Department stores already faced plenty of challenges -- most notably, ever-rising competition from e-commerce and off-price retailers -- before the COVID-19 pandemic started to sweep across America. Now, with non-essential businesses forced to close and many consumers at risk of losing their jobs at least temporarily, their problems have multiplied enormously.
In recent weeks, even the largest and financially strongest U.S. department store chains have had to scramble to conserve cash. Here's what Macy's (NYSE:M), Kohl's (NYSE:KSS), and Nordstrom (NYSE:JWN) are doing to safeguard their businesses.
Working capital is the immediate challenge
Department stores operate on thin margins, carry a lot of inventory, and have relatively high labor costs. All of these factors mean that careful working capital management is important for keeping cash flow stable.
Consider Macy's as an example. As of Feb. 1, it had current liabilities of $5.75 billion, mainly consisting of $1.68 billion of merchandise accounts payable and $3.45 billion of other accounts payable and accrued liabilities. In other words, it owed suppliers and employees billions of dollars for goods and services provided over the previous few weeks and months.
As of the same date, Macy's had $6.81 billion of current assets. However, inventory accounted for the vast majority of its current assets, at $5.19 billion. Cash totaled just $685 million, supplemented by $409 million of receivables.
Normally, as a retailer sells through its inventory, it generates cash that is used to pay outstanding liabilities to vendors and employees. Meanwhile, it would incur new short-term liabilities, such as wages paid in arrears and merchandise purchased for the upcoming season on 60- or 90-day payment terms.
However, Macy's closed all of its stores last week because of the COVID-19 pandemic. Nordstrom, Kohl's, and most other department stores have also temporarily closed all of their stores. While it's continuing to sell merchandise online, e-commerce typically represents only a quarter of Macy's business. Moreover, online sales of apparel and footwear have plunged this month as consumers focus on buying essentials.
That means very little cash is coming in the door. Meanwhile, Macy's still has to satisfy its payables obligations. This abrupt negative shift in Macy's working capital position could create a multibillion-dollar cash flow headwind over the next several months. Kohl's and Nordstrom face similar (albeit somewhat smaller) threats.
Shoring up cash
Department stores are taking a multipronged approach toward shoring up their cash positions. First, they are suspending dividends and share buybacks. Over the past week, Macy's and Nordstrom both confirmed that they will temporarily stop paying dividends. Meanwhile, Kohl's and Nordstrom have paused their share repurchase programs. (Macy's hasn't bought back stock for several years.) Kohl's also said it is evaluating its dividend and may temporarily reduce or suspend it.
Second, Macy's, Kohl's, and Nordstrom have drawn on their credit facilities to give themselves bigger cash cushions, borrowing $1.5 billion, $1 billion, and $800 million, respectively.
Third, all three retailers have slashed their spending plans for the year. For example, Nordstrom said it is "targeting further reductions of more than $500 million in operating expenses, capital expenditures and working capital." Kohl's and Macy's have outlined similar initiatives. These plans include offering bigger discounts to speed up sales of seasonal merchandise online.
Finally, Macy's -- which has more working capital tied up in inventory than Kohl's and Nordstrom, particularly relative to its current liabilities -- recently said that it is cutting future merchandise orders and extending payment terms. In other words, it is buying time to convert its current inventory into cash and working to prevent a future buildup of excess inventory.
A painful year, but these department stores will survive
Kohl's and Nordstrom have solid investment-grade credit ratings, while Macy's is teetering on the brink after S&P analysts cut its credit rating into junk territory last month. All three are far better-positioned to withstand short-term business volatility than many of their retail-industry peers: particularly those with high debt from leveraged buyouts.
Nevertheless, the COVID-19 pandemic will prove very costly. Most notably, the longer their stores are closed and sales trends remain severely depressed, the more aged seasonal inventory retailers will have when traffic finally starts to return. Macy's and Kohl's -- and to a lesser extent, Nordstrom -- may need big markdowns to clear out this inventory. Even if sales trends return to near-normal by the summer, markdowns on spring merchandise could lead to big declines in full-year earnings for these companies.
Additionally, all three retailers have agreed to continue paying their workers for at least two weeks while their stores are closed. Looking ahead into April, they will face a delicate balance between continuing to pay employees to stay home (aggravating their losses) and risking the permanent loss of good workers who may find jobs at rivals like Walmart and Target.
Investors should also recognize that there is a significant risk of an extended slowdown in retail sales. Job losses related to the COVID-19 pandemic could depress consumer spending on non-essential items like fashion apparel. Meanwhile, some epidemiologists warn that there could be multiple waves of COVID-19 outbreaks. Thus, even if life starts to return to normal over the next few months, there could be subsequent lockdowns that decimate retail sales again.
As a result, investors with short time horizons -- as well as those with low or moderate risk tolerance -- should steer clear of Macy's, Kohl's, and Nordstrom. However, for long-term investors with higher risk tolerance, all three stocks are worth a look after the sharp declines of the past month.
Macy's, Kohl's, and Nordstrom generally have stronger business models than other department stores, with substantial revenue contributions from non-mall and/or off-price stores. Macy's -- the weakest of the three on most metrics -- also has an extremely valuable collection of real estate. The value of these properties represents a backstop for shareholder value, provided the company can keep the losses from COVID-19 in check.
The current COVID-19 pandemic will pass sooner or later. When it does, Macy's, Kohl's, and Nordstrom are likely to get back on their feet, enabling share-price recoveries for all three department store operators.