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Analysis: Macy’s in better shape, but still has much work left to do

After a very positive start to the year, the shine seems to have worn off Macy's second-quarter sales numbers. In reality, however, there are reasons for the apparent slowdown in growth. Foremost among these is the shift in the promotional calendar, most notably to the spring Friends & Family event; this boosted first-quarter trade and negatively impacted this quarter. When the effects of this move are taken into account, comparable sales rose by a more respectable 2.9% on an owned and licensed basis.

Given the various shifts, a more balanced measure of performance is to look at the first half of the year. On this measure, comparable sales were up by 1.9% on an owned basis -- which is at the upper end of Macy's guidance for the full year. In our view, this is a respectable result. We are equally encouraged by the continued expansion of the bottom line where net income rose by a strong 60%. This is mostly thanks to better inventory control and the growth of own-label sales, both of which have helped to ease up margins.

All of that said, we are still of the view that Macy's is a long way from being back to full health. The sales numbers are strengthening, but they are doing so off the back of a very strong consumer economy, and it remains the case that Macy's growth is below that of the retail market. By our calculations, it is still losing market share across a number of categories.

Moreover, with the closure of underperforming stores, a natural bounce to comparables is to be expected - especially as some of the trade from shuttered shops finds its way to both other locations and to the digital channel. Finally, Macy's is up against some very weak prior year comparatives; for example, last year's Q2 comparable sales were down by 2.8%. In this context, we believe that trading at Macy's could and should be somewhat stronger.

One of the reasons for relative underperformance is that Macy's is still in the foothills of implementing a holistic strategy. For example, while it has 50 stores where it is quickly implementing new ideas and plans, improvements to much of the rest of the chain are partial. Many shops remain underinvested in and have a down-at-heel feel. While things like better inventory control and an enhanced assortment are helping to raise the bar, they are insufficient to propel growth. To drive that Macy's needs to make more substantive investments across its fleet.

Our sense is that these investments will happen, but the pace of change will be gentle rather than radical. We also hold the view that Macy's will trade-down some stores that are still viable but where it does not believe there is much of a future and therefore little rationale for investing. This will likely result in further store closures over coming years.

One thing boosting performance is the expansion of Backstage [Macy’s off-price concept] which is now happening much faster. It is notable that Backstage is being opened in premium locations, which we believe is a sign of the company's growing confidence in the format. We expect that Backstage will make a positive contribution to growth over the remainder of this year, however, we still have some concerns over the long-term impact on both the brand and full-price sales -- especially if the consumer economy starts to falter.

Overall, Macy's is in much better shape than it has been for years. However, there is still much work to do in refining and honing the proposition.
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