Late last month, Macy's (NYSE:M) announced that sales plummeted about 45% in the first quarter, after the COVID-19 pandemic forced the department store giant to close all of its stores in mid-March. As a result, the retailer said it was on track to record an operating loss of roughly $1 billion for the quarter, dealing a sharp blow to its turnaround effort.

That said, management did highlight some signs of improvement during the late-May update. In recent days, Macy's has given investors additional reasons to be optimistic that the No. 1 department store chain can survive the current crisis without permanent damage to its business.

Financing for the future

At the end of fiscal 2019, Macy's had $4.2 billion of debt, offset by $685 million of cash. This put its balance sheet in much better position than it had been just a few years ago. As recently as 2016, Macy's had over $7 billion of debt. That said, Macy's still began 2020 with more debt than would have been ideal.

M Financial Debt (Quarterly) Chart

Data source: YCharts.

The COVID-19 pandemic dramatically increased the stress on its balance sheet. Sales dried up during the month of March, which meant that Macy's was unable to pay accrued liabilities for merchandise, wages, construction, and other spending. Macy's responded with a variety of measures to conserve cash, including extending payment terms for goods and services. Still, this was only a short-term fix.

Earlier this week, Macy's put the finishing touches on a more permanent solution. First, the company completed a previously announced $1.3 billion secured debt offering. Second, Macy's closed on a new $3.15 billion revolving credit facility backed by its inventory. This mostly replaces the previous $1.5 billion credit facility (which will be repaid in full and reduced to $75 million going forward).

Together, these moves have increased Macy's liquidity by about $3 billion. It now has enough cash and borrowing capacity to pay its outstanding bills, fund potential cash burn over the next few quarters, continue critical investments in the business, and cover all of its debt maturities for the next two years.

Customers are returning

On Tuesday, Macy's provided a more detailed summary of its first-quarter financial performance. (It will release its full earnings report on July 1.) The company reported sales of $3.02 billion and an operating loss of $969 million, including the impact of a $300 million inventory writedown that Macy's took at the end of the quarter. Both figures were within the ranges provided last month. Factoring in tax benefits available under the CARES Act, Macy's said it expects an adjusted net loss of $630 million for the quarter.

The exterior of Macy's Manhattan flagship store

Image source: Macy's.

Macy's store sales plunged last quarter, as all of its stores closed midway through the period. Interestingly, e-commerce sales also declined slightly, with most of the damage coming in March, when Macy's reduced its digital marketing spending and consumers were laser-focused on stocking up on essentials.

However, sales trends have improved dramatically since the beginning of the second fiscal quarter last month. Macy's began reopening stores in early May, and it now has over 400 stores open. Sales volumes in reopened stores have been about 50% of 2019 levels: down significantly, but much better than management had initially anticipated. Moreover, digital sales surged 80% year over year last month. The broad rollout of a new curbside pickup option contributed to this strength.

That's not to say it's all smooth sailing ahead. While sales will likely improve sequentially this quarter, management has warned that gross margin could be even lower than last quarter's severely depressed 17.1%. This reflects the reality that Macy's must aggressively clear out aging spring inventory this quarter, which will require massive discounting. All-in, Macy's expects to report a loss this quarter roughly in line with its first-quarter loss.

On the bright side, Macy's expects to have inventory in line with sales by the end of this quarter. That should pave the way for gross margin to move closer to historical levels in the second half of 2020.

Near-term challenges but long-term opportunities

After initially jumping on Tuesday morning, Macy's stock retreated sharply, ending the day down 7% at $8.87. (That said, the stock traded below the $5 mark less than a month ago.) Cautious comments from management about the expected pace of the recovery probably contributed to this reversal. Specifically, at an investor conference on Tuesday, interim CFO Felicia Williams said that sales trends probably won't return to normal levels until late 2021 -- and possibly even 2022.

However, it's good to see Macy's management planning cautiously. If demand exceeds expectations later this year, it can cut back on discounts, helping gross margin. By contrast, the worst thing would be to order too much merchandise, opening up the possibility of another big inventory writedown.

Looking out a few years, demand should recover. And while traffic to lower-tier malls could plunge permanently, Macy's is rapidly closing its stores at such properties, while refocusing on the highest-volume shopping destinations and its e-commerce business. Management hinted on Tuesday that it could get even more aggressive about store closures over the next year or two. Furthermore, Macy's will have a meaningful opportunity in the years ahead to gain market share from weaker retailers that go out of business due to the pandemic.

Meanwhile, Macy's is using the current crisis as an opportunity to accelerate and expand on its already-aggressive cost reduction plans. As demand returns over the next two or three years, this could allow the company to reach or exceed its pre-coronavirus margin structure while generating strong cash flow that can be used to pay down debt incurred this year. With Macy's stock still down nearly 50% year-to-date, there's plenty of upside for patient investors if the retailer can reinvigorate its business over the next few years.