NEW YORK (

TheStreet

) --

Macy's

(M) - Get Report

plans to win Christmas with Elvis ornaments in Tennessee, wine-themed decorations in Napa Valley, and Our Lady of Guadalupe ornaments in Hispanic-heavy populations.

These may not be must-have holiday gifts like

Apple's

(AAPL) - Get Report

iPad, but they represent how Macy's, with Chief Executive Terry J. Lundgren at the helm, has navigated the recession -- remaking itself from yet another sagging department store into a best in class retailer.

The company's My Macy's localization initiative, which it launched about two years ago and rolled out nationally in 2009, has been predominantly credited for Macy's turnaround and is expected to boost sales during the Christmas season and beyond.

Through the program, Macy's has sliced the 800-plus store chain into 69 regional districts, and appointed 1,600 managers to oversee these districts. Each manager is in charge of no more than 12 stores each, allowing them to more precisely adjust merchandise to shoppers' tastes and needs.

For the holidays, this means Macy's will offer 2,200 different locally-themed ornaments around the country. Beyond Christmas, the My Macy's initiative translates to having "the right sweater weights in the right climate zones," Lundgren says. "And we can be selling larger pots and pans as gifts in Utah, where families are larger, and Scandinavian baking tools in Minnesota."

Lundgren, 58, began his journey with Macy's back in 2003, when he became the chief executive officer of former parent company Federated Department Stores. During his time at the company, he successfully facilitated the $17 billion acquisition of May Department Store in 2005, in the process shuttered regional chains like Marshall Field's.

This opening in local markets created an opportunity for Macy's to swoop in and divise its own program catering to these shoppers' needs.

But aside from its localization efforts, Lundgren, a 35-year retail veteran, has been building Macy's exclusive and private-label merchandise, a strategy that has also been successful for rival

Kohl's

(KSS) - Get Report

.

Boasting lines from Donald Trump, Martha Stewart, Sean Jean, and most recently the "Material Girl" brand from Madonna's daughter Lourdes, Lundgren says he is seeing shoppers move away from purchasing the lowest-priced items toward seeking the best quality for the price. The 152-year-old department store has also become the exclusive retailer of Kenneth Cole Reaction.

Click hear to listen to Lundgren discuss consumer trends.

.

Macy's now says 42% of its revenue is attributable to exclusive brands or store labels.

Indeed, these partnerships with celebrities and designers helped propel Macy's back into the black in its third-quarter, earning $10 million, or 2 cents a share, compared with a loss of $35 million, or 8 cents, in the year-ago period. Excluding items, the company actually earned 8 cents a share, better than the 3 cents analysts expected.

Sales during the three months grew 6.5% to $5.62 billion from $5.27 billion last year, while same-store sales rose 3.9%. Analysts were calling for revenue of $5.55 billion.

Margins were down slightly 0.2% to 40%, which can be read as a positive sign heading into the holiday season. It appears there isn't excessive inventory build-up, which could eliminate the need to excessively discount.

Macy's, which is the No. 2 department store in size, behind

Sears

(SHLD)

, also upped its outlook for the second half of the year, and is now forecasting earnings of between $1.50 and $1.55 a share, up from a prior outlook of $1.45 to $1.50 a share. For the year, management is calling for a profit of between $1.94 and $1.99 a share, compared with previous guidance of $1.89 to $1.94 a share.

The stock has also been on a rally, up about 31% over the past three months, closing on Monday at $25.64, a mere 39 cents from its 52-week high.

Of course, while Macy's has had some good luck over the last several months, there are still some potential headwinds heading into 2011.

The rising costs of cotton, freight and labor are expected to weigh on the entire retail sector next year, and Macy's is no exception. Lundgren forecasts that cotton prices, in particular, will put pressure on the company in the second-half of 2011.

Sterne Agee analyst Ken Stumphauzer says there is a huge degree of uncertainty next year. "The company has exhausted its cost cutting and is operating at peakish gross margins, coupled with massive inflation pressure; Macy's is a top line story more than ever."

Click here to listen to Lundgren discuss the impact of rising sourcing costs.

Of course, stubbornly high unemployment also remains a concern for all retailers, and Lundgren doesn't predict a full recovery at retail until jobs return.

Click here to listen to Lundgren discuss the retail recovery.

The big wait-and-see for Macy's is if it can keep up this momentum post-holiday. It remains unclear whether sales strength has been due to the company's internal improvements or an overall turn in consumer spending.

Still, there's no denying that Macy's is successfully stealing market share from rivals like

J.C. Penney

(JCP) - Get Report

and Kohl's. While Macy's has reported numerous consecutive months of same-store sales increases, J.C. Penney's recovery has been much more sporadic. Over the past six months, J.C. Penney, which tends to skew to a lower-priced assortment, reported four months of sales declines. In October, the company posted a 1.9% slip.

Kohl's, which was a standout in its own right amid the recession, has also begun to see its comparable sales slow over the past several months, no doubt losing some customers' to Macy's.

While Stumphauzer was skeptical earlier in the year about how much of Macy's turnaround was due to the localization efforts and how much was from an overall economic improvement, after speaking with suppliers, he believes you can attribute about 60% of the company's improvement to internal operations.

Lundren sums up Macy's success to being able to capture the "magic" in a shopping experience. "There is magic in assembling exactly the right outfit for a special occasion. There is magic in finding a sales associate who really understands what you need and makes the extra effort to help you find it. There is magic in walking into your favorite Macy's store knowing that you will find new styles, get new ideas and see new innovations."

--Written by Jeanine Poggi in New York.

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