It's not exactly breaking news that department stores are struggling to stay relevant in the fast-changing retail landscape. However, their long-term problems have turned into existential crises in 2020, as the COVID-19 pandemic forced nearly all department stores to close in mid-March. Some stores are slowly starting to reopen, but they now face new problems: low customer traffic and a glut of unsold seasonal inventory.

On Thursday, privately held luxury department store Neiman Marcus became the sector's first casualty of 2020, filing for bankruptcy. J.C. Penney (NYSE:JCP) may be close behind, after it skipped a debt payment last month. Meanwhile, long-suffering Lord & Taylor reportedly plans to go out of business entirely. Even stronger operators like Nordstrom (NYSE:JWN) and Macy's (NYSE:M) are looking to shrink their store footprints significantly to adapt to the new reality.

Neiman Marcus files for bankruptcy

Neiman Marcus is the latest in a long line of companies that took on lots of debt through leveraged buyouts and then struggled to pay it back due to deteriorating business conditions. While Neiman Marcus extended some debt maturities last year, this didn't fix the underlying problem of having too much debt and declining earnings.

The coronavirus related drop-off in business was too much to handle, leading to this week's bankruptcy filing. Adding to the pressure, Neiman Marcus is highly exposed to tourist markets like New York, San Francisco, Los Angeles, Las Vegas, Hawaii, and Florida, where business could suffer for years if COVID-19 concerns continue to depress tourism. The sharp downturn in the oil business could also hurt its seven stores in Texas.

The exterior of a Neiman Marcus store

Image source: Neiman Marcus.

Neiman Marcus said two months ago that it would close the majority of its Last Call off-price stores later this year. Now, it will also look at case-by-case closures of its full-price stores, as the bankruptcy process will allow it to break leases for underperforming locations.

Lord & Taylor could be closing up shop

While Neiman Marcus hopes to emerge from bankruptcy later this year mostly intact, moderate-upscale chain Lord & Taylor won't be so fortunate. While the 194-year-old chain hasn't filed for bankruptcy yet, it is planning to do so once stores are permitted to reopen, at which point it would liquidate and close all of its stores, according to Reuters.

Lord & Taylor's impending demise is not the least bit surprising. The chain has been unprofitable in recent years, even when the economy was strong. Former parent Hudson's Bay essentially paid fashion rental start-up Le Tote to take the last 38 Lord & Taylor stores off its hands last year. (While Le Tote paid $100 million for the brand, Hudson's Bay agreed to cover its rent for three years.)

Even with free rent, it doesn't make sense to keep the business going any longer. While the loss of Lord & Taylor won't be noticed in much of the country, the closure of its remaining stores will mark a big change in the competitive environment in the Northeast (home to more than 80% of Lord & Taylor stores).

More downsizing at Nordstrom

Nordstrom is one of the strongest companies in the department store space, unlike Neiman Marcus and Lord & Taylor. It entered the year with about $850 million of cash on its balance sheet, and has drawn down $800 million from its credit line and issued another $600 million of debt in recent months to fortify its balance sheet. Even with those moves, its debt load remains very manageable.

Nevertheless, with store traffic likely to be unusually weak for at least a year or two, Nordstrom has had to become more aggressive about rationalizing its full-line store footprint. It already closed seven full-line stores last year -- an unusually high number by historical standards. It now plans to close at least 16 of its 116 full-line stores in 2020. While the company hasn't provided a full closing list yet, the closures will include locations in Naples, Florida and the Dallas-Fort Worth, Denver, Hartford, Richmond, and Sacramento metro areas, according to various media reports.

These store closures continue a pivot toward Nordstrom focusing on its biggest markets and serving them with fewer full-line stores. Instead, Nordstrom is opening small-format Nordstrom Local stores and enabling order pickup, returns, and even alterations for full-price goods at Nordstrom Rack off-price stores. The company's growing agility is helping it to serve full-price customers more conveniently than ever without continuing to operate oversized, low-productivity full-line stores.

Much more to come

J.C. Penney is next on the bankruptcy watch list and began negotiating for bankruptcy funding with its lenders last month. The retailer is nearing the end of a 30-day grace period to make up the interest payment it skipped in April. J.C. Penney also has a looming debt maturity of over $100 million due in June, and a burdensome debt load overall. Indeed, it was struggling to manage its liabilities even before COVID-19 crushed its business.

The exterior of a JCPenney store

Bankruptcy risk is high at J.C. Penney, and store closures are likely. Image source: J.C. Penney.

While J.C. Penney will try to close underperforming stores and shrink to a more sustainable store base through the bankruptcy process, the company has been unprofitable in recent years. That casts doubt on its ability to reorganize successfully. Moreover, it is at risk of losing the rights to its Sephora in-store beauty shops, one of the biggest attractions in its stores.

The best-case scenario probably involves J.C. Penney closing hundreds of its 846 stores this year and emerging as a significantly smaller company. However, it's quite plausible that the storied retailer will be forced to shut down, just like Lord & Taylor.

As for Macy's, the top department store chain announced earlier this year that it would close nearly a quarter of its full-line stores within three years as it exits lower-quality malls. This would leave it with a store base of about 400 locations. However, Macy's is considering even deeper cuts in light of the damage from the COVID-19 pandemic.

Trimming the store portfolio faster and further would probably be wise. In a February presentation, Macy's said that after the recently announced store closures, about half of its stores would be in A-rated malls. By contrast, Nordstrom entered 2020 with 95% of its full-line stores in A malls, and yet it still plans to close 14% of its full-line fleet this year. Macy's doesn't necessarily need to close all of its locations in B malls, but having 200 such stores may be too many going forward.

Despite all of these looming closures, the news isn't all bad for stronger department store chains like Nordstrom and Macy's. Between shedding lower-performing locations and market share gains at the expense of weaker rivals, they could become much healthier businesses when retail traffic eventually recovers.