• Bocconi Students Options Club

Macy's : "Butterfly"

DISCLAIMER:

This association and its publications are solely intended for academic purposes and should not be used as investment advice or be interpreted as such.


The Company

Macy’s Inc. (ticker: M) is one of the largest and most famous retail company in the United States. Formerly known as Federated Department Stores Inc., it was founded in 1929 and incorporated in 1985. Over time it has increased its activities and has accomplished several merger and acquisition operations, whose most important is the 1994 merger with R. H. Macy’s Co.


Following this, the company has changed its name to Macy’s Inc. and has moved its headquarter to New York City, where also the historic flagship store of Herald Square, one of the largest store in the world, is located.


The company, with a market capitalization of approximately 5.8 billion of US dollars, is listed on the New York Stock Exchange (NYSE), it has more than 90 thousand employees and 727 physical stores and is currently ranked 120th on the Fortune 500 annual ranking.


Firm Activities

Macy’s Inc. (henceforth “M”) operates according to a department store structure and sells a wide range of merchandise, including apparel and accessories (men's, women's and kids'), cosmetics, home furnishings and other consumer goods through its three main brands: Macy’s, Bloomingdale and Bluemercury.

These three brands accounted in 2019, respectively, for 88%, 11% and 1% of the total sales.

By breaking revenues into department, it is clear that the greatest portion derives from the woman one, which accounts for almost 60% of the overall result.


The company pursues an omnichannel strategy, that is, a strategy aimed to provide a seamless shopping experience to customers between their store locations and their online and mobile environments.

On February 4, 2020, the Company announced its Polaris strategy, a three-year plan designed to stabilize profitability and position the Company for sustainable, profitable growth. The strategy, developed in 2019, includes initiatives focused on strengthening customer relationships, curating quality fashion, accelerating digital growth, optimizing the Company's store portfolio and resetting its cost base. In conjunction with these initiatives, the Company announced plans to close approximately 125 of its least productive stores over the next three years, including the 30 already ended in 2019. As part of the reset of its cost base, the Company developed a plan to streamline the organization through reductions in corporate and support functions, campus consolidations and the consolidation of the Company's sole headquarters to New York City, New York.


As of March 2021, the company has effectively closed down approximately 60 out of the 125 targeted less-profitable store.


Firm Position, Industry Trend and Dynamics

Here a list of peers and some relevant data of the last twelve months (LTM).


Among its peers, it emerges how the firm has the greatest market share. If we expand the comparison to include all the industry constituents in the US, the revenue share nosedives to a small level of 3.4%.

However, this list, provided by Refinitiv, includes a very significant positive outlier, namely Amazon.com, which accounts by itself for almost 83% of the total.

Since the Seattle-based company has a vast portion of revenues deriving also from non-retail activities, it makes sense to normalize the computation by removing it.

After the adjustment the market share stabilizes at a noteworthy 21.5%.

The Covid-19 pandemic has severally affected retail companies, especially the ones which strongly depends on in-store sales, including Macy’s. Indeed, despite a strong increase in online sales and a better-than-expected Q4 result, the FY 2020 ended with a reduction of sales and a negative net income for the New York based chain.


On the opposite, companies with a predominance or exclusivity of the online activities have been benefited from the situation and, as a result, the overall department stores industry has been characterized by a 26.6% increase in revenues in the last twelve months, according to Refinitiv’s data.

By looking back further, it is clear how the company did not perform that well also in the 5 years preceding the pandemic: revenues and net income have been stagnant and the price per share plummeted from the 2015 peak.


Fundamentals


Given the nature of its activities, the retail industry is clearly highly cyclical, therefore we expected to observe a high level of sensitivity with respect to market movements, which is represented by the beta.

Indeed, despite being lower than the sector’s average and median value, the 5-years beta is quite big, suggesting a great level of volatility in stock’s returns.

Even after adjusting the beta to take into consideration the mean reversion phenomenon, as suggested by Blume’s formula, the sensitivity level continues to be high and under the average and median.


Since both Ebit and Earnings were negative, we have decided to not include in the above-presented list the multiples associated with these fundamentals, which would have been meaningless.

Fundamentals show how M outperformed its peers in terms of sales during the last twelve months, while the net profit margin, and thus profitability, is markedly worse than competitors.

This combination of high volumes and great losses may suggest a non-so-performing business model.

Operating profit are significantly worse than peers, but are influenced by a great goodwill impairment, i.e. a non-recurring event. Without this item, which accounted for almost 3.6 $ billions, we observe a close-to-average situation.

The Quick Ratio, which provides a snapshot of the firm’s liquidity, seems in line with peers, while Debt to Equity and Debt to Capital, which represents the firm’s solvability, are both lower than the average, which could be interpreted as a good indicator.

However, we have to keep in mind that, on the one hand, the solvability ratios are not available for all the sample’s component because some firms have filed for bankruptcy, and on the other hand there is a very large outlier, namely Nordstrom Inc., which inflate the statistics.


Motivation

The Coronavirus pandemic has significantly impacted the retail industry, especially the players with a predominance of in-store sales over digital.


The March 2020 panic sell-off caused M’s market price to plummet from approximately 16/17 $ per share to a minimum of 4.4$. With that level of uncertainty regarding the future, a long position was still a risky investment. As matter of fact, even considering that the tangible assets were well in excess of long-term liabilities, the safety cushion provided by a P/BV ratio under 1 was not that safe because of the high level of goodwill, which accounted for almost 80% of Total Equity (and effectively it has been massively written-off during the fiscal year).

Furthermore, the imposition of severe public restriction, for instance lockdowns, produced great concerns regarding liquidity and cash burning, especially because of that quick ratio under 0.5.

Moving forward to recent days, a bet of that kind would have actually paid very good, as the recent maximum of 20.76 $ (closing price on 15/03/2021) testifies. Indeed, a long position would have generated approximately a return of 371.82% in slightly more than one year, while the year-to-date return is around 46%.

That being said, the price has now reached the pre-pandemic levels, which were characterized by a multi-year downtrend. Therefore, we do not expect, at least in a very short-term horizon, another great positive jump in prices. At the same time, with the great rollout of vaccines in the US, the approval of the 1.9$ trillion stimulus plan of the Biden Administration and the economy on the track for a great recovery, we do not expect neither a great negative shift, rather we foresee a fluctuation around the current levels.


Technical Analysis



By looking at charts, it emerges how both RSI and Bollinger Bands suggest that at the most recent market prices there is neither an overbought nor oversold situation.

As matter of fact, both showed overbought around the middle of March and since then the situation has been stabilizing around the Moving Average (20 days), which is currently above the prevailing price.

Volume does not show any extraordinary activity for the time being.


The Play


For all the above-explained reasons, our trading ideas is a Long Butterfly strategy.

Loosely speaking, it generates a positive payoff when there are not great movement in prices and a negative, though bounded, payoff if large changes do happen.


This strategy usually consists of 4 positions:

• Long Call ITM

• 2 Short Call ATM

• 1 Long Call OTM


However, since in the recent days there has been a downward correction in prices, we may prefer to have the short legs slightly in the money, with the twofold scope of maximizing inflows, thus minimizing the overall costs, and to center the maximum payoff on the right-hand side of the current price.

Furthermore, given the recent levels of volatility, we would rather enlarge the distance between each different strike in order to maximize the gap between the two break-even points.


Structure

Our butterfly strategy is made of 4 options:

• Long Call (C1), strike K1=13.5

• 2 Short Call (C2), strike K2 = 16.5

• Long Call (C3), strike K3= 19.5


All the options have the same maturity, i.e. 23/04/2021. We do realize it’s a very near term, but since we profit on small fluctuation, we would rather reduce the time-span available for new information and possible adjustments associated with it.

The options available for the strategy are only of the American Type, so the callable feature of the derivative may cause some worries. However, the early exercise of an American Options can be proven to be sub-optimal for a non-dividend-paying stock just like Macy’s (no dividend planned for the two weeks ahead), hence we can treat them all as European Options without any inconsistency.


Profits and Loss (P&L) profile.














The costs of the strategy, which is also the maximum loss, is equal to:



The maximum (gross) positive payoff is equal to 16.5-13.5 = 3 $ and it is reached if the underlying price at maturity will be equal to 16.5, which is slightly above the current market price.

At this threshold, the first call would expire in the money, the last call out of the money and the two “middle” short call would be perfectly at the money.

This combination would provide a net return of 100% per strategy unit.


At the same time, the two break-even points, equidistant from the middle strike, will be equal to 15 $ and 18 $, i.e. – 9.09% and + 9.09% from closing price on March 30th.

The computation is as follows:


BEP1 = K1 + Costs = 13.5 + 1.5 = 15 $

BEP2 = K3 – Costs = 19.5 – 1.5 = 18$


In the following table payoffs are shown in a more analytical way:


Greeks

Delta = 0.885 – 2 x 0.613 + 0.209= -0.132

At inception, the strategy would be delta-negative, because the negative sensitivity measure of the middle call overtops the other two.

Here is a graph of the evolution over time.

In a specular way, also the gamma is negative, though it is a little bit higher than delta.

Gamma= 0.064 – 2 x 0.136 + 0.096 = -0.112

Here is a graph of the evolution over time.

Same happens for the Vega, which is once again dominated by the double negative position that constitutes the body of the butterfly.

Vega = 0.008 – 2 x 0.016 + 0.012 = -0.012

Here is a graph over time.

The Theta measure is positive and is defined as follows:

Theta = -0.012 – 2 x (-0.023) -0.018 = 0.016

Here’s a graph.



Finally, also the Rho sensitivity measure shows a negative value at inception.

Here is a graph.


Pros

Given the uncertainty regarding the future of the company, it is not so easy to forecast its future performance and take a long or short position without reservations. The Long Butterfly allows to benefit from this standoff with a non-negligible positive payoff.

Moreover, the closest break-even point is set at 15, which is below the current market price, while the furthest breakeven point, which demarks the beginning of the loss-zone, is set at 18, is basically above pre-covid values.

The strategy can provide as much as +100% in a short frame of time with very realistic movements from Macy's.


Cons

Obviously, given the good performance of the underlying in the first quarter of the year and the gap closed with the pre-pandemic price, it may happen that the share stabilizes at lower values, below the break-even threshold.

On the opposite, given the impressive speed of vaccines’ rollout in the US, the real economy may rebound quicker and stronger than anticipated, thus leading to increase in valuation, especially for those activities related to large, physical presence, just like malls and store departments.


Moreover, the forthcoming stimulus check (1400$ per individual, with more than 100 million of people that meet the criteria) related to the stimulus plan of the Biden Administration could also translate into a big increase of liquidity in the market, which means greater prices.

Therefore, it is not possible to exclude a priori a good performance in the future.


Early assignment on the short legs can also represent a strong risk to the strategy, particularly in times of dividend emissions. This risk is present in any strategy that includes shorting calls.