On Thursday afternoon, Nordstrom (NYSE:JWN) became the latest department store giant to report a massive loss for the first quarter of fiscal 2020. Like peers, Nordstrom closed most of its stores in mid-March in response to the COVID-19 pandemic, contributing to a sharp drop in sales and massive margin erosion.

However, the worst of the pandemic's impact may be past for Nordstrom, thanks to the company's aggressive efforts to cut costs and clear out old inventory. While it could take a year or two for Nordstrom to get fully back on track, now could be a great time for patient investors to bet on this long-term outperformer.

Nordstrom logs an ugly loss

The first quarter started off well for Nordstrom, with sales ahead of plan in February (the first month of Nordstrom's fiscal Q1). Unfortunately, the COVID-19 pandemic crushed the company's momentum in March. Store traffic slowed in the first half of the month and the retailer was forced to close all of its stores in mid-March. The reopening process didn't begin until earlier this month, after the end of the fiscal quarter.

The entrance to a Nordstrom Rack store, with Nordstrom's Seattle flagship store pictured in the background

Store closures led to a big drop in Nordstrom's sales last quarter. Image source: Nordstrom.

Nordstrom does have a robust e-commerce business, which accounted for about a third of the company's sales last year. Digital sales did grow modestly in the first quarter, with demand up 9% and sales (after accounting for the timing of shipments and estimated returns) up 5% year over year. However, that wasn't nearly enough to offset the loss of in-store sales. As a result, Nordstrom's total sales plunged nearly 40% to just over $2 billion.

While Nordstrom quickly jumped into action to reduce expenses as sales slowed, there was no way to fully offset the margin impact of lower sales. (Also, like many peers, Nordstrom continued to pay all of its employees for the first several weeks that its stores were closed.) Furthermore, the upscale retailer had to implement significant markdowns to clear out seasonal inventory that was at risk of going stale. That caused gross margin to plummet to just 10.7%, down from 33.5% in the prior-year period.

This led to an operating loss of $813 million, compared to a $77 million operating profit in Q1 2019. Management attributed $280 million of that loss to special charges related to COVID-19, consisting of asset impairments for 16 full-line stores being closed, restructuring costs, and temporary premium pay and benefits for employees. Nordstrom's net loss came in at $521 million, or $3.33 per share, whereas it earned a net profit of $37 million ($0.23 per share) a year earlier.

Nordstrom also reported that it burned $826 million of cash last quarter. While the first quarter is always seasonally weak for cash flow, cash burn was just $240 million in Q1 2019.

The exterior of a Nordstrom store

Image source: Nordstrom.

The worst is over

While Nordstrom's first-quarter performance was quite terrible, there are good reasons to expect rapid improvement. Most notably, Nordstrom exited the quarter with inventory down 25.8% year over year. That's still not fully aligned with sales trends, but it means that future markdown risk is much lower. This should support sequential gross margin improvement in the second quarter, with additional gains likely in the back half of the year.

Furthermore, after peaking in March, Nordstrom's cash burn slowed significantly in April and is set to improve further in the second quarter. CFO Anne Bramman said the company is on track to reach cash breakeven by the end of this quarter.

Stores have started to reopen and Nordstrom hopes to have all of its locations operating by the end of June. The early results from reopened stores have exceeded expectations. The Nordstrom Rack off-price chain (which was particularly hard-hit by the store closures) could be a bright spot in the months ahead as it gets access to excess Nordstrom full-line inventory and closeouts from various vendors. Off-price giant TJX Companies recently reported that sales volumes at reopened stores exceeded 2019 levels within a week.

Plenty of cash and strong long-term prospects

Nordstrom entered fiscal 2020 with $853 million of cash. In April, it strengthened its balance sheet by issuing $600 million of secured debt and amending the terms of its $800 million credit facility (which it has fully drawn). This allowed Nordstrom to exit the first quarter with $1.36 billion of cash: more than enough in light of its slowing cash burn.

Looking ahead to the second half of the year, there's a good chance that Nordstrom can produce positive cash flow, even if store traffic remains well below 2019 levels. After all, the company will benefit from favorable seasonality in the fourth quarter, and it has a strong online business, an improved cost structure, and low capex requirements going forward. Nordstrom is also in line for a tax refund that could total hundreds of millions of dollars due to CARES Act provisions that will allow it to carry back 2020 losses to prior years.

While COVID-19 has had a severe negative impact on Nordstrom in the short term, if anything it could bolster the company's long-term prospects. The pandemic has instilled more urgency with respect to cutting overhead costs, which will drive long-term savings. The company is closing 16 lower-volume full-line stores, which will improve its overall full-line store footprint. Meanwhile, Nordstrom could make market share gains if competitors like Lord & Taylor go out of business.

Nordstrom has already made substantial progress in pivoting away from mall-based stores over the past decade. The opening of a new flagship store in Manhattan last fall, rising online sales, and the recently announced store closures will accelerate its move away from this shrinking part of its business. This could set the stage for a big comeback by Nordstrom over the next few years.