Macy's, Inc. (M) Earnings Call Transcript & Summary

This call is not for media representatives or Bank of America Merrill Lynch investment bankers or commercial bankers, including corporate and commercial [ FX ]. All such individuals are instructed to disconnect now. A replay will be available for Bank of America Merrill Lynch investment bankers and commercial bankers, including corporate and commercial [ FX ]. The replay is not available to the media. Good day, and welcome to Macy's. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Lorraine Hutchinson. Please go ahead.

Thank you. And thanks to everybody for joining. Welcome to the Bank of America consumer and retail conference. This conference has quite a history. We held it on the day of the market low in March 2009. We held it through a huge snow storm in 2017. And this year, we're hosting our first virtual version given all the health and safety concerns out there. So we appreciate everybody's patience. We're looking forward to hosting a great event and really, really happy to kick it off with Macy's. Before we get started, I wanted to hand it over to Monica for the safe harbor statement.

Thanks, Lorraine. And good morning, everyone, and thank you for joining us. Please keep in mind that all forward-looking statements are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions mentioned today. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. With that, I'll turn it over to Paula.

Thank you, Monica. Good morning, everyone. Thank you for your interest in Macy's, Inc. I want to take the opportunity to remind you this morning of what we're focused on not only today but also on the next 3 years. But first, let's acknowledge today the reach and impact of the coronavirus is still unfolding. This is a very dynamic situation, and our teams are working vigilantly to approach this environment and its challenges thoughtfully and strategically. Top of mind is the health and safety of our colleagues and customers, and we are all working hard to minimize the impact this virus could have on our supply chain and product. We have organized a working committee composed of key executives from around the enterprise. This team meets daily to address the challenges posed by COVID-19 and to ensure a coordinated response. Certainly, we're keeping a close eye on this evolving topic, and we'll continue to update everyone as appropriate. So moving into this morning's discussion. I'm going to focus on our Polaris strategy and 3-year plan, which we shared at our Investor Day last month. We believe this strategy is sound and addresses the broader needs of retail and the omnichannel customers. We will work through the near-term challenges while keeping our eye on longer-term goals. At a high level, we're focused on resources, resourcing the healthier parts of our business and investing in the opportunity to grow where retail is both growing today and in the future. And this includes growing profitable categories, off-mall format and customer segments. We're accelerating what's working in our business: our Star Rewards loyalty program, our Backstage off-price business, our Destination Businesses, those important categories that when combined, comprise nearly 40% of Macy's sales and half of our contribution margin; our Growth store treatment invested in our most valuable stores to sustainably improve their trends by enhancing the customer experience; and mobile, the fastest-growing piece of our large e-commerce business. And importantly, we're addressing what is not working in the business and taking actions to stabilize profitability in the face of continued headwinds. Over the next 3 years, our financial targets include rightsizing costs and expanding gross margins, with accelerated savings totaling $1.5 billion by the end of 2022, $600 million of which is in gross margin improvement and $900 million of which is in SG&A expense savings. The 5 points of the Polaris strategy are important as we step up to reclaim and redefine what a department store can and should be and include the following. First, strengthen customer relationships. We will continue to build customer lifetime value, expand our loyalty program and accelerate personalization and monetization. Last month, we expanded our Star Rewards loyalty program. Loyalty 3.0 now allows every Star Rewards member to earn on every purchase and enjoy special benefits regardless of how they pay. Second, curate quality fashion. Our customers come to Macy's for fashion, value and high-quality products. So we will curate an assortment of the latest trends and exclusive products at the best value from the best brands. We will drive disciplined merchandise category roles to be the best destination for the best brands while balancing sales and margin. A key component of this is our commitment to build 4 $1 billion private brands. Third, accelerate digital growth. We know that our omnichannel customer is our most engaged and valuable customer. Our digital business generates approximately $6 billion in revenue across all 3 brands and contributes to profitability. And we see digital as a key engine of growth moving forward. We will improve the digital experience by enhancing features across both dot-com and the app. We will grow our customer franchise with a strong focus on personalization and continued innovation to deliver the best digital fashion experience to our customers. And we will continue to strengthen the profitability of our dot-com business by growing store pickup and ad monetization. Fourth, optimize our store portfolio. We will continue the Growth treatment for our stores in the best malls, including another 100 stores this year. We will focus on improving productivity in our neighborhood stores. We will find ways to profitably expand off-mall, including freestanding Backstage stores. And beginning with 3 markets this year, we will test and prove a market ecosystem to find the right mix of format and location of our stores that drive maximum sales growth across both our stores and digital business. And five, reset our cost base. We're rightsizing our organization, streamlining our store fleet and addressing the inefficiencies in our fixed cost base. And we're focused on improving the productivity of our working capital. We took a big step forward with this in February with the restructuring that we announced, and we will pursue the remainder of our cost reduction goals with discipline. We are committed to delivering all 5 points of our Polaris strategy over the next 3 years. 2020 is a crucial year for us as we implement the structural changes that this plan requires through critical steps necessary to stabilize profitability and cash flow while also repositioning the company for future growth. We're confident that the Polaris strategy will change the trajectory of Macy's, Inc.'s performance, and the team is fully focused on executing our plan. Our vision for Macy's future is a retail ecosystem that gives our customers easier and more convenient access to the fullness of the Macy's brand, from online to off-line, on-mall to off-mall and full price to off price. And when we execute our strategy and get this right, Macy's will grow again with the next generation of American up -- shoppers. Thank you. And with that, I'll turn it over to Lorraine.

Thanks so much, Paula. I wanted to kick things off with a broader macro question. How do you think your core consumer is today?

Well, what I would say, Lorraine, is very similar to what we've said before, with the obvious caveat being that our outlook was prior to the COVID-19 outbreak and the oil plunge. So here's how we think about the consumer fundamentals. U.S. job, wage and income growth remain solid, which should contribute to consumer spending. But while the consumer environment remains healthy, we do expect slower economic growth overall versus prior years. And so with that in mind, we would expect that we would maintain our relative market share as a starting point for how we think about 2020.

Thanks. And then the potential impact to supply chains and sales from the coronavirus is top of mind for investors right now. In terms of sales, are you seeing any impact from the softer tourism? And how exposed are you to this revenue stream?

Yes. So I would start by, again, just saying, as I said in my opening comments, that this continues to be very much an evolving process, and we're getting updates from our teams on a daily basis. And again, first and foremost, our colleagues and customers are top of mind, and we're taking every precaution there. And so as this continues to evolve and more cases are being identified throughout the U.S., it's still too soon to quantify what the impact on sales could be. But what we can say is that we're certainly seeing a slowdown in international tourist sales. And as for the impact from the domestic customer, we'll continue to monitor that very closely.

And then what are you seeing from a supply chain perspective with regards to potential factory and transportation delays? Are there anything that you can do to mitigate the impact?

Yes. So with respect to our supply chain, our team here is just doing an outstanding job keeping us abreast of -- with the latest information and really navigating through the shifting landscape. And so since we last spoke on our earnings call about 2 weeks ago, here's what we know. As it relates to private brand, over 95% of our impacted factories are now open, and most factories have more than 80% of their workers who have returned to work. We do see receipts being impacted from product directly manufactured in China as well as those products that are manufactured outside of China but have raw materials that are sourced in China. And so we have a number of mitigation strategies at our disposal, but we do expect to see some impact in the first quarter and, again, most of the impact in the second quarter. And then as it relates to the other 80% of our business, which are market brands, we're currently modeling a number of scenarios with our partners that will give us the ability to leverage air or some combination of ocean and air to expedite the product to the U.S. where necessary. But again, we're keeping a very close eye on this evolving topic. And our teams are reacting swiftly, and they're responding with measured actions to just ensure the least amount of risk for our colleagues, our customers and our product. And then one more reminder is that while we do expect to see an impact from the outbreak in 2020, these impacts from the coronavirus are not included in our current guidance. So we'll continue to keep everybody updated on this.

You've built one of the largest online retail businesses in the U.S. How do you plan to reinvigorate this business? And what are the opportunities to minimize margin pressures from digital orders?

Sure. There are 3 key pieces as we look at the online business. We've got the digital operation itself, then the marketing piece and then interwoven throughout is the financial savings piece. So starting on the digital side. Jill Ramsey, our Chief Digital Officer, outlined on Investor Day our strategy to reaccelerate on digital growth. And it starts by elevating the digital experience through improvements to our site and our app as well as our omnichannel capabilities, and we'll do this by making our site and app faster and easier to navigate. And we'll also enhance the delivery experience, being more clear on available options and setting clear expectations and delivery dates. We'll grow our customer franchise with a strong focus on personalization and continued innovation to deliver the best fashion to our customers. And we'll also strengthen the profitability of our dot-com business with digital driving improvement by improving the impact of online return and increasing order pickup in our stores. And in terms of marketing, as Rich Lennox, our Chief Marketing Officer, shared at Investor Day, a part of our marketing strategy to -- through Polaris is to accelerate personalization and site monetization. Our loyalty program in particular provides us with valuable behavioral insights that gives us a deep understanding of our customers and also fuels the model that we can use to deliver personalization at scale. And then in 2020, we expect to expand that insight through Loyalty 3.0. And when we get this right, we will combine the power of personalized algorithms and the art of fashion curation to make sure that we inspire customers with fashion tailored for them. And then finally, as I mentioned at Investor Day, through Polaris, we're committed to stabilizing margin in 2020. We anticipate $600 million of Polaris savings over the next 3 years that will improve gross margin. So from initiatives like centralized fulfillment, location-level pricing, markdown optimization, to name a few. And we've been piloting these initiatives and seeing promising results, and so now we're rolling them out. And we're using these savings to offset our changing mix of business as we go where the customer is going. We're redeploying capital from the lowest-performing stores to assets such as digital and Backstage that can generate a higher, longer-term return. So as we pivot towards these lower-margin businesses like digital and Backstage, we're offsetting the short-term margin impact with savings so that we can stabilize our gross margin while we increase the scale of these businesses.

And it sounds like some of the larger drivers of SG&A spending over the next few years will be digital, Backstage. How are you thinking about prioritizing that investment? And when you think about the fleet, will the fleet require substantial investment at this point?

Yes. So just to contextualize that a bit, we are really focused on the 2 main buckets: rolling out Backstage in both store, within store and freestanding, and investing in IT. And we're continuing to invest in our store fleet, as we discussed, through our Growth treatment strategy. And so we're prioritizing according to the return on the business.

And then you presented a very robust $1.5 billion cost savings program at the Analyst Day. Can you just contextualize for investors where the biggest pieces of those savings are coming from and also what you're doing to minimize disruption to the business?

Sure. So just to help contextualize where the savings are coming from, I'll walk through a few of the largest pieces. Our Polaris savings within SG&A are broken into 4 buckets that total $900 million over the next 3 years. So the corporate bucket is about $500 million, and that includes things like campus consolidations and headcount reductions that we've begun, technology efficiency, so system modernization and consolidation; and then there's the marketing and stores bucket, which is about $300 million, so that includes optimizing media and production spend within marketing; and then productivity enhancements like self-checkout and new handhelds within our stores; and then the supply chain, which is about $120 million, which includes things like small-parcel contracting, consolidating freight providers. And then in terms of gross margin, they're also broken down into a few buckets: so supply chain, which is about $300 million, that's basically the centralized fulfillment of what we previously called Hold & Flow; private brand sourcing, which is about $100 million; merchandising mix and pricing, that's another $100 million, so that's the location-level pricing and markdown optimization that we've been speaking about; and then marketing, which is basically more targeted Star Rewards, passes and also couponing. So those are the big buckets. And then in terms of how we are minimizing disruption, we've taken great caution with the operational and day-to-day components of our business to mitigate business disruption. We've actively recruited and are still recruiting an onboarding key talent in specialized positions for the past several months. So we got an early start in New York and Atlanta. And we've been impressed by the talent that we're seeing, highly skilled individuals in New York and the diversity and depth of technical expertise and skills available in the Atlantic area. So I would say that our office consolidation is progressing as anticipated. But that all said, we do expect to see most of the disruption in the first quarter, with improvement thereafter in fall is expected to be slightly better than the spring.

And one of your key initiatives is continuing to expand your Backstage concept, both through shop-in-shops and opening more freestanding stores. On the shop-in-shop side, can you talk about the performance you're seeing? And give us some of the key learnings.

Sure. So starting with the performance in the Backstage store within stores. As of the end of 2019, they're driving about a 5% comp. And we have learned that a store within a store needs to be in a clearly identified and contained Backstage environment within the store, and it needs to sell all the relevant categories you would expect within an off-price offering. Total square footage is one of the areas where we have iterated. We started with around a 20,000-square-foot environment. And what we have learned is that the ideal store within a store is about 12,000 square feet. So as we've been rolling them out, we've been adapting to that size. And then secondly, in terms of our Backstage customer and what we've learned, it's as follows. So our Backstage customer is slightly younger, less affluent and more diverse, and they live in a household with children. 43% of our Backstage customers shop on macys.com, and 76% of them shop in a Macy's store. And they are valuable and very engaged with the brand. And then as we look at expanding our freestanding business, currently we're still growing our Backstage store-within-a-store business, and they're in over half of the Macy's locations.

And in terms of opening freestanding stores, how is the current fleet performing? And what have you learned from these stores?

So we have opened store within stores in every climate, region and market except for Puerto Rico and Guam. And while we still think that there's a lot of room for these stores to grow, we have a scale fleet to work with. So we've turned our attention to the freestanding stores. What we're seeing in the stores that we have, the freestanding ones, is 4x the sales in the current freestanding locations than we see within the store-within-a-store model. And so we think that there's opportunity here, and we're testing this model in our key markets. So with expansion of the freestanding concept, we see an opportunity to grow existing share of wallet with our customers and onboard new customers to the Macy's brand. And these locations that we're rolling out will serve our customers in 2 exciting new ways: They will take returns from Macy's full-line locations, and they will create new pickup locations for BOSS orders.

And how big are these freestanding stores? And what rekindled your interest in opening stores outside of your core fleet?

So we know our customers are shopping differently than they did, say, 3 years ago. So for example, we have a large number of customers who no longer are shopping regularly in malls, but they know when they shopped Macy's in the past. And so Macy's current fleet may not include a physical store in the places where they're shopping regularly today. And so our research and our initial tests suggest that we can win with these customers by leveraging our brands combined with an omni, non-mall-based retail experience. Our Backstage freestanding concept is an important part of the larger market ecosystem, and so we think about it that way as well. We have the opportunity to build a broader yet integrated Macy's experience within a metropolitan area. So as we take a look at the market areas, to the extent that it makes sense, we will fill out those markets with a freestanding store, whether it be Backstage or new store formats, to help retain the customers that we fire when we close a store. And so there are about 30-or-so stores planned. Oh, actually, we've got 7 this year and 25 next year. And the stores are about -- I'm going to say between 25,000 and 30,000 square feet. Let me -- yes. Yes.

And then you're continuing to ramp the Growth treatment program. You're at 150 stores today and are adding another 100 in 2020. When you look at the latest class of 100 stores versus the initial 50, are there any big differences in what worked?

So I think it's important to start with our selection for Growth stores, which is we select stores for the Growth treatment. We're looking at where our mall developers are sort of investing in those malls. And so with that as background, in the first 2 years, in the 150 stores that received the treatment, we've generally seen a 1.9 percentage point increase. And so specifically in the fourth quarter, our 150 stores with the Growth treatment, which contribute roughly 50% of our Macy's brick-and-mortar business, outperformed the rest of our fleet by about 3 points. And as John Harper, who is our Chief Operating Officer, said at Investor Day, there are certain product initiatives that are more effective in helping to boost the store's performance within the Growth treatment. So for example, our top-performing Growth treatment upgrades include food and beverage, big ticket, beauty, fine jewelry. And so we're very, very surgical about how we deploy the Growth treatment as we move forward based on the research. And also, in addition to the benefits to the store sales when we make the Growth investment, we've seen a 2 percentage point lift to our macys.com sales in the corresponding ZIP codes, which adds to the return of this investment. And so the original Growth 50 locations outperformed the Macy's store fleet by about 3.5 percentage points in 2019. So we're committing to another 100 stores in 2020. And with this, we will have touched about 73% of Macy's brick-and-mortar sales. And so what has worked in our original Growth stores will, again, inform how we invest going forward.

And your loyalty program has undergone a transformation over the past few years. Can you talk about the changes that you've made so far? And what's to come with Loyalty 3.0?

So just to give you a little history about the evolution of our Star Rewards loyalty program, we launched the first phase of Star Rewards in October 2017. And so this phase was focused on our best customers who we call advocate and convinced. The benefits included 5% back on the top tier, which is Platinum, and free shipping for the top 2 tiers, which is Platinum and Gold. And then in May 2018, we launched the second phase, which is Bronze, and this phase was targeted at our non-cardholders and customers that shopped us that we didn't know much about. And so we were pleased with the results of Phase 1 and 2 but not satisfied. And so in February 2020, we launched the third phase, and this phase is targeted at improving engagement of customers who visit less often, who we call occasionalist. And we added 1% back reward to all remaining tiers of Gold, Silver and Bronze, and we eliminated less productive markdowns in order to fund this as part of our loyalty strategy. So that's how we're approaching loyalty.

And how will you measure the success of this next iteration?

So we'll look at increased customer spend, the number of visits and the quantity of active members. Yes, those are some of the ways.

And is there more you'd like to do with loyalty on a go-forward basis?

Yes. I mean absolutely. We continue to evolve the program, and we will continue to iterate and measure the results, see how we're engaging and the customers are engaging with us so that we attract new customers to our brand. But we're always looking to evolve this program.

And Paula, you're planning to close 125 stores over the next 3 years. What went into the decision to close these doors? And what are your criteria for closing a store? And maybe talk about how that's changed.

Okay. So the neighborhood stores, about -- the 125 stores, represented about 25% of our store count and less than 10% of our sales volume when we decided to close them. And they're mainly in C and D malls or in markets where we have multiple stores in close proximity. And so while these stores are still cash positive, we expect them to decline at a more rapid pace over time. And so over the course of 2019, we tested new labor models for these neighborhood stores, new layouts and new strategies, and we weren't able to find a brand-right solution that also met our profitability goals. So to select these stores for closure, we conducted a rigorous review of our entire fleet, and we used a market-based approach. And this was informed by store-specific considerations and also included the trajectory of long-term profitability and strategic significance to our brands and customers and the omnichannel business in that particular market. We also looked at the current view of each store's value versus real estate value. So we factored all of these different things into our decision to close these stores. And so these stores will continue to serve an important role in fulfillment and convenience to our customers in those ZIP codes until they are closed. And as we close them over the next 3 years, it will give us a chance to migrate the customer to another format like Backstage or the new store format. And so as we think about our store fleet going forward, our strategy will not be limited to mall-based retail. And we won't be constrained by our current store footprint and format. And as I touched on earlier, customer shopping habits are changing. So we're looking at the market as an entire ecosystem, not just the brick-and-mortar volume or the digital volume, but understanding the total way in which our customer interacts with us and giving her the touch points she needs to keep her engagement with us. And so that led to our freestanding Backstage expansion and the small-scale lifestyle store concept so that we can look at the entire ecosystem.

And do you still plan to spend about $1 billion on CapEx annually? Can you help break down that spending between the different parts of the business?

So I'll give you the big buckets. First, we're investing more in modernizing our foundation, which we're means continuing to develop the merchandise and supply chain to bolster operating performance. And so you heard Patti Ongman and Dennis Mullahy talk about that at the Investor Day. The second bucket is investing in assets that can be our future. So this is investing for sustainable digital growth and testing and scaling the new retail concepts. Third, and we're reinvigorating our retail platform, and this involves upgrading the highest-potential areas of our store fleet. And this is really about being more productive with our capital in the Growth treatment locations versus spending quite a bit more in total remodels, as we did in the past that really weren't giving us the return that we were seeking. So now we're touching more of our stores, and we're thinking about CapEx store -- in our stores differently. And so as we discussed before, we didn't invest in the stores previously as much as we probably should have. So now we're going broader in terms of how we think about store investment. And then the final bucket is making brand-right improvements, which we're down-trending as a percent of the total capital based on our previous investments along the way. We're spending our CapEx on the go-forward fleet. And again, we're able to be more productive and surgical with the use of that capital. And all the while, we're applying a rigorous capital prioritization and investing strategies, requiring our project plans to exceed a hurdle rate that is appropriately in excess of our cost [indiscernible].

And then you expect to be within your target leverage range over the next 3 years. How big of a priority is that for you today?

So I would say that it is a big priority. Our target leverage range is what we believe to be our optimal capital structure, which is -- also happens to be commensurate with an investment-grade profile. So we're really targeting a leverage ratio that we're comfortable with and that will allow us to be more flexible and more durable as we move forward. And it is based on our analysis of our optimal capital structure. And so that's a priority for us.

And not all of your peers are investment grade. So why is investment grade important for Macy's?

We believe and the market data shows that investment-grade companies have the more cost-effective access to capital. And so it's really just an important mechanism to indicate financial strength and prudent risk management to our partners and our vendors. And we can't control how the rating agencies rate us, but we are focused on what we can control, and that is really encapsulated in our plans to stabilize and then grow profitability and cash flows and also to prudently manage our balance sheet and to move towards our optimal capital structure, which -- that's the most important aspect of the target leverage ratio, and it is also commensurate with an investment-grade profile.

And Paula, you announced plans to build a tower on top of Herald Square. What were the thresholds from a return and proceeds perspective that you used to make that decision?

So we're still working through the planning and vetting process, and there are a number of hurdles that we need to cross before we can share a lot of concrete details. But we do believe there's a lot of value in a successful up-zoning for a tower at Herald Square. And we don't necessarily disclose the return metrics or potential proceed amounts, but we would expect it to clear all of our hurdle rates.

And how do you balance monetizing this important asset with a potential disruption?

So we've done, as you can imagine, quite a bit of analysis to ensure that we minimize disruption. So we've done extensive studies of the right kind of foundation structure for the tower to minimize the foundation's footprint in the store itself, which led us to this table-like structure where the legs of the table can be skinny and minimally invasive. And this minimizes both the temporary physical disruption of construction and the time construction will take, which, when combined, have a multiplier effect on disruption. So it further minimizes the permanent loss of selling square footage around the foundation after the foundation is complete. So we've been studying this in some detail. We studied, for example, the location of the office lobby in many different parts of the store, and we chose the current 35th Street location over any of the other street addresses that may have been better from an office or marketing the office perspective that would increase the disruption to our store. And then we chose the sky lobby design for the tower, which minimizes the footprint needed for the office lobby at the ground level, which is our most productive selling level of the store. And so that minimizes the amount of selling square footage that would have to be converted to office square footage. So we've been very careful to seek this balance.

And how should we think about the time frame of this project?

The approval process will dictate many of the details that would drive the schedule or the timing for the project. But should we pass those hurdles, we'll be able to share more concrete details on the timing of the project.

Great. And then the initial 2020 guidance is for a decline in credit income, but it continued to be planned through 2019. What's your -- what's driving your forecast for a decline? And are there areas for potential upside on this line item?

So at -- down 60 basis points, credit penetration was softer than we would have liked, but that's against 80 basis points of increase versus the prior year. That's in Q4 of last year. So we're pleased to have credit penetration up for the second year in a row. In the fourth quarter, our total loyalty penetration was up 90 basis points as more Bronze members came into the program. And so that is also a factor. We do expect our credit revenue to decline year-over-year, which is a combination of top line sales decline and our expectations that a slight uptick in delinquency and bad debt continue in line with market trends. And then as we announced on Investor Day, with Loyalty 3.0, we've expanded the benefits of the program for Gold and Silver cardholders, which we expect will continue to drive customer lifetime value and migrate many of those customers into higher tiers over time. And so as we build momentum throughout the year with Loyalty 3.0, there is the potential for credit penetration upside. So that could drive it higher.

Great. And I think we are about out of time. So Paula, I wanted to say thank you very much for participating. And we appreciate all of your insights.

Absolutely. Thank you.