Last Friday, shares of Macy's (NYSE:M) were hit hard when rival department store operator J.C. Penney slashed its earnings guidance. Macy's stock has continued to decline this week, after Citigroup retail analyst Paul Lejuez slapped a "Sell" rating on the stock and warned that the company may cut its dividend.

Macy's share price has already plunged by more than 50% since last December. Its generous dividend -- which now yields a stunning 8% -- has been one of the few points of consolation for investors. A dividend cut could send more investors running for the exits.

Macy's Stock Performance, data by YCharts.

However, Lejuez probably overstated the likelihood of a dividend cut at Macy's. Furthermore, even a lower dividend wouldn't be a reason to sell Macy's stock, provided the company continues to make progress on its strategy of monetizing less-productive real estate and paying down debt.

Is Macy's in an inevitable tailspin?

The main reason behind Citi's recent downgrade of Macy's stock is that the analyst team doubts Macy's can halt the ongoing declines in its sales and earnings. It's true that Macy's has faced steady erosion of its sales and earnings since 2015. However, Macy's leadership didn't really recognize the scale of the problem until mid-2016. Up to that point, management attributed Macy's sales challenges to temporary factors like unseasonable weather and the strong dollar.

In August 2016, Macy's began a deeper restructuring of the business. The company announced plans to close about 100 stores over the next few years while investing to improve its remaining stores and support continued e-commerce growth.

About two-thirds of those closings have already occurred. Macy's sales and earnings are still falling, but the rate of decline may be slowing. Comp sales fell 2.5% in the second quarter of fiscal 2017, compared to a 4.6% decline a quarter earlier. Adjusted earnings per share decreased by 11% year over year in Q2: a significant decline to be sure, but not an especially alarming one, considering that Macy's generates the vast majority of its earnings in the fourth quarter.

The exterior of a Macy's store

Macy's sales and earnings declines may be moderating. Image source: Macy's.

It's fair to say that Macy's turnaround efforts haven't worked so far. Nevertheless, it's too early to declare that they will never succeed. Several key initiatives -- like the rollout of Macy's Backstage off-price sections to some stores -- are still in the early innings. Additionally, Macy's implemented promising changes to its loyalty program just last month. The updated program is designed to encourage loyal customers to spend more at Macy's.

Will Macy's need to reduce its dividend?

Stripping out asset sale gains, EPS from the underlying Macy's retail business is barely higher than the company's current dividend of $1.51. From this perspective, it's easy to see why Lejuez and his team are worried about the dividend's sustainability.

That said, cash flow is what really matters for paying a dividend. On that front, Macy's is in much better shape. While free cash flow production is lower than it was a few years ago, Macy's is still churning out more than $900 million annually. That's roughly double the $459 million Macy's paid out in dividends last year. Importantly, this figure does not include asset sale proceeds.

Macy's Free Cash Flow (TTM), data by YCharts.

Lejuez implicitly admits that Macy's generates enough cash to cover its dividend, instead arguing that the company may choose to reduce the dividend in order to pay down more debt.

Yet Macy's is already reducing its debt at a rapid clip. Macy's cut its debt load by more than $1 billion during the 12 months ending in July. While the company's leverage ratio is still higher than its target, that reflects its lower earnings. If Macy's recent initiatives to stabilize sales and cut costs start to kick in this fall, it won't take long to reach the company's leverage target.

Furthermore, the pace of asset sales is likely to increase at Macy's. In September, Macy's closed a deal to sell excess space at its store in downtown Seattle for $50 million. More recently, it reached a preliminary agreement to sell about 700,00 square feet of space on the upper floors of its Chicago flagship store, in what will likely be a nine-figure deal.

The potential advantage of a lower dividend

If Macy's does reduce its dividend in order to pay down debt -- as opposed to reducing it because free cash flow plunges -- it wouldn't be the end of the world for investors. A few years ago, Macy's routinely spent the bulk of its cash flow on share buybacks. By contrast, it suspended its share repurchase program at the beginning of 2017 to focus on debt reduction.

This was a painful choice to make, because Macy's stock is dirt cheap. Reducing the dividend would help the company achieve its leverage target faster, allowing it to resume its share buybacks. In the long run, that could pay off for investors if Macy's retail business eventually recovers -- or if it intensifies its focus on real estate monetization.