costs are a plus in the high-end retail industry, because it
means producing and distributing at lower costs. It gives a firm the ability to
reduce prices and stay ahead of the competition. This is not always easy to
achieve in the high-end retail industry since they strive to produce high quality
goods. Lowering production costs usually means substituting high quality
materials with low quality materials, which would destroy quality. Firms in this
industry are sometimes forced to have markdowns to avoid having excess
inventory, which leads to reduction of profits. To avoid this, companies in the
high-end retail industry must keep up with new trends in order to avoid having
excess inventory. Also, maintaining supplier relationships ensures quantity
discounts, which is important to make up for lost sales.
Tight Cost Control
The high-end retail industry is an intensely competitive industry, thus
companies must strive to be innovative and ahead of the competition.
Companies not only compete on price, but also on quality of products. Therefore,
having a low cost strategy must be accompanied with a tight cost control system
in place. Tight cost control can be achieved by having distribution centers. Also,
centralizing organizational tasks can result in efficient control of inventory to
avoid having excess inventory. Having a good relationship with a supplier is
essential because it enables the firms to have a constant stream of inventory, in
a timely fashion, at a controlled or even reduced price.
Low Cost of Distribution
Distribution plays a big part in the high-end retail department. Most firms
in this industry store their merchandise in warehouses before distributing them
to other store. Also some firms in this industry own their own trucks and this
greatly reduces costs in that they can control how and when their merchandise is
to be picked up for delivery.
23
Superior Product Quality/ Variety/ Customer Service
Firms in the high-end retail industry strive to provide high quality
products. Firms in this industry know that their competitors offer most, if not all,
of the same products. It is important for a firm to differentiate themselves from
the competition. Excellent customer service and good shopping atmosphere are
two key ways used in this industry to create customer loyalty. Customer service
is hard to measure because it means something different to every person. One
customer may find the quality of service to be fantastic, while another customer
receives the same service and is disgusted with it. For this reason, it is important
for stores to have customer feedback. This way, if customers are not getting the
service that they feel they deserve, the stores can adjust to the customers’
needs. Also, offering a large variety of products provides the customers different
options to choose from. For example, offering different designers such as
Giorgio Armani, Tommy Hilfiger, and Ralph Lauren allows consumers the
opportunity to choose the designer that best fits their preferences.
Investment in Brand Image
Firms in high-end retail rely on brand image, because some of the
customers only buy certain brands of makeup, shoes, and handbags. Firms that
offer the most varieties create a following of loyal customers. A firm must
therefore strive to have good relations with certain brand retailers and ask to sell
there products exclusively in their stores. This not only attracts customers who
admire that label but ensures that you maintain them as long as you continue to
sell that particular label.
Conclusion
The high-end retail industry is very competitive and firms must therefore
strive to be profitable and separate themselves from the rest. Price is always
going to be a major factor in this industry, therefore, firms must strive to control
24
their costs so as not to be over priced and chase away their customers. By
lowering input and distribution costs, a firm is able to use those resources to
invest on their product and maintain a high standard.
The high-end retail industry puts a large emphasis on product quality. A
firm must adopt certain practices, like investing in product quality and variety, to
ensure a continual high quality product. Customer service is also very important
because providing a good shopping environment for customers is just as
important as providing a good product. The upscale, warm, and friendly
environment provided in this industry helps customers feel like the premium
prices they spend their money on are justified.
Firm Competitive Advantage Analysis
Competitive advantage is very important. It helps us see how well Macy’s
is utilizing cost leadership and differentiation tactics to stay on top of the
competition, which will lead to maximizing its profits. In order for Macy’s to be
operate efficiently they need to be able to lower input and distribution costs in
order to be a price leader. They also need to focus on superior product
quality/variety and customer service in order to retain the customer they already
have and ultimately attract new customer.
Economies of Scale & Scope
Macy’s is enjoying economies of scale based on its big size. They have
858 retail stores, allowing them to serve an extremely large market. This large
scale allows them to buy in bulk and take advantage of quantity discounts.
25
Macy’s does not depend on its suppliers and has no long-term
commitments with any suppliers. That is why they do not get more than 5% of
their merchandise from one supplier. Macy’s overpowering market share gives
them the ability to dictate quantities and prices to their suppliers.
Low Input Cost
Operating with minimal cost shows that the company is operating
efficiently. Macy’s hires extra employees around holidays to help out with the
high demand. This prevents these workers from being on the payroll all year,
which keeps wage costs low. With the recent merger of Macy’s and May’s, they
“acquired about 500 department stores and approximately 800 bridal and
footwear stores,” (Macy’s 10-K). This puts a large strain on management and
therefore makes it easy to mismanage funds in terms of employees or inventory.
Macy’s has computer systems to track inventory to avoiding accruing excess
inventory or essentially, waste.
“Macy’s realized more than $175 million in cost savings in 2006 and
expects to realize at least 450 Million in cost savings in 2007 due to the
consolidation of central functions and division integrations,” (Macy’s 10-K). The
taking over of other companies, like May’s, has lead to great price savings for
Macy’s overall. They are able to adopt the good practices that other companies
had before the take over and merger.
In striving to provide quality customer service to its customers, Macy’s
realizes that they need to retain the employees they currently have. This will lead
to lower employee turnover, which will allow Macy’s to save money needed to
spend on training new employees.
Macy’s also invested in a centralized organizational system for ordering
merchandise. Having the same decision implemented in all of their other stores
enhances uniformity while ensuring the same strategies and decisions are being
implemented in all other stores.
26
Low Cost of Distribution
When a firm owns its distribution centers, warehouses, and trucks it
reduces distribution costs. This gives them the ability to apply those resources
elsewhere. Macy’s has distribution centers and warehouses that cut distribution
costs significantly.
Superior Product Quality & Variety
The high-end retail industry is all about quality. Customers will not pay
high prices if they are not assured of getting a quality product. Macy’s is no
exception to this. Macy’s have taken pride in keeping up with all changes in
fashion trends. Some of the customers, especially women and children, will go to
a different store to shop if the new trend they are looking for is not available at
the store. Macy’s has built up strong relationships with designers which enables
them to stay ahead of changes in fashion and keep their customers happy.
Superior Customer Service
The customers are the reason for any firm’s success, therefore, it is
important to have the customers’ needs met in order to attract and retain new
customers. Macy’s has done this by simplifying prices to make the shopping
experience easy and better for all customers. They have different sections for
mark downs and clearly label sale prices on items. “Macy’s has created a
customer loyalty program, called Star Rewards,” (Macy’s 10-K). This program
provides special offers and discounts to customer with the Macy’s credit cards.
This not only rewards the customers, but also encourages spending. The credit
cards increase sales, normally resulting in customers buying items that they
otherwise may not have had the funds for.
27
Investment in Brand Image
In the high-end retail industry, fashion changes relatively quickly and the
companies have to keep up with these changes in order to stay competitive.
Macy’s has done a good job of keeping up with emerging designers and
maintaining relationships with other brand retailers. A result of this practices the
sustaining of loyal customers. They achieve this through strong private label
merchandising, which has created a loyal following of certain designer items
offered exclusively at Macy’s.
Conclusion
Macy’s has positioned itself in the high-end industry as a major player.
They now only strive to provide high quality products but, they are also trying to
emerge as a cost leader in the industry. Macy’s has successfully done so by
implementing tight cost control systems that truly work for them, like having a
centralized organization system. They have also installed an inventory system to
avoid having excess inventory at any one time. Since Macy’s is a high-end
industry, their customers expect to pay high prices on products because they
know they are getting high quality goods, in the latest designs.
If Macy’s successfully implements the cost control measures, while
producing efficiently, they will enjoy high profits because they can still charge
the high prices on well-known brand names.
28
Analyzing Accounting
An accurate accounting analysis is vital to both the firm and the public,
because it shows the true financial health of the firm. Investors and
shareholders will rely on an accounting analysis for to help them make informed
decision on whether or not to invest in the company, and to know what to
expect in the future. It is assumed that the firm gives correct information in
their accounting disclosure, but through careful examination this may not always
the case.
The structure of an accounting analysis consists of six steps. The first is
to identify the key accounting polices associated with the firm. These key
policies will be directly linked to the key success factors of the firm. The second
step is to assess the degree of potential accounting flexibility. This is where the
firms identify how much “wiggle” room they have within the limits of GAAP. The
next step is to evaluate the actual accounting strategy the firm implements. This
is where the level of disclosure in the financials is used to determine how
conservative or aggressive the company is in its accounting methods. The fourth
step is to evaluate the quality of disclosure, looking at both a qualitative and
quantitative analysis of the firm. The fifth step is to identify any potential “red
flags” that may arise. The sixth and final step is to undo accounting distortions.
29
Key Accounting Principles
To be successful in the high end retail industry, a firm must have a good
mixture of cost leadership and product differentiation. The ability to cut cost,
while providing a high quality product is essential. Macy’s key accountings
principles reflect these needs because they are directly linked to their six key
success factors: economies of scale and scope, low input costs, low cost of
distribution, superior product quality and variety, superior customer service, and
investment in brand image.
Capitalized and Operating Leases
One of the most influential accounting principles comes from a firm’s
decision on using operating lease versus capital leases. Operating leases allow
the firm leasing the property to avoid the risk associated with owning the
property and are able to treat it as an operating expense, reported on the
income statement. This allows the firm to keep this information off of their
balance sheets. Capital leases are less appealing because they are presented on
the balance sheet, and above all, increase the amount of liabilities shown on the
balance sheet. Macy’s, like many of the other high-end retail stores, deal
primarily with operation leases. For example, in 2006, Macy’s had operating
lease obligations of $225 million as compared to only $10 million in capitalized
leases. Choosing to use all operating leases will drastically lower the amount of
liabilities shown on the company’s financials. This type of accounting method can
misrepresent the financial strength of the firm by distorting the financial
statements. It allows the firm to appear cost efficient, which is important to a
highly competitive market, yet may not always be true of the company.
However, Macy’s helps to prevent this by disclosing the future operating and
capital lease obligations for the next five years, and the remaining obligation
after five years, in the footnotes of its financial statements.
30
Year
2007
2008
2009
2010
2011
After 2011
Future Lease Commitments
Capitalized Operating
Leases
Leases
$10
$225
$9
$211
$9
$193
$8
$181
$7
$166
$45
$1,826
Total Lease
$88
$2,802
Payments
*table derived from Macy’s 10-K
Total
$235
$220
$202
$189
$173
$1,871
$2,890
Goodwill
When a firm purchases another firm it usually pays more than the book
value of the company. This is known as goodwill and is shown on the balance
sheet as an intangible asset. Macy’s chooses to review its goodwill on an annual
basis for possible impairment. This review is done by the management, and is
subject to many judgment based decisions. Through taking into consideration
sales, gross margin, and expense growth rates, the management makes a
decision on how much impairment to take on these assets. These assumptions
made by the management can greatly affect the amount of goodwill shown on
the balance sheet. Because they do not disclose the details of these decisions
used to impair its goodwill, there is lots of room for flexibility.
Advertising Disclosure
As a high end department store, Macy’s relies greatly on advertising for its
success. Because of this, they incur a very high level of advertising costs.
However, Macy’s chooses to disclose the totals for their advertising expenses in
the “notes to consolidated financial statements.” It is also to note that because
it sells other “vendors” merchandise, they receive allowances for advertising.
31
These arrangements with the “vendors” are typically informal and for a short
period of time (one year or less). The allowances show up in the notes to
consolidated financial statements as well. For example, Macy’s had $1,171
million in advertising costs in 2006 not considering the $517 million in advertising
allowances in 2006. These allowances make up a considerable amount of the
total advertising costs and must be accounted for properly.
Pension and Retirement Plans
From an industry standpoint, it is extremely important to keep costs low,
in order to pass on the savings to its customers. Being able to cut cost, when
available, can increase net income considerably. Macy’s recently raised its
pension discount rate .15% from 5.70% in 2005 to 5.85% in 2006. This
increase in the discount rate results in a decrease in the pension expense
recognized on the financial statements each year. This will allows Macy’s to pass
on these savings to the customers. However, this is offset slightly by two large
“voluntary” contributions to the pension plans in 2005 and 2006 of $136 million
and a $100 million respectively. Macy’s uses the accrual method when it is
recognizing pension expense, by estimating the remaining service period of the
employee to collect the benefit.
Conclusion
Being able to identify the key accounting principles is very important
because it is the first step of the method for a structured accounting analysis.
Macy’s must be able to link its key success factors (economies of scale and
scope, low input costs, low cost of distribution, superior product quality and
variety, superior customer service, and investment in brand image) to its key
accounting principles. Macy’s ability to focus on the accounting methods of
capital and operating leases, goodwill, advertising disclosure, and pension plans,
is vital to the profitability and success of the firm.
32
Degrees of Accounting Flexibility
Capital vs. Operating Leases
Macy’s has tremendous flexibility in accounting principles when dealing
with capital or operating leases. An operating lease is just that, it is a lease for
operating a business for the terms of the contract. When the contract or lease is
up then they have the option of renewing the lease or giving up use to the
facility. Companies use this type of lease to keep the expense off the balance
sheet. Ownership does not transfer from lessor to lessee, therefore only
reflecting the expense on the income statement as an operating expense.
Manipulation can occur using operating leases because liabilities can be severely
understated, which leads to expenses being understated. If expenses are being
understated that would in turn cause net income to be overstated which would
lead to retained earnings being overstated. This could be misleading because it
overstates retained earnings and would entice investors to invest more money
under false pretenses.
A capital lease, on the other hand, does affect the firm’s balance sheet. It
is listed on the balance sheet as both a liability and an asset, lease payment and
an increase to PPE respectively. This is why Macy’s chooses to deal mainly with
operating leases. For example, Macy’s had $225 million operating leases
compared to only $10 million in capitalized leases. However, Macy’s can benefit
from capital leases in many ways such as depreciation and reducing interest
expense. Macy’s assumes risks when dealing with capital leases, for example
taxes and payments for the property, capital leases can lead to increased equity
because payments are being made toward ownership. Most high-end retail
department stores option to use operating leases because the expenses
associated with capital leases are recognized sooner than if you were to use an
operating lease.
33
Pensions
Pension plans are another area where Macy’s can show flexibility. “The
Company has a funded defined benefit pension plan and an unfunded defined
benefit supplementary retirement plan” (the “Pension Plan”). “The company
funds this plan using SFAS 187,” (Macy’s 10K, pg. 24). Macy’s keeps these plans
on the books as long-term liabilities. Pensions to be paid are based on estimates
such as length with the company, how long they will live after retiring, the
expected rate of return on the investment and actual contribution towards the
plan by the employee. If estimates are not accurately done, then net income will
be overstated or understated based on the mistake made. Estimates must be
done accurately based on the present value of the liabilities. Although funding
requirements do exist, they are due to government regulations not SFAS 87 or
158. At February ’07 the company had 2 big unrecognized losses from the
pension plans totaling $371 million, these loses will be recognized as a
component of pension expense in future years in accordance with SFAS 158
(Macy’s 10K, pg 24).
Advertising Disclosure
How Macy’s discloses and accounts for its advertising costs leaves
room for flexibility within GAAP. Macy’s chooses to disclose its total advertising
costs for the year in the notes to consolidated financial statements. For 2006
Macy’s had $1,171 million in advertising costs. However, they also have
allowances that they receive from venders which totaled $517 million in 2006.
This is a very significant number, and it is accounted for differently than the
typical advertising costs. Macy’s chooses to credit these allowances to the costs
of sales when the transaction (sale) takes place. Where the flexibility comes in is
when and how they account for their normal advertising costs (i.e. radio and TV
ads, promotional events, etc). They can choose either to expense the costs as
incurred, or over a period of time. Having this choice allows them to choose
when the advertising expense will show up on the income statement.
34
Actual Accounting Strategy
When a company reports their financial information each year, they can
take either a conservative, aggressive, or a combination accounting strategy.
Due to the flexibility provided by GAAP, corporations may adjust their income
statement or balance sheet to make it seem more appealing to investors in an
effort to inflate stock prices. This approach is referred to as an aggressive
strategy. On the other hand, some firms take the opposite strategy and are more
conservative in their approach to reporting financial information.
After reviewing Macy’s financial statements from recent years, it is
apparent that they use a mixture of these accounting strategies. The reported
net income for Macy’s Inc. was average compared to its competitors. This
reveals that they are not trying to inflate their figures in order to appear better
than their competitors. However, Macy’s recent merge with Federated may hint
towards an aggressive strategy. Often firms will merge with other corporations in
order to hide or cover up certain financial information that may be unattractive
to investors. The process of merging with a similar corporation will allow Macy’s
to perhaps combine their financial data with Federated in order to make it seem
more pleasing to investors.
Similar to many of Macy’s competitors, they offer a retirement pension
plan to employees that have worked for the company for over one year. These
retirement expenses along with stock based compensation expenses have
severely impacted the Selling, General, and Administrative Expenses portion of
the Income Statement. The SG&A Expenses have increased rapidly over the past
few years. This systematic reporting of these vague expenses reveals that Macy’s
is leaning towards a conservative accounting strategy for this particular instance.
35
In the departmental retail industry it is extremely common for these
companies to utilize operating leases. Macy’s uses operating leases to reduce the
amount of risk related to owning property and records it as an operating expense
on the income statement. This will often lead to financial information being
misinterpreted. In addition, the ownership of the property does not transfer from
the lessor to the lessee. Therefore, there is no impact on the balance sheet. This
may cause the assets and liabilities section to be much different than if they did
not have operating leases. Furthermore, this reduces the amount of disclosure of
information that Macy’s reveals to investors because they are not showing it on
their balance sheet.
Capitalization of operating leases using 9.9% discount
rate
year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
counter
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
raw pmt
225
211
193
181
166
181.8
181.8
181.8
181.8
181.8
181.8
181.8
181.8
181.8
181.8
Pv Factor
0.9099
0.8280
0.7534
0.6855
0.6238
0.5676
0.5164
0.4699
0.4276
0.3891
0.3540
0.3221
0.2931
0.2667
0.2427
Pv pmt
204.73
174.70
145.40
124.08
103.54
103.18
93.89
85.43
77.73
70.73
64.36
58.56
53.29
48.49
44.12
BB
1455.31
1374.39
1299.45
1231.10
1171.97
1122.00
1051.28
973.55
888.14
794.26
691.09
577.71
453.10
316.16
165.66
Int
144.08
136.06
128.65
121.88
116.03
111.08
104.08
96.38
87.93
78.63
68.42
57.19
44.86
31.30
16.40
Pmt
225
211
197
181
166
181.8
181.8
181.8
181.8
181.8
181.8
181.8
181.8
181.8
181.8
Principal
80.92
74.94
68.35
59.12
49.97
70.72
77.72
85.42
93.87
103.17
113.38
124.61
136.94
150.50
165.40
Ending
B
1374.39
1299.45
1231.10
1171.97
1122.00
1051.28
973.55
888.14
794.26
691.09
577.71
453.10
316.16
165.66
0.26
36
The above diagram shows the operating lease payments. Macy’s 10k has
operating lease schedule from 2007 till 2011. We used an average for 2012 till
2021 because Macy’s stated that the rest of the lease payments would be
distributed till 2087. The beginning balance in 2007 of 1455.31 is how much the
liabilities and assets have been understated by. This is 4.5% of total assets and
8.41% of total liabilities. The discount rate of 9.9% was reached at by trial and
error method from the lease schedule.
Balance sheet 2006, with and without lease adjustments
original
adjusted
millions
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable
Merchandise inventories
Supplies and prepaid expenses
Assets from discontinued operations
Deferred income tax assets
Total current assets
Long-term assets:
Capital lease rights
Net property and equipment
Goodwill
Other intangible assets, net
Other assets, net
Total Non-Current Assets
Total Assets
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Short-term debt
Accounts payable and accrued liabilities
Income taxes
Deferred income taxes
Liabilities of discontinued operations
Total current liabilities
Long-term liabilities:
Capital lease obligation
millions
1,211
517
5,317
251
126
1,211
517
5,317
251
126
7,422
7,422
11,473
9,204
883
568
22,128
29,550
1,455
11,473
9,204
883
568
23,583
31,005
650
4,944
665
52
48
6,359
650
4,944
665
52
48
6,359
1,455
37
Long-term debt
Deferred income taxes
Other liabilities
Total Non-current Liabilities
Total liabilities
Stockholders Equity
Dividends
Common Stock
Additional paid-in capital
Retained earnings
Treasury Stock
Accumulated other comprehensive income (loss)
Unearned Restricted Stock
Total shareholders' equity
Total Liabilities and Shareholders' Equity
7,847
1,728
1,362
10,937
17,296
7,847
1,728
1,362
12,389
18,748
274
6
9,486
6,375
-3,431
-182
274
6
9,486
6,375
-3,431
-182
12,254
29,550
12,254
31,005
Above is Macy’s 2006 balance sheet including and excluding the capital
leases. By Macy’s using operating leases they are understating their liabilities by
almost 1.5 billion dollars, therefore misleading the value of the firm.
As one can see, Macy’s Inc. utilizes both aggressive and conservative accounting
strategies. For the most part, Macy’s is fairly straightforward about disclosing its
financial information, but there are some circumstances in which this information
can be misinterpreted.
38
Quality of Disclosure
Qualitative
The 10-K is the main source of information disclosed by a company on
how well or bad they have performed in the previous year. Investors and
analysis rely on this source of information so that they evaluate the company
and having an idea whether to invest in the company or not.
Macy’s disclosure on their 10-K is moderate; they excel in some areas and
do a terrible job in other areas. We think that they have because worse in the
management section of the 10-K, for example in the 2002 10k they state that
sales reduced from 16,638 million to 15,651 million and then go on to say why,
because of the events of September 11 and the closing of Stem’s. But when you
get to the 2006 10-K they do not talk about increase in sales.
Macy’s does a good job in showing information about common stock.
Low
High
Dividends
1st quarter
32.37
39.21
0.1250
2nd quarter
32.57
39.69
0.1275
3rd quarter
33.52
45.01
0.1275
4th quarter
36.12
44.86
0.1275
This kind of information is vital to shareholders and investors because it
shows how the stock prices faired in every quarter. However they do not explain
why there was as increase in the 4th quarter.
39
Quantitative
Quantitative analysis is the use of ratios to explain or backup the
performance of a company. Macy’s will be evaluated using sales manipulation
diagnostic ratios and expensive manipulation diagnostic ratios. These ratios will
be used to see if Macy’s numbers add up to what there are supposed to and
eventually identify potential red flags. Since we not only evaluate Macy’s number
but also for the companies in the industry it will help us identify industry trends.
Sales Manipulation Diagnostics
These diagnostic ratios include: net sales/cash from sales, net sales/net
accounts receivable, net sales/inventory, net sales/unearned revenues, net
sales/warranty liabilities. The key measurement in each of theses ratios is the
denominators’ relation to net sales.
Net sales / Cash from sales
1.200
1.000
Macys
0.800
Nordstrom
Saks
0.600
Dillards
Industry
0.400
0.200
0.000
2002
2003
2004
2005
2006
Net sales/ cash from sales
40
The net sales/cash from sales ratio is calculated by dividing the net sales
by (the change in accounts receivable plus the net sales). This ratio should
ideally be equal or close to 1. This ratio tells us that the company is backing up
all they’re sales with money. If the ratio keeps increasing, it means that the
company has lots of sales that are not backed up by any money.
Dillard’s shows a deviation in 2004 because they were using the private
label credit card program. “The private label credit card plan is a plan established
for the primary purpose of providing customer financing for goods and services
purchased from a company,” (Onecle.com). As a result of the private label credit
cards, Dillard’s does not show the accounts receivable for the purchases on those
credit cards.
Macy’s net sales/cash from sales ratio was above 1 in 2002, meaning that
they had a lot of sales not back up by money. “In 2002, Macy’s sold off operation
of Fingerhut companies including Arizona mail order, Figi’s, and popular club plan
business conducted by Fingerhut’s subsidiaries,” (Macys 10-K 2003).
41
Net sales / Net accounts receivables
Net sales / Net accounts receivables
14
12
10
Macy's
Nordstrom
8
Saks
Dillard’s
6
Industry
4
2
0
2002
2003
2004
2005
2006
This ratio is calculated by diving net sales by accounts receivable. Saks
only had accounts receivable for 2002 and 2003, meaning they eliminated their
credit cards and operated on a straight cash basis. Dillard’s however, showed a
drastic increase in the ratio, which is due to the sale of its “credit cards to GE
fiancé charge,” (Dillard’s 10-K). As a result, their accounts receivable reduced on
the books, thus a high ratio. Macy’s jolt increase from 2005 to 2006 is explained
by their acquisition of May’s company. All of their sales were backed up with
cash.
42
Net sales / Inventory
9.000
8.000
7.000
Macy's
6.000
Nordstrom
5.000
Saks
Dillards
4.000
Industry
3.000
2.000
1.000
0.000
2002
2003
2004
2005
2006
Net sales/inventory
This ratio is calculated by dividing the net sales by the inventory. It
evaluates how well a firm uses its inventory to generate revenue. All of the
companies appear to stay very consistent in turning over their inventory. If the
ratios start increasing rapidly it would signify that sales are increasing, but
inventories are decreasing. This would be an indication of manipulation of sales
because there is no way you can increase sales and have nothing to sell.
43
Net sales / unearned revenue
This ratio is calculated by dividing net sales by unearned revenue.
Unearned revenue is when a service or a job is provided and payment is received
at a later date. In the high-end retail industry, sales are backed up by cash of
accounts receivables. Unearned revenue can be a way for a company to
overstate their sales and make it seem like they are doing better than they
actually are.
Macy's
Dillard's
Saks
Nordstrom
2006
39.26
128.16
N/A
N/A
2005
34.82
126.01
N/A
N/A
2004
35.93
N/A
N/A
N/A
2003
37.04
N/A
N/A
N/A
2002
39.17
N/A
N/A
N/A
Net sales / warranty liabilities
“Warranty is an obligation that an article or service sold is factually stated
or legally implied by the seller, and that often provides for a specific remedy such
as repair or replacement,” (Wikipedia). The high-end retail industry does not
offer warranties; the only warranties are backed directly by the manufacture.
44
Sales Manipulation Diagnostics
Net sales / cash from sales
Macy’s
Nordstrom
Saks
Dillard’s
Industry
2002
1.121
0.996
1.008
1.0190
0.784
2003
1.038
1.010
1.005
1.0344
1.021
2004
1.018
0.981
2005
1.014
1.002
2006
1.042
0.999
0.9811
0.993
0.8640
0.96
1.0004
1.013
Net sales / Net accounts receivables
2002
6.579
8.066
4.834
7.586
6.766
2003
5.241
7.878
4.562
5.912
5.898
2004
4.751
10.242
2005
4.494
11.045
2006
8.878
12.075
6.378
7.124
7.7695
10.477
Macy's
Nordstrom
Saks
Dillard’s
Industry
2002
4.636
6.334
0.732
5.221
4.231
2003
4.595
6.269
0.733
4.962
4.140
2004
4.748
7.200
0.659
4.655
4.316
2005
4.923
7.775
0.633
4.344
4.419
2006
4.101
8.078
0.508
4.194
4.220
Net sales / unearned revenue
Macy’s
Nordstrom
Saks
Dillard’s
2002
39.17
N/A
N/A
N/A
2003
37.04
N/A
N/A
N/A
2004
35.93
N/A
N/A
N/A
2005
34.82
N/A
N/A
126.01
2006
39.26
N/A
N/A
128.16
Macy's
Nordstrom
Saks
Dillard’s
Industry
Net sales / inventory
Expense Manipulation Diagnostics
Expense diagnostic ratios, much like revenue diagnostic ratios, provide
ways for analysts and investors to check the numbers reported in a firm’s
financial statements. Expense diagnostic ratios include: Asset Turnover, Change
in CFFO/OI, Change in CFFO/NOA, Total Accruals/Change in Sales, Pension
Expense/SG&A, and Other Expenses/SG&A. In addition, the expense ratios
indicate how well a firm is managing their expenses.
45
Asset turnover
The asset turnover ratio is computed by dividing net sales by the average
of the total assets from the previous and the current year. This ratio is useful
when determining the amount of sales that are generated from each dollar of
assets. Companies with low profit margins tend to have high asset turnover,
while those with high profit margins have low asset turnover. In the retail
industry, companies experience high turnover ratios. This is mainly because of
competitive pricing between stores. (insvestopedia.com) In general, asset
turnover for the industry tends to move together. However, in 2005 there was a
large decline in Macy’s asset turnover compared to its competitors. This is
because of the acquisition of May’s Department Stores, which increased Macy’s
total assets substantially.
46
Cash Flows from Operating Activities / Operating Income
Cash flows from operations refers to the amount of cash a company
generates from the revenues it brings in (wikipedia.org). On the balance
sheet, this is calculated by subtracting a firms expenses from its revenues.
Operating income, also known as EBIT (earnings before interest and taxes),
is found on the income statement. CFFO/OI indicates how a firm’s operating
income matches the cash generated from operations. Looking at the graph,
we can see that CFFO/OI for the industry has been a bit volatile. However,
Macy’s is relatively stable. Macy’s showed a slight decrease in 2003, but this
was due to the closing costs associated with their purchase of Stern’s
Department Store.
47
Cash Flows from Operating Activities / Net Operating Assets
CFFO, again, is the cash that is generated from operating activities and can
be found on the balance sheet. Operating assets would include PPE.
Therefore, CFFO/NOA is a measure of how well a company is utilizing their
PPE in respect to their cash flows from operations. An increase to this ratio
indicates an increase in the firm’s utilization of PPE.
Looking at the graph we can see Macy’s has a high CFFO/NOA, when
compared to the industry. The sharp increase in 2005 is a result of Macy’s
acquisition of May’s Department Stores. With the acquisition of new PPE,
Macy’s experienced an increase in their CFFO. From 2005-2006, we can see
that Macy’s CFFO has been increasing at a higher rate than their PPE. This is
reflected in the increase of Macy’s CFFO/NOA.
48
Total Accruals / Change in Sales
In accrual basis accounting, an accrued expense is a liability resulting from
an expense for which no invoice or other official document is available yet.
Similarly, accrued revenue is an asset resulting from revenue for which no official
document was issued yet (wikipedia.com). Accrual based accounting provides a
more accurate view of a firm’s financial standing at any given time because it
takes into account expenses and revenues that have not actually been paid or
received.
When compared to the industry, Macy’s accrual/change in sales is a bit
above average. This could indicate that Macy’s tends to sell more merchandise
on credit, as opposed to cash sales. However, in the high-end retail industry, it is
common practice for firms to offer company credit cards like a Macy’s card or a
Dillard’s card.
49
Expense Manipulation Diagnostics
M
CFFO/OI
CFFO/NOA
Asset Turnover
Total Accruals/Change in Sales
Pension Expense/ SG&A
2002
1.2428
0.3847
1.0389
-0.3433
2003
0.8697
0.3287
1.047
-0.0724
2004
1.1857
0.4455
1.053
-0.1859
2005
1.0764
0.4696
1.1299
-0.1658
2006
0.8045
0.7632
0.9319
-0.0779
JWN
CFFO/OI
CFFO/NOA
Asset Turnover
Total Accruals/Change in Sales
Pension Expense/ SG&A
2.8408
0.3738
1.4716
-0.1678
1.4687
0.2317
1.4671
-0.1039
1.7162
0.4077
1.5164
-0.17
1.0989
0.4928
1.5723
-0.1054
1.0573
0.6206
1.6213
-0.1071
SKS
CFFO/OI
CFFO/NOA
Asset Turnover
Total Accruals/Change in Sales
Pension Expense/ SG&A
3.5832
0.3804
1.2587
-0.269
1.1853
0.2459
1.2885
-0.1894
2.0243
0.4324
1.3114
-0.2591
1.8475
0.315
1.3756
-0.1844
0.9307
0.2352
1.3918
-0.107
0.3264
1.1426
-0.2482
0.1591
1.1506
-0.349
2.1638
0.256
1.1613
-0.2015
2.2386
0.4439
1.2441
-0.2079
1.4198
0.368
1.349
-0.1213
DDS
CFFO/OI
CFFO/NOA
Asset Turnover
Total Accruals/Change in Sales
Pension Expense/SG&A
50
Potential “Red Flags”
Financial Statements are constructed by people and people make
mistakes. These mistakes are identified as “red flags” to investors. It is not
always clear whether a “red flag” is a result of a common human error or an
attempt at something much more serious, such as fraud. Therefore, it is
essential to catch every extreme fluctuation in the financials that may seem
questionable.
Macy’s 10-K report appears to be very thorough. The final forty-seven
pages are detailed notes of the consolidated financial statements. Included in
these notes is an explanation for an accounting error from their 2004
statements. “During 2004, the Company reviewed its accounting for leases in
accordance with the accounting policies set out above. As a result of this review,
certain errors were identified and were corrected in the fourth quarter of 2004.
Depreciation expense was increased by $42 million and rent expense was
decreased by approximately the same amount, resulting in an insignificant
impact on selling, general and administrative expenses.
Additionally, property and equipment, net was increased by $65 million
and accounts payable and accrued liabilities were increased by approximately the
same amount” (Macy’s 10-K). This is just one example of how Macy’s shows the
ability to go into great detail in their statements and allow investors to easily
understand the changes that they make. Having this much attention to detail of
their past statements also forces them to focus more when they are preparing
their current statements. High attention to detail is a good attribute for Macy’s to
have while preparing their statements because it reduces mistakes (and potential
“red flags”). Dramatic over/understatements of sales and expenses are common
things to key in on while searching for “red flags.” Macy’s has two areas in their
financials that raise question about validity. The 2002 sales / cash from sales
ratio and the 2006 net sales ratios could both be marked as potential “red flags.”
51
Undo Accounting Distortions
As mentioned earlier, one potential “red flag” found in Macy’s financial
statements is from 2002. The sales/cash from sales ratio for 2002 was
abnormally high, insinuating a potential problem. There were no cash receipts to
explain the overstatement of sales for this ratio. However, since the ratios
appeared to be normal for every year after that, we believe that the problem
was discovered and already resolved.
Another potential “red flag” found in the Macy’s financial ratios deals with
the net sales ratios for 2006. The net sales / net accounts receivable ratio
doubles between the years 2005 and 2006. Meanwhile, net sales / unearned
revenue is the other abnormal ratio for this year, as it is constant around 7 for
the previous few years and then jumps to over 12 in 2006. An explanation for
this behavior is a dramatic increase of sales during this time period. However, if
the large increase in net sales was truly the reason for this ratio influx, all of the
net sales ratios would be inflated. This is not the case. Only half of the net sales
ratios seem to be abnormal. The net sales / changes in cash collectibles and net
sales / inventory ratios seem to be perfectly in line with their previous years’
trends. This poses the question, which trends are incorrect?
A closer look at the ratios indicates that the trends are not extremely
abnormal due to net sales, but because of the other components. The net
accounts receivables and the unearned revenues decreased over the year
instead of increasing, as one would anticipate. To double-check this theory, we
look at inventory and cash collectibles to confirm that they both increased in a
similar fashion as net sales. It also is appropriate for the net accounts receivable
and unearned revenue to flow together. Since the net accounts receivables
decreased, it would be expected that the unearned revenue liability would also
decrease.
52
Conclusion
Therefore, we can conclude that there is nothing wrong with the financial
ratios for Macy’s for 2006; they simply just had more cash transactions. After
looking deep into Macy’s financial statements, it is apparent that each of the
potential “red flags” is easily explained and in fact, normal.
53
Ratio Analysis
The primary goal of ratio analysis is to measure the performance of a
company relative to its main competitors in a particular industry. The value of a
firm is determined mainly by its profitability and growth. In addition, ratios are
useful for evaluating how the firm will perform in the future. The three main
types of ratios are liquidity, profitability, and capital structure. Ratio analysis also
provides useful information on how key components of a company’s financial
statement relate to one another.
Liquidity Analysis
Liquidity ratios are used to show how easy (or difficult) it is for a firm to
pay off short-term debt. Generally, a firm with a higher ratio value will be able to
cover short-term debts with a larger margin of safety than a company with a
smaller ratio (www.investopedia.com). The most common liquidity ratios that we
will discuss in regards to Macy’s include: Current Ratio, Quick Asset Ratio,
Inventory Turnover, Days Supply Inventory, Receivables Turnover, Days Sales
Outstanding, and Working Capital Turnover. It is important for investors to be
educated on these ratios to better understand the companies that they are
investing in. The higher the ratio, the better off the investor is.
Current Ratio
The current ratio is a measurement of a company’s ability to pay short
term obligations, such as loans and lease payments. The current ratio is
favorable for a company when it is greater than one and less than two. Macy’s
Current Ratio is the lowest in its industry. This illustrates that Macy’s is not nearly
as liquid as the other companies that it is competing against. Another trend to
take notice of in this graph is Macy’s yearly trend. Not only are they the least
liquid in the industry, but they are on a downward slope, getting less liquid each
54
year. Investors should beware of Macy’s increasing dominance of current
liabilities over its current assets.
Quick Asset Ratio
The quick asset ratio is a measure of how effective a company is in paying
off its current debt obligations by using its most liquid and current assets. The
quick asset ratio is also a good indicator of a company’s short term liquidity. In
order for this ratio to be beneficial to the company, the ratio must be greater
than or equal to one. This formula can be calculated by taking the sum of the
quick assets: cash, securities, and accounts receivable, and then dividing this by
the current liabilities.
Macy’s quick asset ratio has declined sharly from 2004 to 2006. In 2002
Macy’s quick asset ratio was in stable and good financial condition, but has
recently decreased due to either an increase in current liabilities or a decrease in
quick assets. Furthermore, Macy’s quick asset ratio was close to the industrial
average from 2002 to 2004, but has fallen far below this average in 2006. This is
definitely an area that Macy’s upper management should work on improving.
55
Quick Asset Ratio
2
Macy's
1.5
Saks
Dillards
1
Nordstrom
0.5
0
Industry Average
2002
2003
2004
2005
2006
Macy's
1.05
1.09
1.02
0.62
0.33
Saks
0.77
0.61
0.6
0.99
0.54
Dillards
1.73
1.04
0.54
0.3
0.28
Nordstrom
1.23
1.28
1.23
1.18
1.2
Industry
A
1.24
0.98
0.79
0.82
0.67
Receivables Turnover
The accounts receivable turnover ratio is an important measurement of
how efficient a company utilizes its assets, especially accounts receivable. It is
also a determinant of how effective the company is in collecting debt. The ratio
is computed by dividing the sales by the accounts receivable. The higher this
ratio, the more profitable it is for the company.
Macy’s accounts receivable ratio stayed about the same from 2002 to
2005, until it rose significantly in 2006 from 8% all the way up to nearly 52%.
With exception of 2006, Macy’s accounts receivable ratio stayed fairly close to
the industry average. When computing our accounts receivable ratios for our
competitors, we noticed that Saks did not report accounts receivable on their
balance sheet. Therefore, we did not include them in this ratio. The receivables
turnover ratio is extremely inconsistent in the high-end retail industry. The ratio
56
tends to fluctuate significantly from one year to the next. This ratio is not as
relevant in this industry compared to other ratios.
In addition, Dillard’s receivable turnover ratio was significantly higher
than all the other firms. Overall, it appears that Macy’s has a respectable
accounts receivable turnover ratio compared to its competitors.
Receivables Turnover
800
Macy's
600
Saks
Dillards
400
Nordstrom
200
0
Industry Average
2002
2003
2004
2005
2006
5.24
4.75
4.57
8.88
52.17
0
0
0
0
0
Dillards
5.91
6.38
Nordstrom
7.86
10.24
Industry
A
6.89
8.31
Macy's
Saks
780.08 603.70 726.69
11.04
12.07
12.5
395.56 307.89 369.60
Days Sales Outstanding
Days sales outstanding is a method of determining the amount of days it
takes for a company to collect revenue after a sale has been made. The smaller
this number, the better it is for the company because it means that they are
collecting revenue from their customers on a timely basis. This figure can be
higher for companies that sell products, which require payments over a long time
period.
After analyzing Macy’s and it competitors, there are several conclusions
that can be drawn from the data. For instance, from 2002 to 2005 Macy’s day’s
57
sales outstanding ratio was significantly higher than its competitors. However, in
2006 this number suddenly dropped by almost 34 days and fell below the
industrial average. This can be attributed to a policy change in the way Macy’s
collects revenue after a sale has been made. This substantial decrease in the
day’s sales outstanding has a favorable impact on Macy’s.
Days Sales Outstanding
100
Macy's
80
Saks
60
Dillards
40
Nordstrom
20
Industry Average
0
2002
2003
2004
2005
2006
69.66
76.84
79.87
41.1
7
0
0
0
0
0
61.74
57.23
0.47
0.61
0.50
Nordstrom 45.58
53.66
Industry
A
36.25
33.04
28.52
28.32
46.74
16.75
14.56
14.41
Macy's
Saks
Dillards
Inventory Turnover
“The inventory turnover ratio reveals how many times a company’s
inventory is sold and replaced over a period,” (www.investopedia.com). This
ratio is calculated by dividing the cost of goods sold by the inventory of a
company. The higher this ratio is the better because it means that inventory is
being sold and restored. Having a large amount of inventory can be harmful to a
company because as inventory sits in storage it can deteriorate. In addition, as
inventory accumulates, it will cause profits to decrease due to the seasonality of
58
this industry. For instance, as a company’s merchandise becomes outdated, the
prices for the products are discounted. Therefore, this negatively impacts the
profitability of a company.
Macy’s inventory turnover has been relatively low compared to its
competitors. However, this ratio has been gradually increasing for Macy’s over
the past five years, with exception to 2005.
Inventory Turnover
6
5
Macy's
4
Saks
3
Dillards
2
Nordstrom
1
Industry Average
0
2002
2003
2004
2005
2006
Macy's
2.76
2.83
2.98
2.43
3.01
Saks
2.86
2.59
2.64
4.64
2.3
Dillards
3.30
3.17
2.90
2.78
2.84
Nordstrom
4.26
4.43
4.95
5.11
5.32
Industry
A
3.47
3.40
3.50
4.18
3.49
Days Supply of Inventory
The days’ supply of inventory ratio is used to determine how many days
inventory sits in storage or on the shelves. This figure often varies depending on
the time of year, especially in the retail departmental industry. To calculate this
formula, you divide 365 days by the inventory turnover.
Macy’s days’ supply of industry in recent years has ranged from 121 days
to 150 days. This number is higher than the industrial average, but has not
59
necessarily been the highest during this time period. For instance, competitors
such as Saks and Dillard’s have also had high days’ supply of inventory.
Days Supply Inventory
200
Macy's
150
Saks
Dillards
100
Nordstrom
50
0
Industry Average
2002
2003
2004
2005
2006
Macy's
132.25 128.98 122.48 150.21 121.26
Saks
127.62 140.93 138.26 78.66
Dillards
110.76 115.24 126.06 131.23 128.54
Nordstrom
Industry
A
87.21
82.56
73.52
71.42
158.7
71.54
108.53 112.91 112.61 93.77 119.59
Working Capital Turnover
“The working capital turnover ratio is used to analyze the relationship
between the money used to fund operations and the sales generated from these
operations.” (www.investopedia.com) Working capital is current assets minus
current liabilities. In order to find the working capital turnover, you take sales
and divide it by working capital. “Therefore, a higher working capital ratio means
that the company is generating more sales than the amount of money that is
required to fund these sales.” (www.investopedia.com)
After evaluating Macy’s working capital turnover it appears that this ratio
has decreased drastically from 2002 to 2003 and then has leveled off. In 2006,
the working capital ratio for Macy’s was 4.34. Therefore, it is producing $4.34 in
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sales for every dollar of working capital. This particular number is the lowest out
of all of its competitors.
Working Capital Turnover
30
25
Macy's
20
Saks
15
Dillards
10
Nordstrom
Industry Average
5
0
2002
2003
2004
2005
2006
Macy's
25.37
8.76
4.87
4.28
4.34
Saks
5.26
5.62
5.65
7.45
7.58
Dillards
3.53
4.50
6.03
7.54
7.13
Nordstrom
5.09
5.38
5.77
6.2
6.4
Industry
A
4.63
5.17
5.82
7.06
7.04
Conclusion
After analyzing Macy’s liquidity ratios, it is apparent that Macy’s is not a liquid
firm compared to most of its competitors. For instance, it falls short of its
competitors in areas such as current ratio and quick asset ratio. In order for a
company to be successful in the retail industry it is important that they are as
liquid as possible.
Profitability Analysis
The main goal of profitability ratios is to determine how well a company is
performing in terms of profit. The profitability ratios consist of gross profit
margin, operating profit margin, net profit margin, asset turnover, return on
assets, and return on equity. We have analyzed Macy’s profitability ratios and
have compared them to it competitors.
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Gross Profit Margin
The gross profit margin provides us with information concerning the
amount of money left over after accounting for the cost of goods sold. Gross
profit margin also functions as a tool to determine the amount of money left to
pay for future expenses. Therefore, it is a good indication of the financial health
of a company. Macy’s gross profit margin has remained fairly constant over the
last five years, ranging from 40 to 41%. For the most part, gross profit margin
should not change too much from year to year, unless there are drastic changes
that will severely impact the cost of goods sold. Furthermore, the gross profit
margin for Macy’s has been relatively higher than its competitors signaling that it
financial health is in good standing.
Gross Profit Margin
0.42
0.4
Macy's
0.38
Saks
0.36
Dillards
0.34
Nordstrom
0.32
Industry Average
0.3
2002
2003
2004
2005
2006
0.4
0.4
0.41
0.41
0.4
Saks
0.37
0.38
0.38
0.37
0.39
Dillards
0.34
0.32
0.33
0.34
0.34
Nordstrom
0.34
0.35
0.36
0.37
0.37
Industry
A
0.35
0.35
0.36
0.36
0.37
Macy's
Operating Profit Margin
The operating profit margin is a useful percentage, which reveals the
amount of money a company has remaining after paying for variable costs
associated with maintaining a business such as wages and raw materials. It is
calculated by dividing the operating income by net sales. This ratio gives us
62
information about the efficiency of a company and is also useful for determining
the amount of money a company has left over to pay for fixed costs. The higher
the percentage is for the gross profit margin, the more profitable it is for the
corporation. After analyzing Macy’s gross profit margin, it is apparent that their
gross profit margin is significantly higher than its competitors. However, over the
last few years the margin percentage has declined slightly.
Operating Profit Margin
0.150
Macy's
0.100
Saks
Dillards
0.050
Nordstrom
0.000
-0.050
Industry Average
2002
2003
2004
2005
2006
Macy's
0.087
0.088
0.090
0.110
0.068
Saks
0.039
0.038
0.03
0.034
-0.007
Dillards
0.02
0.001
0.023
0.017
0.033
Nordstrom
0.02
0.05
0.08
0.09
0.11
Industry
A
0.027
0.030
0.044
0.047
0.045
Net Profit Margin
The net profit margin is a valuable measurement when analyzing a
company. “It basically tells you the amount of profit a company makes from
every dollar of revenue it generates,” (invetopedia.com). It is calculated by
taking net income divided by sales. The net profit margin is a key indicator of
63
how profitable a company is in its particular industry. A high net profit margin is
always favorable because it reveals that the company is generating more profit.
If a company reports a low net profit margin it could be a result of price
competition between the company and its competitors.
Macy’s net profit margin has remained fairly consistent over recent years
and continues to be higher than most of competitors. The only competitor that
competes with Macy’s in regards to net profit margin is Nordstrom’s.
Net Profit Margin
0.1
Macy's
0.05
Saks
Dillards
0
Nordstrom
-0.05
-0.1
Industry Average
2002
2003
2004
2005
2006
Macy's
0.05
0.05
0.04
0.06
0.04
Saks
0.004
0.01
0.01
0.004
0.02
Dillards
-0.05
0.001
0.016
0.016
0.032
Nordstrom
0.02
0.04
0.05
0.07
0.04
Industry
A
-0.01
0.02
0.03
0.03
0.03
Asset Turnover
Asset turnover is a ratio that evaluates how efficient a firm is in utilizing
its assets to generate sales. It is calculated by taking sales and dividing it by total
assets. In addition, it can also be a good indicator of pricing strategy. For
example, “If a company has high profit margins it will most likely have low asset
64
turnover,” (investopedia.com). In most cases the higher the asset turnover, the
more favorable it is for the company.
After analyzing Macy’s asset turnover ratio, it is obvious that their ratio is
significantly lower than it competitors. From 2004 to 2005 there was a notable
drop in asset turnover, but recovered slightly in 2006. This is one area of the
profitability analysis where Macy’s suffers compared to its competitors.
Asset Turnover
2
Macy's
1.5
Saks
Dillards
1
Nordstrom
0.5
0
Industry Average
2002
2003
2004
2005
2006
Macy's
1.07
1.05
1.05
0.68
0.91
Saks
1.29
1.3
1.37
1.55
1.16
Dillards
1.19
1.19
1.32
1.37
1.41
Nordstrom
1.46
1.45
1.54
1.57
1.78
Industry
A
1.31
1.31
1.41
1.50
1.45
Return on Assets
Return on assets is useful for determining how efficient a company is in
using its assets to generate income. Therefore, it is computed by taking the net
income from the current year and dividing by the total assets from the previous
year. This formula is also used to help calculate the sustainable growth rate and
the internal growth rate. The higher the return on assets, the better it is for a
company because they are earning more return on their investments.
65
Macy’s return on assets is average compared to the competitors in its
industry. It remained constant at 5% from 2002 to 2004 until it increased to 9%
in 2005. However, in 2006 it declined significantly all the way to 3%. As one can
see, the return on assets ratio for Macy’s has fluctuated in the past few years,
but it still remains competitive in it industry.
Return on Assets
0.15
Macy's
0.1
Saks
0.05
Dillards
0
Nordstrom
Industry Average
-0.05
-0.1
2002
2003
2004
2005
2006
Macy's
0.05
0.05
0.05
0.09
0.03
Saks
0.005
0.018
0.013
0.005
0.014
Dillards
-0.06
0.001
0.02
0.02
0.05
Nordstrom
0.02
0.05
0.08
0.11
0.14
Industry
A
-0.01
0.02
0.04
0.05
0.07
Return on Equity
Return on equity is key indicator of how profitable a company is in regards
to the money that has been invested by shareholders. It is calculated by taking
the net income and dividing it by the total equity.
Macy’s return on equity figures are higher than the majority of it
competitors. This is extremely favorable to the company because this means that
they are efficiently using the funds invested by shareholders. Even though the
66
return on equity percentage has fluctuated over the last five years, it still
remains near the top of its competition.
Return on Equity
0.3
Macy's
0.2
Saks
0.1
Dillards
0
Nordstrom
Industry Average
-0.1
-0.2
2002
2003
2004
2005
2006
Macy's
0.15
0.12
0.12
0.23
0.07
Saks
0.011
0.037
0.026
0.011
0.027
Dillards
-0.18
0.004
0.05
0.05
0.10
Nordstrom
0.09
0.19
0.24
0.25
0.08
Industry
A
-0.03
0.08
0.11
0.10
0.07
Conclusion
After evaluating Macy’s profitability ratios, it is evident that they have
been extremely productive over the last five years. The only concern to the
company may be the asset turnover ratio. Otherwise, the company looks to be in
good financial shape and the future looks relatively optimistic for the company.
Capital Structure Analysis
The capital structure analysis is very important when valuing a firm,
because it shows how assets are financed through the combination of the debt
and equity on the balance sheet. We conducted our capital structure analysis by
calculating the Debt to Equity Ratio, Times Interest Earned, and the Debt Service
Margin for Macy’s as well as three of its competitors.
67
Debt to Equity Ratio
The Debt to Equity Ratio is used to calculate the proportion of debt to
equity a firm uses to finance its assets. This is also known as “financial
leverage.” (www.investopedia.com). It is calculated by dividing the total
liabilities of a firm by the total owner’s equity. The D/E Ratio is extremely
important to investors and other lending institutions because it assesses the
credit risk of a firm.
For the past five years the high end retail industry has averaged a D/E
ratio between 1.27 and 1.67. Saks has shown the best D/E ratio in the past with
a low at .93, but they have seen some inconsistencies in the last few years with
their ratio jumping around. Both Dillard’s and Nordstrom’s have been able to
consistency decrease their D/E ratio over the last few years, which shows a
switch from debt to equity financing. Macy’s has stayed relatively consistent with
the industry average, only varying .10 over the last five years. They have been
68
able to lower their D/E ratio which shows they have been able to rely less on
debt financing, decreasing their credit risk, and making them a healthier firm.
Times Interest Earned
The Times Interest Earned ratio is very important to a firm because it
shows how well the firm's earnings are able to cover the required interest
expense. It is calculated by dividing Income from Operations by the Interest
expense for a given year. A financially healthy firm will have more than
sufficient income to cover its annual interest expense, resulting than a higher
than average ratio. A good benchmark for times interest earned ratio is 3 or
slightly better.
From an industry standpoint the average for the high end retail falls
between 2 and 4 which is a healthy average. Macy’s has one of best times
interest earned ratios, staying above 4 for the last 5 years. A high income from
operations and a relatively low interest expense allows Macy’s to cover its
interest expense with money left over to fund its other operations. Dillard’s had
69
the lowest ratio due to exceptionally low operating income in 2003, and large
amounts of interest expense for all five years.
Debt Service Margin
A firm’s Debt Service Margin ratio is important because it measures the
capability of the cash provided by operations to cover the required annual debt
service. It is calculated by dividing the cash flows from operations of the current
year, by the notes payable of the previous year. The higher the margin of a
particular firm, the better the firm is able to retire its long term debt.
For our analysis, inconsistencies with Saks debt service margin caused our
industry average to vary to some degree. This was caused by extremely low
levels of notes payable for years 2001, 2003, and 2004. Because of this, the lack
accuracy of the industry average must be accounted for when comparing to
Macy’s. Nevertheless, Macy’s has the lowest debt service margin of the four
companies we calculated. This is a good indication that the firm is having
70
difficulty covering its long term debt. However the industry trend from 2005 to
2006 was a decreasing debt service margin, while Macy’s saw a dramatic
increase (nearly quadrupling). Hopefully this is a tendency that will increase in
the years to come.
Internal Growth Rate
The internal growth rate (IGR) of a firm determines the sustainable growth
rate a firm can achieve through internal financing only. In other words, the firm
would be seeking to finance future projects with funds from internal operations
as opposed to financing with debt through banks or any other financial
institutions. Macy's IGR of 2.17% is relatively low the industry average of 8.62%.
However, the industry average is deceiving because Nordstrom's IGR has been
increasing at a very high rate over the past few years. Macy's actually fares
better than its competitors Dillard’s and Saks. This shows that Macy's has been
maintaining a steady balance between internal and external financing.
IGR
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
Macy's
Macy's
Saks
Dillards
Nordstrom
Industry Average
2002
6%
2003
2004
2005
2006
4.50% 4.33% 3.55% 2.17%
Saks
0.50% 2.00% -3.25% 0.50% -1.89%
Dillards
-5.80% -0.10% 1.60% 1.90% 4.20%
Nordstrom 4.61% 13.24% 17.21% 21.36% 23.56%
Industry
Average
-0.23% 5.05% 5.19% 7.92% 8.62%
71
Sustainable Growth Rate
The sustainable growth rate (SGR) is the level growth a firm can maintain
without having to finance projects with new debt. This is very similar to the IGR
however, they differ in one respect and that is that the SGR is a measure of
sustainability. Macy's SGR is measured at 5.23%, which is low compared to the
industry average of 10.04%. The SGR is also a prime determinant of profitability
as well. This is because if the firm has to finance future projects through the use
of new debt they will have more obligations to pay and therefore making them
less profitable. Perhaps one reason that Macy's has been experiencing low IGR
and SGR rate is because of the acquisition of the May's Department Stores.
SGR
30.00%
20.00%
Macy's
10.00%
Saks
Dillards
0.00%
Nordstrom
Industry Average
-10.00%
-20.00%
2002
2003
2004
2005
2006
Macy's
15.06% 11.03% 10.44% 8.70% 5.23%
Saks
1.01% 4.00% -7.35% 0.97% -4.39%
Dillards
-15.40 -0.20% 4.70% 4.70% 10.00%
Nordstrom 5.70% 14.45% 19.12% 23.42% 24.50%
Industry
Average
-2.90% 6.08% 5.49% 9.70% 10.04%
72
Conclusion
The analysis of a firm’s capital structure is very important because it
shows how assets are financed through the combination of the debt and equity
on the balance sheet. Compared to the industry, Macy’s Debt to Equity ratio was
right in line with the average. However, Macy’s was able to separated itself from
the competition in the times interest earned ratio because of its large cash flows
and low interest expenses. Where Macy’s faltered was in its Debt Service Margin.
The analysis showed that Macy’s is currently having trouble covering its long
term debt. These three different ratios, as compared to the industry averages,
show that Macy’s strength lies in keeping its interest expenses low while
increasing its cash flows.
Forecasting Financial Statements
Forecasting financial statements of a firm helps us see where the firm will
be in the future in terms of financial health. We evaluate historical values from
the firm’s current and past statements and use those to give us an idea of where
the firm will be in the future. To do this, we first put together Macy’s financial
statements from the past five years using the 10-K. Then, applied that data to
forecast out the next 10 years in order to see what kind of trend Macy’s would
have. We calculated an average of the important accounts and made a few
assumptions to forecast Macy’s income statement. To forecast the cash flow
statement, we took ratios of CFFO/NI, CFFO/SALES, and CFFO/OI and use the
ratio that shows the most consistency. We forecasted the balance sheet by using
Macy’s current ratio, asset turnover ratio, and the inventory turnover ratio.
73
Income Statement
The income statement is considered the most accurate financial statement
because it has the least assumptions to be made. Since Macy’s released its 10-K
for the period ended February 03, 2007, they already have a 10-Q published for
the first quarter. We were able to use this document as a guideline while
forecasting.
We began by calculating an average of the sales growth over the last five
years, but when we did, we discovered there was a great level of inconsistency.
There was negative growth in 2002 and 2003, and then in 2005 and 2006,
growth shot up to 43% and 20%, respectively. Due to this, we felt that an
average would not depict an accurate measurement. Therefore, we researched
Macy’s 10-K to explain what happened to sales during those years. In 2005,
”Macy’s completed a merger and acquired May’s approximately 500 department
stores and approximately 800 bridal and formalwear stores,” (Macy’s 10-K). This
transaction explains the increase in sales. Since the merger is a one-time thing,
we do not expect sales to keep growing at a high rate of 43% every year. We
averaged the sales growth of the other firms in the industry and then made an
assumption more specific to Macy’s and came up with a sales growth of 10.71%.
74
Macys Inc
Actual Financial statements
As Reported Annual Income Statement
2002
2003
2004
2005
2006
2/2/2002
2/1/2003
1/31/2004
1/29/2005
1/28/2006
2/3/2007
Millions
Millions
Millions
Millions
Millions
Millions
Net sales
Total cost of sales
Gross margin (loss)
Forecast Financial Statements
2001
ASSUME
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
15,651
15,435
15,264
15,630
22,390
26,970
10.71%
$29,858
$33,056
$36,597
$40,516
$44,855
$49,659
$54,978
$60,866
$67,385
$74,602
$82,592
9,584
9,255
9,099
9,297
13,272
16,019
59.83%
$17,864
$19,778
$21,896
$24,241
$26,837
$29,711
$32,893
$36,416
$40,316
$44,634
$49,415
6,165
6,333
9,093
10,773
40.17%
$11,994
$13,279
$14,701
$16,275
$18,018
$19,948
$22,085
$24,450
$27,069
$29,968
$33,177
-
-
Selling, general & administrative expenses
4,801
4,837
4,824
4,933
6,980
8,678
31.42%
$9,382
$10,386
$11,499
$12,730
$14,094
$15,603
$17,274
$19,124
$21,172
$23,440
$25,950
Operating income (loss)
1,104
1,343
1,341
1,400
2,424
1,836
8.52%
$2,544
$2,816
$3,118
$3,452
$3,822
$4,231
$4,684
$5,186
$5,741
$6,356
$7,037
321
301
257
231
438
563
1.89%
$564
$625
$692
$766
$848
$939
$1,039
$1,150
$1,274
$1,410
$1,561
3.74%
$1,117
$1,236
$1,369
$1,515
$1,678
$1,857
$2,056
$2,276
$2,520
$2,790
$3,089
Interest on debt
Interest on capitalized leases
-6
-6
-6
-5
-5
-6
Interest expense, gross
334
312
266
299
423
466
Interest expense
331
311
266
299
422
451
Interest income
Income (loss) fr cont opers bef income
taxes
7
16
9
15
42
61
780
1,048
1,084
1,116
2,044
1,446
Total income tax expense-federal
212
336
367
380
581
406
50
74
24
47
90
52
Federal, state & local income tax expense
262
410
391
427
671
458
Income (loss) from continuing operations
Discontinued operations, net of income
taxes
518
638
693
689
1,373
988
33
7
689
1,406
995
Total income tax expense-state & local
Net income (loss)
-
-276
-
-
818
693
0.1071
Actual financial statements
Forecast Financial Statements
Common Sized Income Statement
2001
2002
2003
2004
2005
2006
-1.380%
-1.108%
2.398%
43.250%
20.456%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
61.24%
59.96%
59.61%
59.48%
59.28%
59.40%
40.39%
40.52%
40.61%
39.94%
Sales growth Percent
Net sales
Total cost of sales
Gross margin (loss)
Selling, general & administrative expenses
Average
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
31.85%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
59.83%
30.68%
31.34%
31.60%
31.56%
31.17%
32.18%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
31.42%
Operating income (loss)
7.05%
8.70%
8.79%
8.96%
10.83%
6.81%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
8.52%
Interest on debt
2.05%
1.95%
1.68%
1.48%
1.96%
2.09%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
1.89%
3.74%
3.740%
3.740%
3.740%
3.740%
3.740%
3.740%
3.740%
3.740%
3.740%
3.740%
3.740%
Interest on capitalized leases
-0.04%
-0.04%
-0.04%
-0.03%
-0.02%
-0.02%
Interest expense, gross
2.13%
2.02%
1.74%
1.91%
1.89%
1.73%
Interest expense
2.11%
2.01%
1.74%
1.91%
1.88%
1.67%
Interest income
Income (loss) fr cont opers bef income
taxes
2.11%
2.01%
1.74%
1.91%
1.88%
1.67%
4.98%
6.79%
7.10%
7.14%
9.13%
5.36%
Total income tax expense-federal
1.35%
2.18%
2.40%
2.43%
2.59%
1.51%
Total income tax expense-state & local
0.32%
0.48%
0.16%
0.30%
0.40%
0.19%
Federal, state & local income tax expense
1.67%
2.66%
2.56%
2.73%
3.00%
1.70%
Income (loss) from continuing operations
Discontinued operations, net of income
taxes
3.31%
4.13%
4.54%
4.41%
6.13%
3.66%
0.15%
0.03%
-1.76%
5.30%
4.54%
4.41%
6.28%
3.69%
Net income (loss)
75
The next line item to be forecasted was the cost of goods sold. We used
an average from the common sized income statement and came up with 59.83%
of net sales each year. The common sized income statement is very important as
it helps us see everything as a percentage of sales. We felt this was fair because
the growth of cost of goods sold has been increasing steadily at this rate over
the past five years. After that, we subtracted the forecasted sales from the cost
of goods sold to get the gross profit. We also used the common sized income
statement to forecast the SG&A expenses, operating profit, interest expense, and
net income. We did not forecast every line item on the income statement
because not every measurement is able to be forecasted, such as taxes.
Balance Sheet
We began by computing the ratios that are directly linked to the balance
sheet and eliminated the ones we believed to be irrelevant. We then used the
inventory turnover, accounts receivable turnover, asset turnover, and current
ratios.
The asset portion of the balance sheet was examined first. In order to
forecast cash and cash equivalents, total current assets, and net property and
equipment, we averaged years 2001-2006 in each category to come up with a
percentage rate. The next item inspected was the accounts receivable turnover
ratio. For this ratio, we computed a value of 5.86, which allowed us to forecast
the accounts receivable account. We then moved on to the inventory turnover
ratio so we could forecast the inventories account. We calculated our inventory
turnover ratio at 3.01, which is not far behind the industry average of 3.37. The
main estimation we focused on for the asset section was the asset turnover
ratio. This ratio is a prime indication of how well a firm is utilizing their assets
and links the balance sheet to the income statement through net income. We
determined our asset turnover to be 0.91; which by industry standards, is low
considering the industry average is around 1.32.
76
Macys Inc
Actual financial statements
As Reported Annual Balance Sheet
forecast financial statements
2001
2002
2003
2004
2005
2006
2/2/2002
2/1/2003
1/31/2004
2/1/2005
2/1/2006
2/3/2007
Millions
Millions
Millions
Millions
Millions
Millions
ASSUME
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
ASSETS
Current assets:
Cash and cash equivalents
636
716
925
868
248
1,211
4.35%
1,427
1,580
1,749
1,937
2,144
2,374
2,628
2,910
3,221
3,566
3,948
Accounts receivable
2,379
2,945
3,216
3,418
2,522
517
5.86
5,095
5,641
6,245
6,914
7,655
8,474
9,382
10,387
11,499
12,731
14,094
Merchandise inventories
3.01
5,935
6,571
7,274
8,053
8,916
9,871
10,928
12,098
13,394
14,829
16,417
3,376
3,359
3,215
3,120
5,459
5,317
Supplies and prepaid expenses
124
124
99
104
203
251
Assets from discontinued operations
744
1,713
126
Deferred income tax assets
Total current assets
21
10
7,280
7,154
7,455
7,510
10,145
7,422
42.29%
13,876
15,362
17,007
18,829
20,845
23,078
25,550
28,286
31,315
34,669
38,382
40.66%
13,341
14,770
16,352
18,103
20,042
22,189
24,565
27,196
30,108
33,333
36,903
Long-term assets:
6,506
6,379
6,174
6,018
12,034
11,473
Goodwill
Net property and equipment
508
262
262
260
9,520
9,204
Other intangible assets, net
683
378
378
378
1,080
883
Other assets, net
575
268
284
719
389
568
8,272
7,287
7,098
7,375
23,023
22,128
15,552
14,441
14,553
14,885
33,168
29,550
Total Non-Current Assets
Total Assets
18,936
20,964
23,209
25,694
28,446
31,493
34,866
38,600
42,734
47,311
52,378
0.91
32,812
36,326
40,216
44,523
49,292
54,571
60,415
66,886
74,049
81,980
90,760
1.17
11,860
13,130
14,536
16,093
17,817
19,725
21,837
24,176
26,765
29,632
32,806
19,723
22,292
25,113
28,213
31,621
35,370
39,496
44,037
49,038
54,547
60,617
282
291
299
308
318
327
337
347
358
368
379
7,209
8,155
9,224
10,431
11,791
13,321
15,041
16,970
19,133
21,554
24,264
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Short-term debt
1,012
946
908
1,242
1,323
650
Accounts payable and accrued liabilities
2,645
2,584
2,613
2,707
5,246
4,944
57
71
362
352
Income taxes
454
665
Deferred income taxes
103
52
Liabilities of discontinued operations
464
48
7,590
6,359
Total current liabilities
3,714
3,601
3,883
4,301
Long-term debt
3,859
3,408
3,151
2,637
8,860
7,847
Deferred income taxes
1,345
998
998
1,199
1,704
1,728
Long-term liabilities:
Other liabilities
1,070
672
581
581
1,495
1,362
Total Non-current Liabilities
6,274
5,078
4,730
4,417
12,059
10,937
Total liabilities
9,988
8,679
8,613
8,718
19,649
17,296
Dividends
0
0
68
92
164
274
Common Stock
3
3
2
2
3
6
9,486
Stockholders Equity
Additional paid-in capital
5,098
5,106
3,880
3,124
9,241
Retained earnings
2,367
3,185
3,809
4,405
5,654
6,375
-1,881
-2,252
-1,477
-1,322
-1,091
-3,431
Accumulated other comprehensive income (loss)
-12
-273
-270
-40
-288
-182
Unearned Restricted Stock
-11
-7
-4
-2
Treasury Stock
Total shareholders' equity
Total Liabilities and Shareholders' Equity
3%
5,564
5,762
5,940
6,167
13,519
12,254
13,088
14,034
15,103
16,310
17,670
19,200
20,920
22,849
25,012
27,433
30,143
15,552
14,441
14,553
14,885
33,168
29,550
32,812
36,326
40,216
44,523
49,292
54,571
60,415
66,886
74,049
81,980
90,760
77
Macy's Common Sized Balance Sheet
Actual financial statements
Forecasted Financial Statements
2,007
2008
2009
2010
2011
2012
2013
2014
2015
2016
ASSETS
Current assets:
Cash and cash equivalents
4.09%
4.96%
6.36%
5.83%
0.75%
4.10%
4.35%
4.35%
4.35%
4.35%
4.35%
4.35%
4.35%
4.35%
4.35%
4.35%
4
Accounts receivable
15.30%
20.39%
22.10%
22.96%
7.60%
1.75%
4.35%
15.53%
15.53%
15.53%
15.53%
15.53%
15.53%
15.53%
15.53%
15.53%
15.53%
15
Merchandise inventories
18.09%
18.09%
18.09%
18.09%
18.09%
18.09%
18.09%
18.09%
18.09%
18.09%
18
21.71%
23.26%
22.09%
20.96%
16.46%
17.99%
Supplies and prepaid expenses
0.80%
0.86%
0.68%
0.70%
0.61%
0.85%
Assets from discontinued operations
4.78%
0.00%
0.00%
0.00%
5.16%
0.43%
Deferred income tax assets
0.14%
0.07%
0.00%
0.00%
0.00%
0.00%
46.81%
49.54%
51.23%
50.45%
30.59%
25.12%
42.29%
42.29%
42.29%
42.29%
42.29%
42.29%
42.29%
42.29%
42.29%
42.29%
42.29%
42
40.66%
40.66%
40.66%
40.66%
40.66%
40.66%
40.66%
40.66%
40.66%
40.66%
40.66%
40
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100
36.15%
36.15%
36.15%
36.15%
36.15%
36.15%
36.15%
36.15%
36.15%
36.15%
36
0.66
0.67
Total current assets
Long-term assets:
Net property and equipment
41.83%
44.17%
42.42%
40.43%
36.28%
38.83%
Goodwill
3.27%
1.81%
1.80%
1.75%
28.70%
31.15%
Other intangible assets, net
4.39%
2.62%
2.60%
2.54%
3.26%
2.99%
Other assets, net
3.70%
1.86%
1.95%
4.83%
1.17%
1.92%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
Total Assets
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Short-term debt
Accounts payable and accrued liabilities
Income taxes
6.51%
6.55%
6.24%
8.34%
3.99%
2.20%
17.01%
17.89%
17.96%
18.19%
15.82%
16.73%
0.37%
0.49%
2.49%
2.36%
1.37%
2.25%
Deferred income taxes
0.31%
0.18%
Liabilities of discontinued operations
1.40%
0.16%
Total current liabilities
23.88%
24.94%
26.68%
28.89%
22.88%
21.52%
Long-term liabilities:
Long-term debt
24.81%
23.60%
21.65%
17.72%
26.71%
26.55%
Deferred income taxes
8.65%
6.91%
6.86%
8.06%
5.14%
5.85%
Other liabilities
6.88%
4.65%
3.99%
3.90%
4.51%
4.61%
Total liabilities
64.22%
60.10%
59.18%
58.57%
59.24%
58.53%
Dividends
0.00%
0.00%
0.47%
0.62%
0.49%
0.93%
Common Stock
0.02%
0.02%
0.01%
0.01%
0.01%
0.02%
Additional paid-in capital
32.78%
35.36%
26.66%
20.99%
27.86%
32.10%
Retained earnings
15.22%
22.06%
26.17%
29.59%
17.05%
21.57%
-12.09%
-15.59%
-10.15%
-8.88%
-3.29%
-11.61%
Accumulated other comprehensive income (loss)
-0.08%
-1.89%
-1.86%
-0.27%
-0.87%
-0.62%
Unearned Restricted Stock
-0.07%
-0.05%
-0.03%
-0.01%
0.00%
0.00%
Total shareholders' equity
35.78%
39.90%
40.82%
41.43%
40.76%
41.47%
40%
39%
38%
37%
36%
35%
35%
34%
34%
33%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
Shareholders' equity:
Treasury Stock
Total Liabilities and Shareholders' Equity
3%
1%
1%
1%
1%
1%
1%
1%
1%
0%
0%
22%
22%
23%
23%
24%
24%
25%
25%
26%
26%
78
1
We believe that our asset turnover was negatively affected by Macy’s
acquisition of May’s Department Stores in 2005. It is noticeable that our
property, plant, and equipment, as well as total non-current assets, spiked
dramatically in 2005-2006. This may be a result of Macy’s acquisition of May’s
Department Stores.
After the asset section, we examined the liability and equity sections of
the balance sheet. The current ratio was used to forecast Macy’s total current
liabilities. To do this, we divided the current ratio, of 1.7, into the current assets
for 2006 to arrive at 2007’s current liability forecast. Finally, we focused on
dividends. It is especially important to note that before Macy’s acquisition of
May’s, dividend payments were almost non-existent. However, after the
acquisition, dividends showed a dramatic increase, so we grew the dividends out
using a 3% growth rate. The total shareholders’ equity is one of the most
important items to be forecasted on the balance sheet because it’s a check
figure. These numbers add up to equal the numbers on the valuation methods.
To forecast the shareholders’ equity, we added together last year’s shareholders’
equity and next year’s retained earnings, and then subtracted last year’s retained
earnings.
Statement of Cash Flows
The cash flow statement is one of the hardest financial statements to
forecast because it has several inconsistencies. The first thing we did was to
calculate the CFFO/NI, CFFO/OI, and CFFO/Sales ratios to see which ratio
showed the most consistencies. We found that the CFFO/Sales showed the
largest range of consistency among the three ratios that we ran. We used this
ratio to forecast out the cash from operating activities. “Cash flow from financing
activities reports the aggregate change in a company’s position resulting from
any gains or losses from investing in a financial market or resulting from
amounts spent in capital assets such as plant and equipment,” (Financial
dictionary). Therefore, the negative cash flows will reflect money spent on assets
79
or investment. To forecast the CFFI, we first used the CFFO/sales ratio for
forecasting, but the numbers were too large and inconsistent. We then went
back to the balance sheet and looked at the non-current assets. We noticed that
in 2005 and 2006, the property and equipment was almost half of the noncurrent assets. This means that the CFFI’s for those 2 years were negative
because they show that Macy’s had heavy investing expenditures on plant and
property. As we forecasted out the non-current assets only 2008, the first year,
had a positive cash flow and the rest of years had negative cash flows. We did
not think this was consistent, especially taking into considering that Macy’s had
just acquired May’s. Since this forecast was illogical, we changed that cash flow
to be negative in order to avoid heavily understating Macy’s stock price in our
valuation. We did not forecast too many items on the cash flow statement since,
as seen from the two items we forecasted, they are based on a lot of
assumptions and have a great deal of inconsistencies.
80
Macy's
As Reported Annual Cash Flow
Actual financial statements
Forecast Financial Statements
2001
2002
2003
2004
2005
2006
2/2/2002
2/1/2003
1/31/2004
1/29/2005
1/28/2006
2/3/2007
Millions
Millions
Millions
Millions
Millions
Millions
Net income (loss)
-276
818
Income (loss) from discontinued operations
784
-180
Depreciation & amortization
657
676
706
83
39
-257
305
17
143
95
495
-51
25
-5
122
-41
Accounts receivable
Merchandise inventories
Supplies & prepaid expenses
-
Other assets not separately identified
693
-
-
689
1,406
734
-
-7
943
1,265
-87
2
-1
-2
25
Accts pay & accrued liabil not sep identified
-236
-1
60
-24
-444
-841
Current income taxes
-181
14
284
-6
49
-139
17
-119
3
59
-36
-18
Other liabilities not separately identified
7
-18
-76
-60
-132
12
Net cash flows from operating activities
1,372
1,168
1,590
1,507
1,950
3,692
-615
-568
-508
-467
-568
-1,317
-36
-59
-60
-81
-88
-75
55
20
6
27
19
679
-771
-637
-562
-727
-2,506
1,273
186
4,580
1,146
Purchase of property & equipment
Capitalized software
Disposition of property & equipment
Net cash flows from investing activities
Debt issued
Financing costs
Debt repaid
Dividends paid
1,000
7
-16
-1
-1,140
-1,015
-
Increase (decrease) in outstanding checks
Acquisition of treasury stock
164
-
-
-
-2
-10
-457
-365
-4,755
-2,680
-69
-93
-157
-274
37
-3
-5
38
-53
-77
-2,500
-299
-392
-645
-901
-7
Issuance of common stock
323
29
193
298
336
382
Net cash flows from financing activites
-95
-1,375
-819
-837
-58
-4,013
Net cash flows from continuing operations
Net cash flows from discontinued operating
ac
506
-844
209
-57
-614
952
-92
924
-
-
63
54
Net cash flows from discontinued investing ac
-
-
-
-
-61
-97
Net cash flows from discontinued financing ac
-
-
-
-
-8
54
Net cash flows from discontinued operations
-
-
-
-
-6
11
963
Net incr (decr) in cash & cash equivalents
414
80
209
-57
-620
Cash & cash equivalents beginning of period
222
636
716
925
868
248
Cash & cash equivalents end of period
636
716
925
868
248
1,211
Interest paid
351
335
269
300
457
600
7
14
8
16
42
59
221
123
60
322
481
561
Interest received
Income taxes paid (net of refunds received)
CFFO/NI
2009
2010
2011
2012
2013
2014
2015
2016
2017
$4,006
$4,346
$4,716
$5,117
$5,552
$6,023
$6,535
$7,091
$7,694
$8,348
$9,057
$3,192
$2,028
$2,245
$2,486
$2,752
$3,047
$3,373
$3,734
$4,134
$4,577
$5,067
282
291.00
299.00
308
318
327
337
347
358
368
379
-
-52
Deferred income taxes
2008
995
-33
-
2007
-4.97
1.43
2.29
2.19
1.39
3.71
CFFO/SALES
0.09
0.08
0.10
0.07
0.07
0.14
CFFO/OI
1.02
0.87
1.14
0.62
1.06
2.01
0
81
Macy's Common Sized Cash Flows
Actual financial statements
Forecast Financial Statements
2001
2002
2003
2004
2005
2006
-20.12%
70.03%
43.58%
45.72%
72.10%
26.95%
Income (loss) from discontinued operations
57.14%
-15.41%
#VALUE!
#VALUE!
-1.69%
-0.19%
Depreciation & amortization
47.89%
57.88%
44.40%
48.71%
48.36%
34.26%
6.05%
3.34%
-16.16%
#VALUE!
#VALUE!
#VALUE!
22.23%
1.46%
8.99%
6.30%
25.38%
-1.38%
1.57%
-0.33%
6.26%
-1.11%
Net income (loss)
Accounts receivable
Merchandise inventories
Supplies & prepaid expenses
Other assets not separately identified
-3.79%
-7.45%
0.13%
-0.07%
-0.10%
0.68%
Accts pay & accrued liabil not sep identified
-17.20%
-0.09%
3.77%
-1.59%
-22.77%
-22.78%
Current income taxes
-13.19%
1.20%
17.86%
-0.40%
2.51%
-3.76%
Deferred income taxes
1.24%
-10.19%
0.19%
3.92%
-1.85%
-0.49%
Other liabilities not separately identified
0.51%
-1.54%
-4.78%
-3.98%
-6.77%
0.33%
Net cash flows from operating activities
100.00%
100.00%
100.00%
100.00%
100.00%
79.77%
89.17%
90.39%
64.24%
22.67%
100.00%
103.46%
4.67%
9.26%
10.68%
11.14%
3.51%
-5.89%
-7.13%
-3.14%
-1.07%
-3.71%
-0.76%
53.34%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
Purchase of property & equipment
Capitalized software
Disposition of property & equipment
Net cash flows from investing activities
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Debt issued
Financing costs
Debt repaid
Dividends paid
Increase (decrease) in outstanding checks
Acquisition of treasury stock
Issuance of common stock
Net cash flows from financing activites
Net cash flows from continuing operations
Net cash flows from discontinued operating
ac
Net cash flows from discontinued investing ac
Net cash flows from discontinued financing ac
Net cash flows from discontinued operations
Net incr (decr) in cash & cash equivalents
Cash & cash equivalents beginning of period
Cash & cash equivalents end of period
Interest paid
Interest received
Income taxes paid (net of refunds received)
82
Cost of Capital Estimation
A firm grows by either issuing debt, equity, or using internal financing.
Therefore, to value a firm we have to see how much debt they actually have.
This is to ensure they are not giving a wrong impression of being successful
when they are actually in debt. In order to calculate the cost of capital, we need
to calculate the cost of equity and the cost of debt.
Cost of Equity
The cost of equity of a company is “the rate of return on investment that
is required by the company’s ordinary shareholders,” (Wikipedia). We used the
CAPM model to calculate our cost of equity. The formula consists of the firm’s
beta, market premium, and the risk-free rate.
We started by calculating the beta. To do that, we ran a number of
regression analyses to come up the best beta estimation. We used the St. Louis
Federal reserve website to get the constant maturity rates that we needed. We
ran regressions for six periods in order to test for the highest explanatory power
of R^2. These periods were: 3 months, 1 year, 2 years, 5 years, 7 years and 10
years. In each period we ran regressions for 72, 60, 48, 36, and 24 months, to
test the stability of beta over time. Macy’s beta results were pretty constant from
period to period with just a little variation, which means that Macy’s beta was
pretty constant over time. We picked the beta with the highest explanatory
power, which is the highest R^2. It is important to use the beta with the highest
R^2, and with the T-stat higher than 1.69, which happened to be the 72 month
regression on every observation. The 3 month regression was the best choice
because it had the highest overall R^2. This made our chosen beta 1.26, which
is different from Macy’s published beta of 1.03. After going through the
regression analysis, it is not so clear how fiancé.yahoo.com came up with that
beta, because none of our regression tables yielded anything close to it. Since
the 3 month regression yielded the best beta in all periods, it means that the T-
83
bill interest rate in that period would give the best estimate of the risk-free rate.
This rate is equal to 4.01%.
After researching several websites and reading through the textbook, we
chose to use 8.5% for our MRP. We came to this conclusion because Macy’s is in
the high-end retail industry and there is little volatility from year to year unless
an event such as a merger or an acquisition, like Macy’s had in 2005, occurs.
After looking at Macy’s history of acquisitions and ventures sales we increased
the MRP by 1.7% to accommodate for Macy’s market cap, based on the table
from the textbook. Once all of these rates were calculated, finding the Ke for
Macy’s was a simple math equation. We applied all of the rates that pertain to
Macy’s into the CAPM formula to compute a cost of equity of 14.72%.
Ke=.0401+1.26(.085)
=14.72%
3 mo
72
60
48
36
24
Beta
1.26
1.63
1.41
1.65
1.65
T-Stat
2.8
2.24
1.29
1.16
0.75
R^2
0.088
0.064
0.013
0.01
-0.019
Ke
0.1472
0.1787
0.1600
0.1804
0.1804
72
60
48
36
24
Beta
1.25
1.52
1.36
1.55
1.3
T-Stat
2.79
2.11
1.25
1.097
0.57
R^2
0.087
0.084
0.0197
0.024
-0.039
Ke
0.1464
0.1693
0.1557
0.1719
0.1506
72
60
48
36
24
Beta
1.25
1.62
1.39
1.63
1.65
T-Stat
2.78
2.23
1.27
1.15
0.75
R^2
0.086
0.063
0.012
0.009
-0.019
Ke
0.1464
0.1778
0.1583
0.1787
0.1804
1 yr
2 yrs
84
5 yrs
72
60
48
36
24
Beta
1.24
1.61
1.37
1.63
1.66
T-Stat
2.76
2.21
1.26
1.15
0.75
R^2
0.085
0.061
0.012
0.001
-0.019
Ke
0.1455
0.1770
0.1566
0.1787
0.1812
72
60
48
36
24
Beta
1.24
1.6
1.36
1.62
1.66
T-Stat
2.75
2.2
1.25
1.14
0.75
R^2
0.084
0.06
0.011
0.009
-0.019
Ke
0.1455
0.1761
0.1557
0.1778
0.1812
Beta
1.23
1.59
1.36
1.62
1.67
T-Stat
2.75
2.19
1.24
1.14
0.75
R^2
0.084
0.06
0.011
0.008
-0.019
Ke
0.1447
0.1753
0.1557
0.1778
0.1821
7 yrs
10 yrs
72
60
48
36
24
Cost of Debt
The cost of debt is the interest rate that Macy’s pays on all of its debt. For
our purposes, we are calculating the weighted-average cost of debt. Therefore,
we needed to discover the short-term interest rate and also the interest rate paid
on long-term debt. In the end, we concluded that the weighted-average cost of
debt for Macy’s is 6.22%. This percentage was calculated through a several step
process.
First, we analyzed the Macy’s 10-K report to collect all of the short-term
debt that the company had in 2006. Then, we found the weighted average of
those numbers and turned all of them into one percentage that represents all
outstanding short-term debt, which equals 5.42%. Repeating this process for all
85
outstanding long-term debt equals 6.68%. These are the two percentages we
needed to calculate the weighted-average cost of debt. Next, we applied the
short-term percentage to the current liabilities portion and applied the long-term
percentage to the non-current liabilities portion of the Balance Sheet. The weight
of each account is calculated by dividing the account balance by the total
liabilities of the firm. Once we knew the weights, we multiplied them with their
corresponding interest rates to create the values of the weights. Finally, all of the
weight values are added together to yield the weighted-average cost of debt.
Interest
rate
LIABILITIES AND SHAREHOLDERS
EQUITY
Weight
Value
weighted
rate
Current liabilities:
Short-term debt
$650,000
5.42%
0.0376
0.20%
Accounts payable and accrued liabilities
$4,944,000
5.42%
0.2858
1.55%
Income taxes
$665,000
5.42%
0.0384
0.21%
Deferred income taxes
$52,000
5.42%
0.0030
0.02%
Liabilities of discontinued operations
$48,000
5.42%
0.0028
0.02%
Total current liabilities
$6,359,000
5.42%
0.3677
1.99%
Long-term liabilities:
Long-term debt
$7,847,000
6.68%
0.4537
3.03%
Deferred income taxes
$1,728,000
6.68%
0.0999
0.67%
Other liabilities
$1,362,000
6.68%
0.0787
0.53%
Total liabilities
$17,296,000
6.2168%
Shareholders' equity:
Common Stock
$6,000
Additional paid-in capital
$9,486,000
Retained earnings
$6,375,000
Treasury Stock
Accumulated other comprehensive income
(loss)
($3,431,000)
Total shareholders' equity
$12,254,000
Total Liabilities and Shareholders' Equity
$29,550,000
($182,000)
86
Weighted Average Cost of Capital
The weighted average cost of capital (WACC) is a calculation of Macy’s
debt and equity combined proportionally to yield a “weighted” percentage of the
company’s capital. For our research, we looked at the WACC on a before and
after tax basis. Calculating the WACC was one of the easier parts of our research
because all of the components were already found, we just simply had to insert
them into the formula.
As stated earlier, we calculated the WACC for Macy’s both before and
after taxes. The before tax WACC for our company is 10.25%. The steps taken
to discover this percentage went straight through the formula. We calculated the
cost of debt (as reported earlier) and multiplied it by its weight, 0.11. Then, we
found the cost of equity and multiplied it with its weight, 0.89. After that, we
added the two together to produce our WACC before taxes. The WACC after tax
rate was the same process with one addition, taxes. We calculated the effective
tax rate for Macy’s to be 35% by dividing the 2006 tax expense by the income
before taxes. Then, we followed the formula again, this time applying
(1 – tax rate) to the cost of debt. Adding together the weighted cost of debt
after tax and the weighted cost of equity, we concluded that the WACC after tax
for Macy’s is 9.11%.
WACC(BT)
Vd/Vf (Kd) + Ve/Vf (Ke)
17,296/32,968 (.062) +15,672/32,968 (.1472)
=10.25%
WACC(AT)
Vd/Vf (Kd) (1-Tax) + Ve/Vf (Ke)
17,296/32,968 (.062) (1-.35) + 15,672/32,968 (.1472)
=9.11%
87
Credit Risk Analysis
The Altman Z- Score is a formula used to determine the credit risk of a
company. If the company’s Z- Score is greater than 2.67, then it falls into the
category of low credit risk. However, if the firm’s Z-Score is less than 1.81, then
it is considered a high credit risk. Furthermore, if the credit score falls anywhere
in between the range of 1.81 to 2.67, then it is labeled as the gray area.
Therefore, it is undetermined whether the company has a high or low credit risk.
The Altman Z- Score is calculated by using the following formula.
Z- Score =
1.2(Working Capital / Total Assets) + 1.4(Retained Earnings / Total Assets) +
3.3(EBIT / Total Assets) + .6(MVE / BVL) + 1.0 (Sales / Total Assets)
We calculated the Altman Z- Score for Macy’s for the last five years and
came up with these results.
2002
2.65
2003
3.14
2004
3.18
2005
2.8
2006
2.211
As one can see, the credit risk for Macy’s Inc. has been relatively
low throughout the past five years. However, over the last few years the credit
score has dropped gradually and in 2006, their credit score fell into the grey
area. This may cause concern to the company and investors if their credit score
continues to decline.
88
Method of Comparables
Macy's Share Price
Forward P/E
Trailing P/E
Price to Book
Dividend Yield
P.E.G
Price to EBITDA
EV to EBITDA
Price to Free Cash Flows
$60.69
$23.01
$75.96
$55.17
$74.82
$61.12
$2.46
NA
The method of comparables is used to find the share price of a firm base
upon an industry average. We calculated the ratios for Macy’s, as well as the
ratios for Sacs, Dillard’s, and Nordstrom’s, and then calculated an average for our
industry. By using the industry average for our ratio we were able to work back
to find a Price per Share. Then By comparing the calculated share price to the
posted share price as of November 1, 2007, we are able to make an assumption
on whether the firm is overvalued, undervalued, or fairly priced.
Forward P/E Ratio
Forward
P/E
Macy's
Sacs
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
EPS
2.36
0.69
0.64
3.29
P/E
13.36
31.72
33.95
11.47
Industry
Average
25.72
Macy's
Share
Price
60.69
We calculated the forward P/E ratio by dividing the stock price as of
November 1, 2007 by the forecasted earnings per share for Macy’s. For all of
the ratios for our competitors, we used the numbers posted on yahoo finance,
but again using the share price as of November 1. To find Macy’s Share Price we
took the average of our competitors P/E ratios and multiplied that number by
Macy’s earning s per share. This gave us a share price of $60.69, which
compared to the posted $31.54; suggest that our firm is undervalued. However
89
we must take into consideration that Sacs and Dillard’s both had extremely low
earnings per share, causing their P/E ratios to be high and creating a high
industry average.
Trailing P/E ratio
Trailing
P/E
Macy's
Saks
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
EPS
2.22
0.21
3.36
2.71
P/E
14.21
104.24
7.99
12.74
Industry
Average
10.37
Macy's
Share Price
23.01
The trailing P/E ratio is calculated by dividing the stock price by the
earnings per share for the past twelve months. This ratio differs from the
forward P/E because it uses actual earnings; also making it a more accurate
valuation. We then took the average P/E of our competitors (excluding Saks)
and multiplied that number by our earnings per share, giving us a share price of
$23.01. Compared to the posted $31.54, this valuation shows that the firm is
currently overvalued. Again, because this ratio is based on previous earnings per
share, we should regard this more viable than the forward P/E ratio.
Price to Book Ratio
Price to
Book
Macy's
Saks
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
BPS
24.66
8.42
34.49
6.28
P/B
1.28
2.60
0.63
6.01
Industry
Average
3.08
Macy's
Share Price
75.96
The price to book ratio compares the price per share to the book value of
equity. It is calculated by dividing the current PPS (31.54) by the BPS (24.66) to
get our P/B ratio of 1.28. This is good, because a P/B ratio greater than 1
usually means a company is creating value. By again finding the industry
90
average of our competitors and multiplying by our BPS we get a share price of
$75.96. This valuation, compared to a posted price of $31.54, suggests that
Macy’s is significantly undervalued. With this assumption we must consider that
the BPS for both Macy’s and Dillard’s is three to four times the size of Saks and
Nordstrom’s.
Dividend Yield
Dividend
Yield
Macy's
Saks
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
DPS
0.51
NA
0.16
0.42
D/P
0.016
NA
0.007
0.011
Industry
Average
0.009
Macy's
Share Price
55.17
Macy’s dividend yield (D/P) is calculated by dividing the dividends per
share by the current price per share. We then calculated the D/P for our
competitors using their posted DPS, and then took an average of these numbers.
We could not calculate Saks dividend yield because they did not pay out a
dividend. To then find Macy’s share price of $55.17 we divided our DPS of 0.51
by the industry average of 0.009. This ratio also suggests that Macy’s is
currently undervalued. However, because Sacs didn’t pay dividends, our sample
for the industry average is relatively small and may be unreliable.
Price/Earnings to Growth Ratio
P.E.G
Ratio
Macy's
Saks
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
EPS
2.22
0.69
1.04
3.40
PEG
1.33
3.93
4.46
1.05
Industry
Average
3.15
Macy's
Share Price
74.82
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The Price-Earnings Growth ratio is used to establish a stock’s P/E relative
to the earnings growth rate. By taking the trailing P/E ratio and dividing it by the
earnings per share growth rate, we get a firms P.E.G ratio. For our valuation we
took the average of our competitors PEG ratios and multiplied it by our growth
rate and our EPS to get a share price of $74.82. This valuation also implies that
Macy’s is significantly undervalued.
Price to EBITDA
Price to
EBITDA
Macy's
Saks
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
Industry
EBITDA P/EBITDA Average
1.84
17.14
33.22
0.22
98.60
0.53
41.27
1.50
25.17
Macy's
Share Price
61.12
For this ratio we used the price per share as of November 1, 2007 and
EBITDA calculated from Macy’s 10-k. By dividing the PPS by the EBITDA we got
our Price to EBITDA of 17.14. We then used the given numbers on yahoo
finance to calculate our competitors P/EBITDA ratio and then took the average
(excluding Saks). We calculated a share price of $61.12 for Macy’s by
multiplying the industry average by our EBITDA of 1.9. Comparing the posted
share price of $31.54 to the calculated $61.63 again tells us that Macy’s is
currently undervalued.
Enterprise value to EBITDA
Enterprise
value to
EBITDA
Macy's
Saks
Dillard's
Nordstrom
EV
29.74
3.47
3.02
9.89
Industry
Macy's
EBITDA EV/EBITDA Average Share Price
1.84
16.16
9.32
2.46
0.22
15.63
0.53
5.74
1.50
6.59
92
The enterprise value (EV) to EBITDA is calculated by dividing the firms EV
by its EBITDA. To find Macy’s EV we took its price per share times outstanding
shares plus the book value of liabilities minus cash. We then divided that
number by Macy’s EBITDA to get 16.16. Next we calculated the EV/EBITDA for
each of the competitors and took the average. Then by inserting the industry
average as the EV/EBITDA and solving for price (using the same number of
liabilities, cash, and shares), we came up with a share price of $2.46 for Macy’s.
This number compared to our November 1 stock price of $31.54 would suggest
that the company is extremely overpriced. However, due to the extremely large
enterprise value of Macy’s, this number does not represent good assessment of
the value of the company.
Price to Free cash flows
Price to Free cash
flows
Macy's
Saks
Dillard's
Nordstrom
PPS
31.54
21.89
21.73
37.75
FCF
5.14
1.24
0.09
0.90
P/FCF
6.14
17.63
230.61
42.13
Industry
Average
NA
Macy's
Share Price
NA
The price to free cash flows ratio is calculated by dividing the current
stock price of the firm by the free cash flows. Then we would have found an
industry average and then calculated Macy’s share price using this number. As
shown in the table above we had some huge discrepancies when we calculated
our P/FCF. This is due to large difference in the number of the free cash flows
from one firm to the next. Because of this we decided not to calculate the
industry average and share price, feeling that the number would not have been
an accurate assumption.
93
Conclusion
The method of comparables is a tool for taking a quick look at a company
and its competitors and making an assumption based upon ratios. Five out of the
seven ratios we computed suggested that Macy’s is significantly undervalued.
However, we must question the accuracy and validity of these ratios. What they
fail to consider is the size and structure of the companies being compared.
Macy’s is significantly larger than the three competitors we compared it. With
higher earnings, costs, and liabilities, along with different capital structures, the
assumptions made by these ratios are just not accurate. The method of
comparables is good for a quick snapshot, but it just isn’t as viable as an intrinsic
valuation.
Intrinsic Valuation Methods
Intrinsic valuation models are models that we will use to help us estimate
or predict the value of Macy’s share price. This method uses the forecasted data
from the balance sheet, income statement, and the cash flow statements. We
also used WACC or Ke already calculated. We will be estimating Macy’s share
price using five different models: the discount dividend model, free cash flows
model, residual income model, residual income perpetuity, and the abnormal
earnings model.
In every model we calculate a perpetuity, and then discount that
perpetuity back to the current year. Then, we discount that number back to the
valuation date of the project, which we are valuing Macy’s share price as of
November 1, 2007.
94
Discounted Dividend Model
The discounted dividend model is the first valuation method that we
evaluated. This model has a lot of assumptions built into it, thus making it less
reliable as a method of stock valuation. One assumption that we made is that the
company will pay dividends indefinitely and that the dividends will grow at a
constant rate over the number of years.
To do this, we first identified the dividend per share and grew it out at a
rate of 3% over the next 10 years. The next step is to calculate the present
value by using the formula: 1/(1+Ke)^t. We then calculated the present value
of the dividends for each year by multiplying the dividends per share and the
present value factor together. The perpetuity started in 2018. We assumed that
the dividends would grow at the same 3% growth rate, so we took the
perpetuity and divided by (Ke minus the growth rate). Then, we discounted it
back to 2007 to get the terminal value of the perpetuity. Next, we added the
terminal value of the perpetuity to the sum of the present values of the dividends
to come up with a share price of $4.99. This share price is far below the
observed share price of $31.54, which means that using this model, we conclude
that Macy’s is extremely overvalued.
We conducted a sensitivity analysis to assess how sensitive the share
price was to changes in the Ke and growth.
Growth
Ke
0
0.03
0.107
0.11
0.1956
4.78
4.99
6.14
6.23
7.01
0.1574
4.93
5.29
7.83
8.1
11.41
0.1472
4.99
5.37
8.85
9.28
15.95
0.1114
5.33
6.02
50.82
152.29
0.1054
5.42
6.02
N/A
N/A
0.13
N/A
N/A
over valued
under valued
95
Macy’s sensitivity analysis clearly shows that they are an overvalued firm.
We did not place too much credibility on this model, since dividends are very
sticky. Therefore, there is no telling if Macy’s will continue paying dividends or if
the dividends will continue to grow at a constant rate.
Discounted Free Cash Flow
The discounted free cash flow valuation model is used to determine the
future value of cash flows for the next ten years and discount them back to the
present. This valuation model is based on the discount dividend model. For
instance, this particular model assumes that the only cash flows received by
stockholders are dividends. The dividends are equal to the operating cash flow,
minus the capital outlays, and plus the net cash flows from debt owners. We also
had to make some assumptions of our own. We assumed the 2008 CFFI was a
negative cash flow because the original calculated number was a positive cash
flow. This led to over-estimating the share price. We used the reasoning that
from 2006 to 2007 plant and property increased, but the non-current assets
decreased. This was inconsistent with logic because if plant and property
increased, then logically the non-current assets would also increase. Based on
that, we assessed a negative cash flow in 2008.
In order to calculate the annual free cash flows for the company, we
subtract the cash flows from investing out of the cash flows from operating
activities. This present value of free cash flows is equal to the market value of
liabilities plus the market value of equity. After that, it is necessary to determine
the present value factor. This is computed by using the formula:
(1/(1+WACC)^t. The present value factor is then multiplied by the annual free
cash flow to get the present value of free cash flows. Next, we calculated the
total present value of future cash flows by computing the sum of the present
value of cash flows over the forecasted ten year period.
96
Furthermore, the terminal value of the perpetuity is calculated by taking
the value of the perpetuity and dividing it by the (WACC minus the growth rate).
This number is then multiplied by the present value factor to get the terminal
value of the perpetuity. Next, the total present value of the free cash flows is
added to the present value of the terminal value of the perpetuity. Then, the
book value of liabilities is subtracted out to get the estimated market value of
equity. The market value of equity is divided by the number of outstanding
shares to discover the estimated price per share. Lastly, we calculate the time
consistent implied by discounting back to November 1 using the following
formula: est. price per share x (1+ WACC before tax) ^ (10/12).
Sensitivity Analysis:
Growth
WACC
0
0.03
0.05
0.07
0.09
0.08
83.62
117.52
168.97
426.2
N/A
0.09
78.06
97.74
127.27
215.84
N/A
0.1025
67.86
80.74
97.49
134.86
291.83
0.1125
61.39
70.87
82.25
104.33
165.68
0.1325
51.49
56.98
62.87
72.52
91.24
over valued
undervalued
The sensitivity analysis exposes that there is a great deal of price
variation. For instance, by changing the growth rate to 7% at an 8% WACC, the
estimated share price increases by nearly five times the original price. In
addition, a higher discount rate causes the estimated share price to decrease.
Our sensitivity analysis reveals that our share price is overvalued at every growth
rate.
97
Residual Income Valuation
“Residual income, also known as passive income, is income earned on an
ongoing basis for effort done once in the past,” (Wikipedia). Based on this
definition, we believe this valuation model attempts to show how much Macy’s is
worth, plus any value added. Of all the valuation models, the residual income
model has the highest degree of explanatory power, and is therefore the most
reliable. We used the net income and dividends from our forecasts in our
calculations.
To calculate the equity, we took the previous year’s equity, added the
current year’s net income, and subtracted the current year’s dividends. The
equity calculated should match the equity on the forecasted balance discussed
earlier. We then calculated the benchmark earnings by multiplying the previous
year’s equity by the cost of equity (Ke) of 14.72%. We computed the difference
of the benchmark earning and the net income to see if Macy’s is creating or
destroying value. Our result revealed that Macy’s is destroying value every year,
so our recommendation is to stop operations. Next, we discounted the perpetuity
back using a growth rate of -0.1%. We used a negative growth rate in the
residual income model because we are trying to bring the negative residual
income back to equilibrium. A positive growth rate would continue increasing the
value instead of bringing it to zero.
Finally, we added the equity, the annual residual income, and the terminal
perpetuity. We divided this sum by the number of shares outstanding, which is
496 million, to compute a share price of $17.65 (as of November 1, 2007). Once
again, this shows that Macy’s is overvalued being traded at the observed price of
$31.54.
98
Ke
0
-0.1
Growth
-0.2
-0.3
-0.4
0.0522
55.77
45.18
42.99
42.05
41.52
0.1156
23.28
23.65
23.78
23.85
23.9
0.1472
17.65
18.23
18.47
18.61
18.69
0.1988
12.12
12.53
12.74
12.86
12.94
0.2033
11.77
12.16
12.36
12.48
12.56
over valued
under valued
The sensitivity analysis above shows that Macy’s is overvalued. However,
the results confirm that the share price is sensitive to changes in Ke and growth
rate. If we reduce the Ke to 5.2%, the share price jumps above the observed
share price of $31.54. Macy’s being overvalued means that they would have to
drive sales in order to get the fair value. We estimated that sales would be
growing by 10.71%. These results conclude that Macy’s would have to nearly
triple their sales growth in order to obtain fair value. Everything in the sensitivity
analysis illustrates that Macy’s is overvalued except the top line of the table,
which diagrams a Ke of about 5%. However, a cost of equity that low is not
realistic because it’s unfathomable that Ke would fall that low.
Residual Income Perpetuity
This model is derived from the residual income model. It values Macy’s on
the basis of return on equity, the calculated Ke, and the growth rate. We used
the formula:
Po= BVE(1+(ROE - Ke)/(Ke - G)
To calculate the ROE, we divided equity by net income and computed an
average. We then derived the growth rate from the ROE. With that, we were
able to calculate a share price of $15.07. This illustrates that Macy’s is
overvalued based on the observed share price of $31.54.
We then did three sensitivity analyses to see how sensitive the price was
to increase in ROE, Ke, and growth.
99
Growth
Ke
0.02
0.04
0.06
0.08
0.1
0.0972
24.02
23.15
21.36
15.4
94.59
0.1372
16.25
14
10.57
4.76
N/A
0.1472
15.07
12.77
9.42
4.08
N/A
0.1772
12.43
10.18
7.15
2.87
N/A
0.1972
11.17
8.99
6.18
2.41
N/A
0.0973
ke
0.1372
0.1472
0.1772
0.1972
0.05
10.28
6.96
6.46
5.33
4.76
0.07
17.13
11.61
10.76
8.88
7.98
0.09
23.99
16.25
15.07
12.43
11.17
0.113
31.87
21.59
20.02
16.52
14.84
0.151
44.89
30.41
28.2
23.27
20.9
0.06
0.08
ROE
ROE
0.02
Growth
0.04
0.05
6.46
2.55
0.07
10.76
7.66
3.14
0.09
15.07
12.77
9.42
4.08
0.113
20.02
18.65
16.65
13.45
7.54
0.151
28.2
28.36
28.58
28.93
29.59
N/A
0.1
N/A
N/A
N/A
N/A
N/A
overvalued
undervalued
within 5% fairly valued
The above sensitivity analyses clearly demonstrate that Macy’s is
overvalued.
100
Abnormal Earnings Growth
“The abnormal earnings growth rate says equity value consists of:
Capitalized next period earnings and the infinite sum of present values of
capitalized expected changes of earnings adjusted for dividends (abnormal
earnings),” (Yong Keun Yoo). This model is less reliable than the residual income
model. This model shows how drip income (dividends) affects earnings. The drip
income is calculated by multiplying last year’s dividends by the Ke. We then
calculated the normal annual income (benchmark) by dividing the previous year’s
net income by (1+Ke). AEG was computed at by getting the difference of the
cumulative dividends income and the benchmark. The change in residual income
should equal the AEG as shown below. This is what links the AEG model and the
residual income model.
Change in Residual
Income
Annual AEG
-3.91
-3.91
-6.10
-6.10
-11.50
-11.50
-14.67
-14.67
-21.19
-21.19
-26.22
-26.22
-33.04
-33.04
-39.95
-39.95
The perpetuity is discounted back to year ten by dividing it by (Ke minus
the growth rate). The AEG growth rate is negative, like the residual income
model, in order to bring the perpetuity back to zero. The present value of the
AEG is calculated using the present value factor. The share price was calculated
to be $15.01, which again, shows that Macy’s observed share price of $31.54 is
overvalued.
The sensitivity analysis clearly shows that Macy’s is overvalued with every
variation in growth rate and Ke.
101
-48.25
-48.25
Growth
Ke
-0.01
-0.05
-0.09
-0.1
-0.11
0.1972
11.69
11.75
11.79
11.8
11.81
0.1672
13.45
13.54
13.61
13.62
13.63
0.1472
15.01
15.14
15.23
15.24
15.26
0.1272
17.04
17.23
17.34
17.04
17.39
0.1072
19.78
20.07
20.24
20.28
20.31
over valued
under valued
Conclusion
From the intrinsic valuation models we can say that Macy’s is an
overvalued company. All of the valuation models, with the exception of the free
cash flow model, show the share price is less than the observed share price of
$31.54. We did not put too much credibility on the free cash flow model because
it is based on a lot of assumptions, and has a low level of explanatory power.
102
Appendix
Liquidity Ratios
Current Ratio
Quick Asset Ratio
2002
2003
2004
2005
2006
2002
2003
2004
2005
2006
Macy's
1.99
1.92
1.75
1.34
1.17
Macy's
1.05
1.09
1.02
0.62
0.33
Saks
2.41
2.11
2.21
1.95
1.45
Saks
0.77
0.61
0.6
0.99
0.54
Dillard's
3.53
2.26
2.19
1.87
2.1
Dillard's
1.73
1.04
0.54
0.3
0.28
Nordstrom
2.38
2.33
1.92
1.77
1.91
Nordstrom
1.23
1.28
1.23
1.18
1.2
Industry Average
2.58
2.16
2.02
1.73
1.66
Industry Average
1.20
1.01
0.85
0.77
0.59
2002
2003
2004
2005
2006
Macy's
2.76
2.83
2.98
2.43
3.01
Saks
2.86
2.59
2.64
4.64
2.3
Dillard's
3.30
3.17
2.90
2.78
2.84
Inventory Turnover
Days Supply Inventory
Macy's
2004
2005
2006
122.48
150.21
121.26
Saks
127.62
140.93
138.26
78.66
158.7
110.76
115.24
126.06
131.23
128.54
4.26
4.43
4.95
5.11
5.32
Nordstrom
Industry Average
3.29
3.25
3.37
3.74
3.37
Industry Average
Receivables Turnover
Saks
2003
128.98
Dillard's
Nordstrom
Macy's
2002
132.25
87.21
82.56
73.52
71.42
71.54
114.46
116.93
115.08
107.88
120.01
2006
Days Sales Outstanding
2002
2003
2004
2005
2006
5.24
4.75
4.57
8.88
52.17
none
none
Macy's
2002
2003
2004
2005
69.66
76.84
79.87
41.1
none
none
Saks
Dillard's
61.74
57.23
0.47
0.61
0.50
Nordstrom
45.58
36.25
33.04
28.52
28.32
Industry Average
58.99
56.77
37.79
23.41
11.94
Dillard's
5.91
6.38
780.08
603.70
726.69
Nordstrom
7.86
10.24
11.04
12.07
12.5
Industry Average
6.34
7.12
265.23
208.22
263.79
2004
2005
2006
4.34
none
none
none
none
7
none
none
Working Capital Turnover
2002
Macy's
2003
25.37
8.76
4.87
4.28
Saks
5.26
5.62
5.65
7.45
7.58
Dillard's
3.53
4.50
6.03
7.54
7.13
Nordstrom
5.09
5.38
5.77
6.2
6.4
Industry Average
9.81
6.07
5.58
6.37
6.36
103
Profitability Ratios
Gross Profit Margin
Operating Profit Margin
2002
2003
2004
2005
2006
0.4
0.4
0.41
0.41
0.4
Macy's
2002
2003
2004
2005
2006
Macy's
0.087
0.088
0.090
0.110
0.039
0.038
0.03
0.034
0.068
0.007
0.02
0.001
0.023
0.017
0.033
Saks
0.37
0.38
0.38
0.37
0.39
Saks
Dillard’s
0.34
0.32
0.33
0.34
0.34
Dillard’s
Nordstrom
0.34
0.35
0.36
0.37
0.37
Nordstrom
Industry Average
0.36
0.36
0.37
0.37
0.38
Industry Average
Net Profit Margin
0.02
0.05
0.08
0.09
0.11
0.042
0.044
0.056
0.063
0.051
Asset Turnover
2002
2003
2004
2005
2006
2002
2003
2004
2005
2006
0.05
0.05
0.04
0.06
0.04
Macy's
1.07
1.05
1.05
0.68
0.91
Saks
0.004
0.01
0.01
0.004
0.02
Saks
1.29
1.3
1.37
1.55
1.16
Dillard’s
-0.05
0.001
0.016
0.016
0.032
Dillard’s
1.19
1.19
1.32
1.37
1.41
Nordstrom
0.02
0.04
0.05
0.07
0.04
Nordstrom
1.46
1.45
1.54
1.57
1.78
Industry Average
0.01
0.03
0.03
0.04
0.03
Industry Average
1.25
1.25
1.32
1.29
1.32
2003
2004
2005
2006
2003
2004
2005
2006
Macy's
Return on Assets
2002
Macy's
Return on Equity
0.05
0.05
0.05
0.09
0.03
Saks
0.005
0.018
0.013
0.005
0.014
Dillard’s
2002
Macy's
0.15
0.12
0.12
0.23
0.07
Saks
0.011
0.037
0.026
0.011
0.027
0.10
-0.06
0.001
0.02
0.02
0.05
Dillard’s
-0.18
0.004
0.05
0.05
Nordstrom
0.02
0.05
0.08
0.11
0.14
Nordstrom
0.09
0.19
0.24
0.25
0.08
Industry Average
0.00
0.03
0.04
0.06
0.06
Industry Average
0.02
0.09
0.11
0.14
0.07
104
Capital Structure Ratios
Debt to Equity
Times Interest Earned
2002
2003
2004
2005
2006
Macy's
1.51
1.45
1.41
1.45
1.41
Saks
1.02
1
1.26
0.93
1.32
Dillard’s
1.95
1.87
1.45
1.36
1.09
2002
2003
2004
2005
2006
Macy's
4.37
Saks
1.89
5.08
4.73
5.84
4.21
2
1.74
2.1
Dillard’s
0.97
0.16
0.04
1.26
1.19
2.90
Nordstrom
2.05
2.01
1.57
1.35
1.41
Nordstrom
1.96
3.68
7.12
3.25
2.19
Industry Average
1.67
1.63
1.43
1.21
1.27
Industry Average
1.61
1.91
3.37
2.18
1.75
2002
2003
2004
2005
2006
1.23
1.75
1.21
1.47
5.68
Macy's
57.79
3.07
46.51
24.1
0.23
Saks
Dillard’s
3.55
3.07
3.30
3.82
1.76
Nordstrom
22.5
1.94
5.53
2.66
3.5
27.95
2.69
18.45
10.19
1.83
Debt Service Margin
Macy's
Saks
Industry Average
IGR
Dillard’s
Nordstrom
Industry Average
2002
2003
2004
2005
2006
6%
4.50%
4.33%
3.55%
2.17%
0.50%
2.00%
-3.25%
0.50%
-1.89%
-5.80%
-0.10%
1.60%
1.90%
4.20%
4.61%
13.24%
17.21%
21.36%
23.56%
-0.23%
5.05%
5.19%
7.92%
8.62%
SGR
Macy's
Saks
Dillard’s
Nordstrom
Industry Average
2002
2003
2004
2005
2006
15.06%
11.03%
10.44%
8.70%
5.23%
1.01%
4.00%
-7.35%
0.97%
-4.39%
-15.40%
-0.20%
4.70%
4.70%
10.00%
5.70%
14.45%
19.12%
23.42%
24.50%
-2.90%
6.08%
5.49%
9.70%
10.04%
105
Methods of Comparables
PPS
EPS
P/E
Industry
Average
Macy's Share Price
Macy's
31.54
2.36
13.36
25.72
60.69
Sacs
21.89
0.69
31.72
Dillard's
21.73
0.64
33.95
Nordstrom
37.75
3.29
11.47
PPS
EPS
P/E
Industry
Average
Macy's Share Price
Macy's
31.54
2.22
14.21
10.37
23.01
Saks
21.89
0.21
104.24
Dillard's
21.73
3.36
7.99
Nordstrom
37.75
2.71
12.74
PPS
BPS
P/B
Industry
Average
Macy's Share Price
Macy's
31.54
24.66
1.28
3.08
75.96
Saks
21.89
8.42
2.60
Dillard's
21.73
34.49
0.63
Nordstrom
37.75
6.28
6.01
PPS
EPS
PEG
Industry
Average
Macy's Share Price
Macy's
31.54
2.22
1.33
3.15
74.82
Saks
21.89
0.69
3.93
Dillard's
21.73
1.04
4.46
Nordstrom
37.75
3.40
1.05
PPS
EBITDA
P/EBITDA
Industry
Average
Macy's Share Price
Macy's
31.54
1.84
17.14
33.22
61.12
Saks
21.89
0.22
98.60
Dillard's
21.73
0.53
41.27
Nordstrom
37.75
1.50
25.17
PPS
FCF
P/FCF
Industry
Average
Macy's Share Price
Macy's
31.54
5.14
6.14
NA
NA
Saks
21.89
1.24
17.63
Dillard's
21.73
0.09
230.61
Nordstrom
37.75
0.90
42.13
EV
EBITDA
EV/EBITDA
Industry
Average
Macy's Share Price
Macy's
29.74
1.84
16.16
9.32
2.46
Saks
3.47
0.22
15.63
Forward P/E
Trailing P/E
Price to Book
P.E.G Ratio
Price to EBITDA
Price to Free cash flows
Enterprise value to EBITDA
Dillard's
3.02
0.53
5.74
Nordstrom
9.89
1.50
6.59
PPS
DPS
D/P
Industry
Average
Macy's Share Price
Macy's
31.54
0.51
0.016
0.009
55.17
Saks
21.89
NA
NA
Dividend Yield
Dillard's
21.73
0.16
0.007
Nordstrom
37.75
0.42
0.011
106
3 MONTH REGRESSION
107
ONE YEAR REGRESSION
108
2 YEAR REGRESSION
109
5 YEAR REGRESSION
110
7 YEAR REGRESSION
111
10 YEAR REGRESSION
112
Cost of Equity, Weighted Average Cost of Debt, and WACC
LIABILITIES
Current liabilities:
Short-term debt
Accounts payable and accrued
liabilities
Income taxes
Deferred income taxes
Liabilities of discontinued operations
Total current liabilities
Long-term liabilities:
Long-term debt
Deferred income taxes
Other liabilities
Total liabilities
Interest rate
Value
weighted
rate
Weight
$650,000
5.42%
0.0376
0.20%
$4,944,000
$665,000
$52,000
$48,000
$6,359,000
5.42%
5.42%
5.42%
5.42%
5.42%
0.2858
0.0384
0.0030
0.0028
0.3677
1.55%
0.21%
0.02%
0.02%
1.99%
$7,847,000
$1,728,000
$1,362,000
$17,296,000
6.68%
6.68%
6.68%
0.4537
0.0999
0.0787
3.03%
0.67%
0.53%
Weighted Average Kd =
6.2168%
WACCBT =
10.2591%
WACC=
9.1176%
tax rate=
35%
Ke = 14.72%
113
Discounted Dividend Model
DISCOUNTED DIVIDENDS VALUATION
WACC(BT)
0.1025
Kd
0.0622
Ke
0.1472
0
2007
1
2008
0.57
2
2009
0.59
3
2010
0.60
4
2011
0.62
5
2012
0.64
6
2013
0.66
7
2014
0.68
8
2015
0.70
9
2016
0.72
10
2017
0.74
0.872
0.496
0.760
0.446
0.662
0.399
0.577
0.359
0.503
0.323
0.439
0.289
0.382
0.260
0.333
0.233
0.291
0.210
0.253
0.188
Perp
DPS (Dividends Per Share)
PV Factor
PV Dividends Year by Year
Total PV of Annual Dividends
Continuing (Terminal) Value Perpetuity
PV of Terminal Value Perpetuity
3.202
5.163
1.308
time consistent price
Estimated Price per Share (February 1,
2007)
4.509
Implied November 1, 2008 Price
Observed Share Price
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
2018
0.76
Growth
0
0.03
0.107
0.11
0.13
0.1956
4.78
4.99
6.14
6.23
7.01
4.999
0.1574
4.93
5.29
7.83
8.1
11.41
31.54
0.1472
4.99
5.37
8.85
9.28
15.95
0.1114
5.33
6.02
50.82
152.29
0.1054
5.42
6.02
0.1472
Ke
0
N/A
N/A
N/A
N/A
.
over valued
under valued
114
Free Cash Flow Model
WACC
(BT)
Free Cash Flow Valuation
0.1025
Kd
0.0622
Ke
0.1472
Perp
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
0
1
2
3
4
5
6
7
8
9
10
2018
EPS (Earnings Per Share)
DPS (Dividends Per Share)
BPS (Book Value Equity per Share)
Cash From Operations
4,006
4,346
4,716
5,117
5,552
6,023
6,535
7,091
7,694
8,348
9,057
-1,800
-2,028
-2,245
-2,486
-2,752
-3,047
-3,373
-3,734
-4,134
-4,577
-5066.97
Annual Free Cash Flows
2,206
2,318
2,471
2,631
2,800
2,976
3,162
3,357
3,560
3,771
3,900
PV Factor
0.907
0.823
0.746
0.677
0.614
0.557
0.505
0.458
0.416
0.377
1,907.03
1,843.75
1,781.00
1,719.04
1,657.38
1,597.08
1,537.83
1,479.24
1,421.33
Cash Investments
Book value of Debt and Preferred Stock
17,296
PV of Annual Residual Income
Total PV of Annual Residual Income
2,000.91
16,945
54.16%
Continuing (Terminal) Value Perpetuity
PV of Terminal Value Perpetuity
Book Value of the Firm
31,285
45.84%
Book Value of Liabilities
17,296
100.00%
Estimated Market Value of Equity
13,989
496
Number of Shares
38,049
14,340
Growth
0.03
0.05
0.07
0.09
0.08
83.62
117.52
168.97
426.2
N/A
0.09
78.06
97.74
127.27
215.84
N/A
0.1025
67.86
80.74
97.49
134.86
291.83
Estimated Price per Share (end of January)
63.07
Estimated price per share(end of November 1)
67.86
0.1125
61.39
70.87
82.25
104.33
165.68
Observed Share Price
31.54
0.1325
51.49
56.98
62.87
72.52
91.24
Initial WACC
Perpetuity Growth Rate (g)
WACC
0
0.1025
0
over valued
undervalued
115
Residual Income Model
Residual Income
2007
0
Total net Income
Dividends
BPS (Book Value Equity per Share)
Total Net Income
"Normal" (Benchmark) Earnings
Residual Income (Annual)
PV Factor
PV of Annual Residual Income
change in Residual income
ROE
Growth
Total PV of Annual Residual Income
Continuing (Terminal) Value Perpetuity
PV of Terminal Value Perpetuity
Initial Book Value of Equity (per Share)
Book Value of Liabilities
12,254
WACC(BT)
0.1025
2008
1
1117
282
13,089
2009
2
1236
291
14034
2010
3
1369
299
15104
2011
4
1515
308
16311
2012
5
1678
318
17671
2013
6
1857
327
19201
2014
7
2056
337
20920
2015
8
2276
347
22849
2016
9
2520
358
25011
2017
10
2790
368
27433
1117
1803.79
-686.79
0.8717
-598.67
1236
1926.70
-690.70
0.7598
-524.82
-3.91
0.09
3.2%
1369
2065.80
-696.80
0.6623
-461.52
-6.10
0.09
2.9%
1515
2223.31
-708.31
0.5774
-408.95
-11.50
0.09
2.5%
1678
2400.98
-722.98
0.5033
-363.86
-14.67
0.09
2.2%
1857
2601.17
-744.17
0.4387
-326.47
-21.19
0.10
1.8%
2056
2826.39
-770.39
0.3824
-294.60
-26.22
0.10
1.6%
2276
3079.42
-803.42
0.3333
-267.81
-33.04
0.10
1.4%
2520
3363.37
-843.37
0.2906
-245.06
-39.95
0.10
1.1%
2790
3681.62
-891.62
0.2533
-225.83
-48.25
0.10
0.9%
0.09
0.0622
Kd
0.1472
Ke
-3717.58
-2525.5
-639.68
12,254
7,896.74
GR
2.0%
Growth
0
-0.1
-0.2
-0.3
-0.4
Estimated Share Price (February 1 2007)
$15.92
0.0522
55.77
45.18
42.99
42.05
41.52
Implied Share Price (November 1 2007)
$17.65
0.1156
23.28
23.65
23.78
23.85
23.9
0.1472
17.65
18.23
18.47
18.61
18.69
0.1472
0.1988
12.12
12.53
12.74
12.86
12.94
0
0.2033
11.77
12.16
12.36
12.48
12.56
Observed Share Price
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
31.54
Ke
over valued
under valued
116
2018
-371.76
0.09
Long-Run ROE Model
Book Value of Equity
Long Run Return on Equity
Long Run Growth Rate in
Equity
Cost of Equity
Number of Shares
Estimated Price per Share (February 1)
Implied share price ( November 1)
observed share price
ROE
12,254
0.09
Growth
0.02
0.1472
496
13.60
$15.07
Ke
31.54
0.02
Growth
0.04
0.05
6.46
2.55
0.07
10.76
7.66
3.14
0.09
15.07
12.77
9.42
4.08
0.113
20.02
18.65
16.65
13.45
7.54
0.151
28.2
28.36
28.58
28.93
29.59
0.06
N/A
overvalued
undervalued
within 5% fairly valued
0.08
0.02
0.04
0.06
0.08
0.1
0.0972
24.02
23.15
21.36
15.4
94.59
0.1372
16.25
14
10.57
4.76
N/A
0.1472
15.07
12.77
9.42
4.08
N/A
0.1772
12.43
10.18
7.15
2.87
N/A
0.1972
11.17
8.99
6.18
2.41
N/A
0.1
N/A
N/A
N/A
N/A
ke
N/A
ROE
0.0973
0.1372
0.1472
0.1772
0.1972
0.05
10.28
6.96
6.46
5.33
4.76
0.07
17.13
11.61
10.76
8.88
7.98
0.09
23.99
16.25
15.07
12.43
11.17
0.113
31.87
21.59
20.02
16.52
14.84
0.151
44.89
30.41
28.2
23.27
20.9
117
Abnormal Earnings Growth Model
AEG Valuation
WACC
2007
0
Total Net Income
Dividends
BPS Book Value Equity
Net Income
Drip Income
Cumulative Dividend Income
"Normal" Annual Income (Benchmark)
Annual AEG
PV Factor
PV AEG (Annual)
Total PV of AEG
Core Perpetuity Earnings
PV of terminal value
Total PV of AEG
Total Average Eps perp (t+1)
intrinsic value of per share (February 1)
# of shares outstanding
0.1025
0.0622
Kd
0.1472
Ke
2008
1
1117
282
2009
2
1236
291
2010
3
1369
299
2011
4
1515
308
2012
5
1678
318
2013
6
1857
327
2014
7
2056
337
2015
8
2276
347
2016
9
2520
358
2017
10
2790
368
1117
1236
41.51
1277.51
1281.4
-3.91
0.872
-3.41
1369
42.84
1411.84
1417.9
-6.10
0.760
-4.64
1515
44.01
1559.01
1570.5
-11.50
0.662
-7.62
1678
45.34
1723.34
1738.0
-14.67
0.577
-8.47
1857
46.81
1903.81
1925.0
-21.19
0.503
-10.67
2056
48.13
2104.13
2130.4
-26.22
0.439
-11.50
2276
49.61
2325.61
2358.6
-33.04
0.382
-12.63
2520
51.08
2571.08
2611.0
-39.95
0.333
-13.32
2790
52.70
2842.70
2890.9
-48.25
0.291
-14.02
12,254
-86.27
-144.78
-42.07
-128.34
Growth
988.66
-0.01
-0.05
-0.09
-0.1
-0.11
13.54
0.1972
11.69
11.75
11.79
11.8
11.81
496.00
0.1672
13.45
13.54
13.61
13.62
13.63
time consistent implied price (november 1)
15.01
0.1472
15.01
15.14
15.23
15.24
15.26
Observed Share Price
31.54
0.1272
17.04
17.23
17.34
17.04
17.39
Perpetuity Growth Rate (g)
-0.01
0.1072
19.78
20.07
20.24
20.28
20.31
over valued
under valued
-14.67
-21.19
-14.67
-21.19
-26.22
-26.22
-33.04
-33.04
Initial cost of equity
Change in Residual Income
Annual AEG
2018
Ke
0.1472
-3.91
-3.91
-6.10
-6.10
-11.50
-11.50
-39.95
-39.95
-48.25
-48.25
118
-22.76
References
www.macys.com
Financial reports (10k)
www.saks.com
Financial reports (10k)
www.dillards.com
Financial reports (10k)
www.nordstrom.com
Financial reports (10k)
Business analysis & valuation using financial statements
www.finance.yahoo.com
www.Onecle.com
www.investopedia.com
http://moneycentral.msn.com
Street Authority website
www.wikipedia.com
Yong Keun Yoo
119