The COVID-19 pandemic has disrupted business for lots of retailers. Few were harder hit than Macy's (NYSE:M), though. Sales fell about 45% in the first quarter of fiscal 2020. Moreover, its inventory of seasonal products lost value rapidly while its stores were closed, leading to huge markdowns and a $300 million inventory writedown. And while most stores have now reopened, COVID-19 cases are surging in many parts of the U.S., raising a significant risk that some stores will have to close again temporarily.

That has made cost reductions more urgent than ever for the department store operator. Last week, Macy's showed that it's getting serious, announcing a new plan to slash expenses by $630 million annually by eliminating thousands of jobs.

Too many half-measures in the past

There have been many cost-cutting maneuvers at Macy's in recent years, but until recently, there was never a sense of urgency. Cost cuts tend to be painful. Jobs are automated out of existence, employees must adapt to new ways of doing business, and offices are consolidated, forcing some workers to either move to a new city or leave the company.

Thus, it's natural to avoid the toughest decisions when results are reasonably good already. And as recently as 2018, Macy's posted full-year comp sales growth of approximately 2%, adjusted earnings per share of $3.26 (excluding asset sale gains), and over $800 million of free cash flow.

As a result, annual operating expenses still totaled $9 billion last year, equal to 36.6% of sales. This is a significantly higher level of expenses relative to sales than No. 2 department store chain Kohl's, let alone discounters like Target or TJX.

Unfortunately, sales slowed dramatically last fall. Even before COVID-19 hit, Macy's expected sales pressure to continue for years. The pandemic has made the outlook even worse. This has forced the top department-store operator to take a closer look at its cost structure.

The exterior of the Macy's Manhattan flagship store

Macy's has been suffering from a bloated cost structure. Image source: Macy's.

Another round of cost cuts

Last fall, Macy's outlined a plan to save between $400 million and $550 million annually by 2023, if not sooner. However, the plan mainly focused on using technology tools to boost gross margin. Estimated operating expense reductions only came to a range of $125 million to $175 million.

As the downturn in sales trends became more evident, Macy's got significantly more aggressive about reducing costs. Back in February, the company said it now planned to unlock $1.5 billion of annual savings by 2022. Most of the incremental savings compared to the targets shared last fall came from greater operating expense reductions, which are now expected to total $900 million.

Some of the additional cost savings will come at the store level, as Macy's plans to close at least 125 full-line stores between 2020 and 2022. However, the biggest new source of savings comes from a major corporate restructuring. Macy's has closed technology offices in San Francisco and Lorain, Ohio, shut down its second headquarters in downtown Cincinnati, and consolidated all of those functions into offices in New York and Atlanta. It also closed a customer contact center in Tempe, Arizona. As part of this reorganization, Macy's said it would cut its corporate and support headcount by 9% (2,000 positions).

On Thursday, Macy's said it would eliminate another 3,900 corporate and management positions. That brings the year-to-date headcount reduction in these functions to about 27%, based on the numbers shared in February. Macy's also said it is reducing staffing in stores and across its supply chain and customer support network to align with current demand. Those cuts also appear to be substantial (albeit not permanent). The RWDSU union, which represents employees at Macy's Manhattan flagship and three other stores, said the company wants to cut more than 650 of the 4,000-plus employees represented by the union.

These moves will save $630 million annually, on top of the $1.5 billion of cost cuts detailed in February, according to Macy's. About $365 million of savings will show up this year, offset by one-time pre-tax restructuring costs of $180 million.

The restructuring Macy's always needed

As of Feb. 1, Macy's had approximately 123,000 non-seasonal employees. About 22,000 of those positions were management and support roles: a figure that certainly seems excessive. Nearly 6,000 of those roles have now been eliminated in 2020.

This should make Macy's far more efficient. Business isn't likely to go back to anything resembling normal in 2020 or even 2021. However, with a much leaner cost structure and cautious inventory planning, the company should be able to get cash flow back to breakeven or better next year, eliminating near-term bankruptcy risk.

Looking further ahead, Macy's will be getting the full benefit of its cost-cutting moves by fiscal 2022. Assuming the threat of the virus has been brought under control by then -- which seems likely but far from certain -- it could pave the way for Macy's to emerge from the pandemic as a smaller but more profitable company.

That would help the company rebuild its balance sheet after being forced to take on a lot of debt this year. And with Macy's stock currently trading for barely more than two times 2019 earnings, it would create a ton of upside for shareholders.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.