F305:Project2

ValuingMacys

Section25654
Team71:002:15

DanielEads
AkashMiriyala
AndrewRodela
KunaalUmarwadia

ExecutiveSummary
OurgoalwastocompleteavaluationanalysisonMacysandcalculateitsstockprice.The
analysisincludedtheconstructionofproformastatements,subsequentlycalculatingfreecash
flow,theintrinsicfirmvalue,andarrivingatstockprice.

Ouranalysisshowsanestimatedpricepershareof$74.67.ComparedtotheApril21,2015stock
priceofaround$67.03,ourrecommendationwouldbetobuyMacysstock.However,we
understandourmodelmayhavesomediscrepancieswetestedthisbyrunningasensitivity
analysisusingterminalsalesgrowth,WACC,andtheinflationrateaskeyvariables.Wefound
thatsharepricewasmoderatelysensitivetotheterminalrealsalesgrowth,as2%realsales
growthincreasesstockpriceto$82.WhileMacyssharepriceissensitivetoWACC,wedonot
believeWACCwillchangesubstantiallyinthefuture.Inflationaffectsmanyfinancialstatement
lineitems,howevertheassumedinflationratewas3%,whichisabovethecurrentinflationrate
ofabout1to1.5%.Atcurrentinflationlevels,thesharepriceisabout$65$70.

Inouranalysis,ourmajorassumptionsincludedusingcashastheplug,usinginflationto
estimatesomebalancesheetandincomestatementaccounts,andthetreatmentofcertainother
atypicalaccounts.

Introduction
Macysisadepartmentstorecompanyfoundedin1858withtwodivisions,themidrange
MacysInc.andthehigherendBloomingdales.MacysisthelargestU.S.departmentstore
companyintermsofsales,withjustover$28billionin2014sales.Macysdepartmentstores
offerawidevarietyofproducts,includingclothing,bed&bath,beautyproducts,jewelry,and
homegoods.Intheclothingdepartment,Macyshasprivatelabelbrands,suchasKarenScott
andJohnAshford,whicharedesignedtotargetspecificconsumers.

Retailisahighlycompetitiveindustry,withvolatilerevenuesdeterminedbyoveralleconomic
conditions.Withtheimprovingeconomy,growthisexpectedoverthecomingdecade.Macys
competitiveadvantagesincludeitsdiversesupplierbase,MacysThanksgivingDayParade,and

itsomnichannelstrategyofcreatingadditionalwaysforcustomerstoshop,suchasonlineand
throughmobileapplications.Themaincompetitorsinthedepartmentstoreindustryinclude:
Dillards,Kohls,JCPenney,Sears,andBonToninthemidrange,andNordstrom,Lord&
Taylor,VonMaur,andSaksFifthAvenueinthehighend.

DataandAnalysis
ProjectingSales
Macysiscategorizedasalowgrowthfirm,astheretailindustryissaturated,andMacysother
competitorscannotmaintainhighgrowthratesduetothenatureofbusiness.Macysisnolonger
inthegrowthstagebecausewedonotseehighcapitalexpendituresintoproductdevelopment
andpromotion.Therefore,webelieveMacysisinthematuritystageofthelifecyclewithhigh
competitionandpressurestodrivedowncosts,andmaymoveintothedeclinestageifitstartsto
seeadeclineinsalesandprofits.Manyfactorscouldcausethisdecline,includingchangesin
consumerpreferences,recessionarypressuresdecreasingspending,orevenaninabilitytoadapt
tochangingcoststothefirm.

Todevelopsalesestimatesforthenexttenyears,westartedbyexaminingrealsalesforthelast
tenyears.Therealsalesgrowthwasquitevolatile,whichisexpectedsinceMacysisa
discretionarycompany.Wechoseannualrealpersonalconsumptionexpenditureson
nondurablesasourdriverforMacyssales.Macys,alongwithotherconsumerbrands,fallsinto
thistypeofpersonalspending.WeregressedMacysrealsalesgrowthagainstthereal
nondurablePCEgrowth,whichgaveanadjustedRsquaredvalueofabout.5indicatingthe
growthismoderatelycorrelated.Thetestwassignificantasthepvaluewas.02,below.05.See
exhibitAforthegraphofoursalesforecast.TheslopeoftheregressionshowedthatMacysreal
salesgrew3.4%forevery1%increaseinrealPCE.ThisgaveusconfidencethatrealPCEwasa
gooddriverforMacyssalesgrowth.Ourcalculationsfoundtheaveragegrowthwas1.2%,
whichresultedinMacysgrowthbeing.6%.

Whilethelongtermrealsalesgrowthratewasestimatedtobe.6%,weexaminedMacys10K
andconferencecallsformoreguidance.Initslatest10K,Macysestimatednominalsalesgrowth
ofonly1%in2015,resultinginarealsalesgrowthof1.9%assuminga3%inflationrate.Onits
Q42014earningscall,Macysannouncedthatithadalreadystartedtoinvestinchangestoits
business,suchasanewITinfrastructure,topromotegrowthinsales.Weestimateda3year
salesgrowthperiodfrom20162018basedonthisgrowthstrategy,withrealsalesgrowthin
2018stabilizingat0.6%.

IncomeStatement
Ourincomestatementstartedwithournominalsalesforecastsfollowedbyforecastingthe
operatingmargins.Wenoticedthatthecostofgoodssoldwasslowlyincreasingto60%ofsales,
andturnedtothe10Kformoreguidance.Inthelatest10K,thecompanyannouncedthatthecost
ofgoodssoldhadincreasedto60%ofsalesduetothecontinuedgrowthoftheomnichannel
businessesandtheresultingimpactoffreeshipping(10Kpage22).Wereasonedthatthe
omnichannelstrategyisapermanentstrategicmovebyMacystocompetewithAmazonand
otherretailers,andthuscostofgoodssoldwouldstayat60%.

Toprojectdepreciation,wesplitfixedassetsintodepreciablefixedassets,suchasbuildingsand
PP&E,andnondepreciablefixedassetssuchasland.Thedepreciationexpenseasapercentage
ofdepreciableassetswasfairlysteadyatanaverageof8.28%.Amortizationwascalculatedasa
percentageofintangiblesexceptgoodwill(whichisnotamortized).Thiswasmorevolatileatan
averageof6.16%.

SG&Awasprojectedasapercentageofsales,andwenoticedSG&Ahaddeclinedatafastrate
from20092012,thenataslowerratesincethen.Inthe10KthecompanynotedthatSG&Ahad
gonedownprimarilybecauseoflowerpensionobligations,andthatthepensionprogramhad
beenfrozenin2012andthecompanyswitchedtoapuredefinedcontributionretirementplan.
ThusweforecastedthatSG&Aasapercentageofsalesthatwouldstabilizeat26%asthe
pensionplanwasfullywounddown.


Nonoperatingandotherincomewerenotexplainedinthe10K,sowehadnoreasonablemeans
toforecastthem.Nonoperatinginterestincomehadbeenstableat$2mforthelast2yearssowe
continueditat$2mannually.Otherincomewas$0mostyearsandweleftitat$0sinceitwould
beunreasonabletoprojectoneoffeventsgeneratingincomeinspecificyearsinthefuture.

Forinterestexpenseweprojectedthegrossinterestexpenseasapercentageofendinglongterm
debtforeachyear,wherethepercentagewasthepretaxcostofdebtat6.25%.Interest
capitalizedhadbeenvolatileinpreviousyears,withnoexplanationinthe10K,soweprojecteda
simpleaverageofthepast10yearsof$9m.Unusualexpensehadbeenincurredineveryyearin
thepastandwasvolatileandunreasonabletoforecastaccurately,soweusedasimpleaverageof
thepast5yearsof$91m.

Forthetaxrate,weexaminedhistoricaltaxratesandfoundthattaxratesinthepast5yearshad
beenabout4%higherthaninearlieryears.Thus,toforecastthetaxrateweusedanaverageof
thetaxratesofthelast5years,atabout36%.Wedidnotforecastthetaxratedecreasingdueto
movingmoneyoverseas,asMacysisvastlyUSbasedandpaysUStaxesonmostofits
revenues.

BalanceSheet
ChoosingCashasourPlug
AfterreviewingMacysbalancesheetfromthe20052014,wesawhighvolatilityincashand
shortterminvestments.Becauseofthis,wedecidedtousecashasourplug.Insteadofusingthe
prioryearscashamountstoestimatetheproformacashbalances,weusecashasaplugto
balancethebalancesheet,andthisallowsthecashbalancetofollowthegrowthtrendofthe
otheritemsonthebalancesheet.

ProjectedAssets
Between2005and2006,Macysbalancesheetshowsadecreaseinnetaccountsreceivableby
79.50%,duetothesaleofcreditcardaccountsandotherreceivablestoCitibankin2006
(Belsky).InourProFormabalancesheet,wedisregarddatafrom2005whencalculatingthe
averagegrowth/declineratesofcurrentassets,duetothisextremechange.

WeusedtheA/Rdaysequationtodeterminetheaveragecollectionperiodfromthepreviousten
yearsandmultiplieditbysales/365tocalculatetheaccountsreceivablebalances.Similarly,to
calculateinventories,wecalculatedtheaverageinventorydaysfromtheprevioustenyearsand
multiplieditbytheCOGS/365.Wemadetheassumptionthatothercurrentassetswillgrowwith
inflation,asthesearerelativelysmall.

ThoughMacysisknownfortheirlargeshoppingstores,theirManagementsDiscussion
explainshowtheretailerisbecominganomnichannelorganization,focusingmoreononline
sales.IntheQ42014earningscall,managementsetaplantobudget$1.2billionin2015capex
toaccelerategrowth,withnoplanstolowerthannumberinthefuture.Welookedatthe
historicalallocationofcapexacrossfixedassetstodeterminethepercentagesofcapextobe
allocatedacrossgrossPP&E..Weassumedbuildingswillgrowat$615mannually,otherPP&E
at$433m,land&improvementsat$149m,andleasesat$3m.Weassumenetgoodwillwould
remainconstant,andweusedtheaveragegrowthratefromthepasttenyearsof6%to
determinethenetotherintangiblesaccount.

ProjectedLiabilitiesandEquity
Tocalculatetheaccountspayablebalances,weusedtheA/Pdaysratiofromthepreviousten
years.Tocalculatetheshorttermdebt,wetookthepreviousyearsbalancedividedbythe
previousyearslongtermdebtbalance,andmultipliedthisbythecurrentyearslongtermdebt
balance.Wemadetheassumptionthatmisc.andothercurrentliabilities,accruedpayroll,and
otherliabilitieswillgrowwithinflation,astheseaccountsarerelativelysmall.Weassumed

incometaxpayable,longtermdebt,andprovisionsforrisksandchargeswillgrowwiththe
averagegrowthrateoftheprevioustenyears,at.6%,2%,and.18%respectively.
Intheequitysection,tocalculateotherappropriatedreserves,additionalpaidincapital,and
treasurystock,weusedtheaveragegrowthrateof2.7%,21.1%,and7.33%respectively.
Thoughtheseratesarelarge,ourcalculationsareconsistentwithpasttrendsandthefuture
strategyofthecompany.

ProjectedCashFlow
Usingourprojectedproformaincomestatementandbalancesheet,wecalculatetheestimated
freecashflowsforthenexttenyears.Startingfromnetincome,weaddbackdepreciation&
aftertaxincomeexpense,andsubtractaftertaxinterestincome.Movingonthethechangeinnet
workingcapital,wesubtractanyincreasesincurrentassetsandaddanyincreasesincurrent
liabilities.WecalculatetheseNWCitemsbyfindingthedifferencebetweenyearsforeach
respectiveaccountontheproformabalancesheetandproformaincomestatement.Lastly,we
mustsubtractanyincreasesingrossfixedassets,excludingdepreciation.AccordingtotheQ4
2014earningscall,MacysCFOKarenHoguettoldinvestorsthatthefirmwillbeinvestingat
least$1.2billionintocapexforthenexttenyears.So,wedecidetouseaconstant$1.2billion
forthenexttenyearsascapexthatwesubtractfromnetincome.

Inourforecast,netincomeincreases41%duringthistimewhilefreecashflowincreasesabout
57%.Thiscanbeattributedtothefactthatcurrentassetsarenotincreasingasfastascurrent
liabilitiesovertime.ThisimpliesadecreaseinMacyscurrentratio,andthusweakeningthe
abilityofthefirmtosatisfyshorttermliabilitieswithshorttermassets.Sincecurrentliabilities
increasemorerelativetoassets,weareaddingbackmoreinliabilitiesthanwearesubtracting
outforanincreaseincurrentassetsandthusincreasingfreecashflowovertime.

FirmValuation
Inordertocalculateafirmvaluationandcomeupwithastockprice,weneededtotakeour
projectedfreecashflowsandusevariousinterestratestocomeupwithanoverallvalue.We

beganbycomingupwithaWACCforMacyswhichrequiredafewkeyassumptions.First,we
calculatedourcostofdebtas6.25%bydividingtheaverageinterestexpenseoverthelast10
yearsbytheaverageamountoflongtermdebtperyear.Weattemptedtofindaweighted
averageYTMbylookingthroughMacyscurrentbondportfoliowhichisstillshownonour
valuationpage,buttheresulting3.19%waslowerthancompetitorsanddidnottakeintoaccount
alloftheirdebt.ThemarketvalueofdebtwasreportedbyFactSet.Next,forthecostofequity,
wecalculatedabetaof.898bymeasuringtheslopeoftheS&P500returnsoverthepast10
yearsversusMacysreturnsoverthesametime.Weassumedamarketriskpremiumof7%
basedonacombinationofaJPMorganestimate(TheQuestforMarketRiskPremium,May
2008)andothersources,

andweusedariskfreerateof5%.Whilethisriskfreerateishigher
thanthecurrentrates,wechose5%becausethe10yearrateshavenormallybeenhigherthan5%
(10YearTreasuryConstantMaturityRateGraph,ExhibitB)andtheFederalReservehas
announcedtheirintentionstoraiseratesinthenearfuture.UsingtheCAPMequation,Macys
costofequitycameouttobe11.29%.Themarketvalueofequitywassimplytheircurrent
marketcapwhichisthecurrentstockpricemultipliedbytheiroutstandingshares.Wethenfound
theweightsforeachofthemarketvaluesandusingamarginaltaxrateof35.95%,calculateda
WACCof9.53%.

Oncealloftherateswerecalculated,welookedatthevariouscashstreamstofindatotalfirm
value.Wecalculatedthevalueofthedepreciationtaxshield(DTS)byfindingtheannual
depreciationandmultiplyingthatbythetaxrateforeachyear.Thecalculationwasthenatwo
stepprocessasweaddedtogetherthepresentvalueofthefirst10yearsoftheDTSandthe
presentvalueoftheDTSperpetuity.Wethencalculatedthevalueofournondepreciationcash
flowsbyusingourWACCtofindthepresentvalueofthe10cashflows.Lastly,wefoundthe
terminalvalueofMacysbyusingaperpetuityformulaandusingtheWACCasourdiscount
rate.Wechoseagrowthrateof0%sincegrowthinthisindustryisforecastedtobelimitedand
salesseemmorelikelytogrowwithinflationratherthanatour10yeargrowthrateofabout.6%.
Forthesecashstreams,weassumedevencashflowsthroughouttheyearandthereforemademid
yearadjustments.Addingthethreevaluestogethergaveusavalueof$32.7billionforthefirm,

andthenwesubtractedoutthevalueofdebt,andalloutstandingoptions/restrictedstocktocome
upwithanequityvalueof$25.5billion.Thiswasdividedbythenumberofoutstandingshares
(341.6million)togiveusacurrentstockpriceof$74.67.OnJanuary2,2015theactualclosing
priceforMacyswas$65.69andthepriceonApril21begantoconvergetowardsourestimateat
aclosingpriceof$67.03.

OurestimatedstockpriceisclearlyhigherthanthepriceonJanuary2,2015,andwhiletheprice
hasbegantoapproachours,thereacouplereasonswehaveidentifiedastowhyourestimate
maybemoreoptimistic.First,ourrealsalesgrowthispositiveandfairlyconstantformostofthe
projected10yearswhichhasproventonotalwaysbethecasewithMacysoverthepast10
years.Thevolatilitytheyhaveshowninthepastandthetoughcompetitiontheyfacemayhave
ledtomoreconservativeestimatesthanourswhichwouldlowerthenetincomeandFreeCash
Flows.Additionally,smallchangesinWACCprovedtohavelargeeffectsonthefinalstock
pricesoitislikelythatourestimatemaybedifferentthananalysts.Forexample,a1%increase
inthecostofequitywouldlowerourestimatedstockpriceover$4toaround$70.Any
assumptiondifferencesbetweenusandotheranalystsintermsofbeta,riskfreerates,andmarket
premiumswouldhavelargeeffects.

SensitivityAnalysis
Aswithanyfinancialmodel,thereareuncertaintiesbehindtheestimates.Toseehow
adjustmentsinsomeofourestimatesaffectedtheshareprice,weransensitivityanalysisonkey
variablesincludingtheterminalrealsalesgrowth,WACC,andinflationrate(ExhibitC).

TheterminalrealsalesgrowthaffectsthediscountedterminalFCFinthemodel.Ourestimated
ratewas0%,suchthatMacysFCFgrewwithinflationaftertheinitialperiodoffastergrowth
duetocapexinvestments.Thesharepricewasmoderatelysensitivetotherealsalesgrowth.As
realsalesgrowthincreasedto2%,thesharepriceroseto$83.

Nextweranasensitivityanalysisontheweightedaveragecostofcapital.Thiswasakey
analysisbecausemanysubjectivevariablesfallintotheWACC,suchasthemarketriskpremium
andbeta.ThesharepriceprovedtobequitesensitivetochangesintheWACC,decreasing
exponentiallyforincreasesinWACC.AtaWACCof7.5%,forexample,thesharepricewas
about$92.AlthoughMacyssharepriceissensitivetoWACC,wedonotbelieveMacys
WACCwillchangesubstantiallyinthefutureasitisanestablishedbusinesswithalongcredit
history,andnoplansforbigchangesinitsbusinessmodel.

Inflationratewasthethirdkeyvariableweranasensitivityanalysison.Inflationfactoredinto
manyaspectsofthemodel,suchasnominalsalesgrowthandgrowthofcertainfinancial
statementlineitems.Sinceinflationwassokeytosalesgrowth,onwhichalmosteveryfinancial
statementlineitemisdriven,thesharepricewasquitesensitive.Theassumedinflationratein
themodelwas3%,whichisabovethecurrentinflationrateofabout1to1.5%.Atcurrent
inflationlevels,thesharepriceisabout$6570whichisthelevelatwhichthesharesare
currentlytrading.

DiscussionandConclusion
InordertocompleteananalysisofMacys,ourteambeganwithforecastingsales,constructing
proformastatements,forecastingfinancialstatementitems,calculatingfreecashflow,and
subsequentlythefirmsvalueandstockprice.

Oursalesprojectionsresultedinaprojectedsalesgrowthrateof.6%inthefuture,however,with
1.9%realsalesgrowthin2015,wedecidedtoadjustsalestogrowtoa.6%rateoveracoupleof
years.Intheconstructionoftheincomestatement,weturnedtothe10Ktoseekexplanationsof
oddlytrendingaccounts,andtoensureourprojectionswerereasonable.Bychoosingcashasour
balancesheetplug,weallowthebalancetofollowthegrowthtrendofotheritems.Toproject
current
assets,weusedA/Rdaysandinventorydaysratios,inadditionweassumeothersmaller

accountswillgrowattheinflationrate.Sinceweassumeconstantcapexof$1,200meachyear,
wecanallocatethisamounttobuildings,land&improvements,leases,andotherPP&Einour

projectionoffixedassets.Liabilitiesandequitywereprojectedinasimilarfashiontocurrent
assets:usingratiosforpayables,inflationrateforsmalleraccounts,andsimpleaveragesforthe
rest.

Theprojectionofincomestatementsandfreecashflowcometoaninterestingresult.Whilenet
incomegrows41%from2015to2024,freecashflowgrows57%inthesameperiod.We
concludethatthisresultfromtheincreaseofcurrentliabilitiesatafasterratethancurrentassets,
andthusdecreasingthefirmsliquidityovertheprojectedtenyears.Next,wecalculateWACC
anduseitalongwiththeriskfreerateasdiscountratesinourcalculationofintrinsicfirmvalue.
Summingthepresentvalueofthedepreciationtaxshield,nondepreciationcashflows,and
terminalvaluewearriveatthevalueofthefirm.

Wetakeoutdebt,options,andrestrictedstocktoarriveatequity.Finallywearriveatastock
priceof$74.67,andrecommendtobuythestockasithasa10.23%upsidefromtheApril21,
2015price.Sincethereareuncertaintiesinourreport,weranasensitivityanalysisonterminal
realsalesgrowth,WACC,andtheinflationrate.Wefoundsharepricetobesensitivetochanges
inWACC,butdisregarditasweassumeMacyskeepstherateconstant.Byadjustinginflation
fromthe3%ratetoactualpresentdayinflationofabout1.5%,weseeourpricepersharedropto
about$65$70,exactlytherangethestockcurrentlytradesat.

Appendices
Belsky,JoelA."FEDERATEDDEPARTMENTSTORES,INC."Sec.gov,7June2005.Web.23Apr.
2015.

"Macy's(M)ManagementKarenHoguetonQ42014ResultsEarningsCallTranscript."Macy's(M)
ManagementKarenHoguetonQ42014Results.SeekingAlpha,24Feb.2015.Web.23Apr.2015.

"Macy's10K."SECFilings.Bloomberg,1Apr.2015.Web.23Apr.2015.

Zenner,Marc,ScottHill,JohnClark,andNishantMago."TheMostImportantNumberinFinance:The
QuestfortheMarketRiskPremium."JPMorganChase&Co.,May2008.Web.23Apr.2015.

ExhibitA:SalesGrowth

ExhibitB:10YearTreasuryConstantMaturityRateGraph

Source:St.LouisFederalReserve

ExhibitC:SensitivityAnalysis