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Department store blues: Macy's shops for growth

Alexander Coolidge
acoolidge@enquirer.com

Macy's is shopping for its next growth opportunity as U.S. department stores struggle to hold onto shoppers.

The Cincinnati-based retailer recently announced plans to acquire a beauty and spa retailer. It also has charged top executives to explore an off-price concept (think T.J. Maxx or Nordstrom Rack). The company also is building stores in the Middle East and keeps flirting with more international expansion.

Behind Macy's moves are the cold reality that its core industry is under siege: department stores' share of total U.S. general merchandise, apparel, accessories and furniture sales have been cut by more than half over the last two decades. Department stores' slice of that $1 trillion pie has gone from 33 percent in 1992 to 13.3 percent in 2014, according to U.S. Census data.

If Macy's wants to get bigger, it may need to look beyond department stores, analysts say.

"The numbers of new malls being built are few and far between – department stores are a shrinking format," said Matthew McGinley, an analyst with Evercore. "Their customer is increasingly shopping in other channels."

Macy's executives are openly talking about a "third phase" of their strategy.

"We expect some of these new activities to enter start-up phases later in 2015, and we remain committed to succeeding in a test-and-learn environment where the best and most promising ideas can be ramped up quickly," CEO Terry Lundgren said last week.

Exploring future growth possibilities

Macy's executives admit they are looking beyond department stores to grow future sales, but so far have only sketched out areas they are exploring. The company has earmarked $100 million of its $1.2 billion capital budget for new growth projects. They say they will disclose new initiatives being tested within a year.

Analysts are the most optimistic about the possibility of Macy's launching a new off-price division. They note off-price retailing – with players like T.J. Maxx, Burlington Coat Factory and Ross Stores – is growing while overall sales for department stores shrink.

Macy's already has a small chain of 13 Bloomingdale's Outlet stores, but the retailer says it is exploring opportunities beyond that concept.

Analysts point to Nordstrom, which has barely grown its revenues for its namesake stores, but grown the off-price concept Nordstrom Rack by 57 percent in the last four years into a $3.2 billion business unit.

If Macy's does it right, analysts say the retailer could use a new off-price concept to court younger and thriftier Millennial customers – who might later become customers of the flagship Macy's brand as they grow older and prosper.

"Off-price is outperforming," said Richard Jaffe, an analyst with Stifel. "There's a lot of crossover opportunity."

Macy's is also seeking to grow through its pending $200 million acquisition of beauty product and spa retailer Bluemercury. The company expects to close this spring on the deal for the Washington, D.C.-based chain of 60 specialty stores in 18 states.

Macy's said it plans to expand the chain as a standalone business, while also adding selected Bluemercury products and boutiques to Macy's stores and its web site nationwide.

Analysts say high-end beauty products make sense, but the trick will be expanding the concept without becoming a distraction.

Macy's also keeps talking about possibly opening more stores overseas. In 2010, it opened its first international store, a Bloomingdale's, in Dubai, Saudi Arabia, which is operated by the Al Tayer Group.

Last fall, Macy's said it would open by 2018 a second Bloomingdale's and its first international Macy's in Abu Dhabi, United Arab Emerates, under the same partnership with the Al Tayer Group. Macy's is also mulling opening stores in China.

Analysts say international expansion for any retailer is risky. They note many successful U.S. retailers have had very mixed results outside the country – Target's recent withdrawal from Canada is only the most recent failure.

Different customers with different tastes, different supply chains, different regulations and real estate all make translating retail concepts difficult outside their native countries.

"Harrods is legendary in London – but they're not in New York, why do you think that is?" asked Paul Swinand, an analyst with Morningstar. "It's obviously hard to do."

Macy's evolving growth strategy

Macy's executives describe the company's last 10 years in two phases.

Macy's became the nation's second-largest department stores behind Sears Holdings in 2005 after it bought out its largest direct competitor May Department Stores in a $16.6 billion deal.

The deal created a juggernaut with more than 800 department stores in 49 states. But company officials worked quickly to update and integrate operations.

Macy's – which had already jettisoned its own storied, but tired regional department store names like Lazarus in the Midwest – ditched May's regional nameplates like Marshall Field's. The company also sold off May's 49-store upscale concept Lord & Taylor and nearly 700 bridal stores operating as David's Bridal and After Hours Formalwear.

The retailer also sold off or closed dozens of overlapping or underperforming stores.

Starting in 2008, Macy's began a second phase of integration. The retailer worked to boost stores performance and profitability by customizing local merchandise and enhancing customer service. The retailer also deployed numerous strategies to encourage shoppers to shop stores but also their web site.

Macy's stock has soared with its profitability even as its annual sales have only climbed modestly. In 2007, the retailer earned a $995 million profit on $27 billion in sales. Last week, Macy's reported it earned $1.5 billion on sales of $28.1 billion.

Macy's stock hit an all-time high of $68.30 on Jan. 8.

"Coming into 2015, we entered our third phase," said chief financial officer Karen Hoguet. "Having now reached one of the industry's highest profitability rates, we are focusing ourselves on accelerating top-line sales growth. ... This new phase we have entered has the opportunity to take our company to a whole new level of success."