Macy's Holiday Prospects May Be Good But Long-Term Chances Murkier

So, will Macy’s stumble in the holiday season or is it just playing possum?

Although the company reported a third-quarter loss that was less than expected, the department store’s guidance for the holidays didn’t live up to analysts’ expectations, which hurt its stock and renewed speculation that the frugal consumer might snub it this holiday season. Macy’s (M) inventory, however, is down over seven percent year over year and fewer markdowns helped the company post the lighter-than-expected loss. Better inventories and more customers paying full price should help for the holidays.

Still, the jitters in the financial community may reflect something more than just conservative guidance. Some analysts continue to worry about the chain’s ability to build sales and earnings as it struggles to complete the integration and repositioning — as Macy’s — of the various department stores it acquired earlier in the decade. Add to that a consumer who is worried about spending and turning to retailers such as Kohl’s (KSS), Costco (Cost) and even Walmart (WMT) when they are willing to spend a few bucks, and prospects look challenging.

Doug Conn, a managing director at Hexagon Securities, an investment banking and securities firm based in New York, assessed Macy’s prospects for Bnet after it posted third quarter sales.

Bnet: Macy’s raised its earning guidance but not as much as some analyst hoped for. Is that a sign of operational weakness or conservatism?

Conn: Believe it is more conservatism. Management stated there is more uncertainty than usual in the current environment so it does appear they are being conservative — for this reason — in their guidance.

Bnet: Can Macy’s drive business without resorting to deep discounts in holiday season?

Conn: It is unclear if Macy’s can avoid deep discounts over the holidays but this is clearly their stated intent. They appear to believe that they are managing their inventories very efficiently and, therefore, they have done what they can do to prevent discounting. However, they cannot control what their competitors do or any impacts of the macro economy on the psyche of the consumer, so the jury is ultimately still out on whether they and other department stores can avoid discounting.

Bnet: Macy’s likes to talk about its My Macy’s initiative, where it has local teams developing merchandising and relaying feedback about trends in the communities they cover. But, given that buying is done in New York, can the company really respond to local markets and will its My Macy’s initiative strengthen the operation long term?

Conn: If the local initiative is properly executed, I don’t believe having the purchasing centralized should be viewed negatively. The corporate office has the most purchasing power via its economies of scale so it likely will be the most cost efficient to do all purchasing there. It should be expected that the orders will differ from region to region, which should allow managers to more accurately target local customers’ tastes. Macy’s overall scale will allow them to process these orders most efficiently for their regional purchasing managers.

Bnet: Opinions seem to vary on Macy’s and where it is in terms of establishing its national presence in the aftermath of its acquisitions and replacement of names such as Marshall Field’s with Macy’s. So, what are the most important assets that Macy’s can draw on to strengthen its performance in the recovery and beyond, and what challenges loom as potentially the more significant in terms of their ability to force a radical reform of the company?

Conn: Macy’s most important asset now is its national scope and scale.  It is among the largest department stores/retailers in the U.S. and should enjoy favorable treatment from its suppliers and pricing power and exclusive product offerings once the economy rebounds. Perhaps the biggest challenge now facing Macy’s is its positioning in the market. With the dawn of the new frugal consumer, stores which are perceived more as discounters, or at least more aggressive on pricing, are attracting greater traffic. This new behavior has caused real issues for the higher-end and moderate-line department stores.  Macy’s needs to walk a fine line between competing on price with its lower-end competitors and providing product which is perceived to be more moderate/higher end in nature.  It is, in my opinion, a very difficult strategy to execute. Of course, if the economy and consumer reverts back to the way they were prior to the current recession, then this will not be an important strategic issue for Macys.