Over the past year and a half, CEO Helena Foulkes has spearheaded an aggressive downsizing campaign at Hudson's Bay (OTC:HBAYF). This plan is in its final stages, and it has enabled the international department store conglomerate to exit underperforming business lines and reduce its debt load.

That said, Hudson's Bay also faces stiff challenges in its core North American retail business. As a result, comp sales declined modestly last quarter and the company experienced severe gross margin erosion, far exceeding what other department store operators like Macy's (NYSE:M) suffered. And while management expects improvement in the quarters ahead, Hudson's Bay has a long way to go just to become profitable.

A change in the sales and earnings trend

Comparable store sales decreased 0.4% for Hudson's Bay's go-forward business in the second quarter. This compared to a 0.3% increase in the first quarter of fiscal 2019. Saks Fifth Avenue posted a meager 0.6% comp sales increase last quarter, partly because it was facing an extremely difficult year-over-year comparison. The Saks Off 5th off-price business performed better, with comp sales up 3.4%. However, these increases were more than offset by a 3.4% comp sales decline for the company's namesake Hudson's Bay chain.

A far more concerning development for investors was the sharp deterioration in Hudson's Bay's gross margin. Gross margin plummeted by 5.3 percentage points year over year to 34%. This was far worse than the company's 0.9 percentage point gross margin decline in the first quarter. It also vastly exceeded Macy's 1.6 percentage points of gross margin deterioration last quarter, which ignited an investor panic a month ago.

Merchandise displays in a department store

Gross margin tumbled by more than 5 percentage points at Hudson's Bay last quarter. Image source: Getty Images.

Management estimated that store closures, changes to vendor relationships (including the removal of unproductive brands), and stepped-up efforts to clear out old inventory each negatively affected gross margin by about 1.1 percentage points. However, nearly 2 percentage points of the decrease was driven by intense promotional activity, which hit the Saks Fifth Avenue chain hardest.

Cost cuts and Hudson's Bay's moves to exit unprofitable businesses did help to offset the impact of lower gross margin. In fact, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) reached $52 million Canadian ($39 million) last quarter, up from CA$33 million ($25 million) a year earlier. Still, on a like-for-like basis, adjusted EBITDA fell more than 50% year over year. Moreover, Hudson's Bay posted a normalized net loss of CA$171 million ($129 million) last quarter: roughly double its loss from the prior-year period.

Hudson's Bay still hasn't proved its staying power

Under Foulkes' leadership, Hudson's Bay has wisely refocused on the best parts of its business. To some extent, this strategy is paying off. Saks Off 5th's performance is improving rapidly, and the Saks Fifth Avenue chain was posting strong comp sales growth until last quarter.

That said, declines in international tourist spending could put pressure on Saks Fifth Avenue's sales, in line with the trends Macy's and Bloomingdale's have seen recently. Falling sales at the Hudson's Bay chain should also be of concern to investors. Management hopes that changes to the merchandise assortment and marketing mix will drive a sales recovery, but there's no guarantee that this strategy shift will succeed.

The exterior of the Macy's flagship store

Stores that rely on international tourist spending are facing major sales headwinds today. Image source: Macy's.

Meanwhile, although Hudson's Bay will reap substantial proceeds from the sale of most of its European operations to SIGNA later this year, it retained hundreds of millions of dollars of lease liabilities for its money-losing stores in the Netherlands. It is also effectively paying fashion rental start-up Le Tote to take the struggling Lord & Taylor chain off its hands.

When all these moves are completed, Hudson's Bay will have a better balance sheet, but it won't be pristine. More importantly, the company will probably still be losing money. It's not clear if the turnaround and growth initiatives that management is implementing can restore the company's profitability in the face of ongoing retail industry headwinds.

Macy's looks like a better investment option

I invested in Hudson's Bay stock last year because of the company's substantial real estate value and management's commitment to simplifying the business by getting rid of underperforming chains. However, I recently sold my remaining shares after the possibility of a go-private transaction caused Hudson's Bay stock to rally.

Right now, Hudson's Bay shares trade for more than the proposed buyout price. It's possible that Chairman Richard Baker and his partners will significantly raise their offer, but investors can't count on it.

There's still a decent chance that an organic turnaround will drive Hudson's Bay's stock price higher over time. However, retail turnarounds are fraught with risk -- particularly given the pace of change in the industry today -- and Hudson's Bay is starting from a baseline of being unprofitable.

By contrast, Macy's is already quite profitable, although it has experienced significant margin pressure in recent years. It has an equally promising turnaround plan, tons of real estate, and the stock trades at a bargain-basement valuation. As a result, Macy's is a higher-probability turnaround bet than Hudson's Bay.