Will Macys' Operating Earnings Continue to Decline.

Implications: Macys' performance is less one of a slowing economy, as much as it is about basic merchandising and value at the local and regional level.  Here's why earnings may continue to decline at Macys.

Analysis: By now it should be clear Terry Lundgren’s ‘one department store fits all’ vision wasn’t the epiphany that investors had hoped.  According to Macy’s, first quarter sales declined (2.9%), while comparable store sales decreased (2.6%).  Translating that to earnings the company said first quarter operating income was $30 million or a decline of (85%) when compared to the same period last year.  Excluding approximately $110 million in one time consolidation costs and contingent liabilities, operating earnings still decreased about (33%).   

Just what was counted as a part of the $87 million in consolidation costs is uncertain.  With two Christmases behind the new Macys' organization, investors should be asking when these recurring ‘onetime’ costs get reclassified as on-going costs of doing business.  In any case, the continuation of these costs raises the question of just how efficient the new structure really is now or will be in the future.   

In addition to higher costs, Macys is struggling to drive top line sales too.  Part of the problem is the economy.  However, that excuse probably underestimates the sales problem.  Customers of the legacy May Co. stores continue to feel the new Macy assortments are either over priced or out of place for their region of the country.  Similarly, Macys' high customers are anxious to see better products and better fashion in their stores.  Now, the Chairman and CEO is struggling to simultaneously remerchandise the Macy’s brand as both a high end and mid-market department store.  

One such attempt is evident in the company’s plans to open FAO Schwarz toy stores in selected Macys' locations.  The company first tested the idea in its State Street location in Chicago, IL in 2007.  Evidently, the 5,300 square foot toy store was successful in what used to be Marshall Fields flag ship location.  Now, the company wants to open about 700 FAO Schwarz departments ranging in size from 200 to 3,500 square feet in most of its Macys brand stores.     

Clearly, the FAO Schwarz ‘store with in a store’ idea is a part of Terry Lundgren’s effort to reenergize the company’s faltering luxury business through local merchandising.  However, whether there’s a market for 700 FAO Schwartz toy stores/departments is problematic at best.  There were only about 42 of the high end toy stores in operation prior to the parent company filing bankruptcy in 2002.   Since then, both the FAO Schwarz New York flagship store and Las Vegas location has reopened and the company has purchased the expensive, preppie children’s clothing business Best & Co.  

This suggests a select few of Macys' locations could successfully sell FAO Schwarz branded toys.  But what remains uncertain, in spite of the State Street store test, is how well the remainder of the Macy’s stores will sell $500 Barbie dolls or $350 Hickey Freeman sports coats for preschoolers if Best & Co products are eventually added to the merchandising mix.  Obviously, it’s to soon for investors to know whether Macy’s new toy strategy will steal any business from stronger toy competitors like Toys R Us or Wal-Mart.  

Sadly, despite promises to fine tune the merchandise mix at the local or regional level, Macys' image has been irrevocably blurred during the process of consolidation.  Contrary to management’s belief that the issue is one of perception, many former May Co. and Federated brand customers see the difference in terms of the variety of brands and price points carried at the stores level.  That’s not something an accelerated PR campaign or the introduction of a few iconic brands will resolve.