On Sept. 2, Macy's (M 0.60%) reported results for its fiscal second quarter ended Aug. 1 that far outpaced expectations.

That's not to say the results were good. Sales plunged 36% year over year due to store closures and depressed traffic in reopened locations, and the company posted an adjusted loss of $0.81 per share. However, analysts had expected Macy's to lose $1.77 per share. The Q2 loss per share also marked a huge improvement over the retailer's first-quarter adjusted loss of $2.03 per share.

Macy's stock rallied following the earnings report, ending that week at $7.65, up from $7.01 just before earnings. Since then, the stock has lost more than a quarter of its value, though, plummeting to a closing price of $5.67 on Tuesday.

M Chart

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Investors should expect more volatility in Macy's stock in the months ahead due to the sheer level of uncertainty created by the COVID-19 pandemic. That said, the stock will likely prove to be a huge bargain for patient investors willing to hold it until the pandemic ends.

Guidance may be conservative

One potential explanation for the recent Macy's stock price swoon is that investors have gloomy expectations for the second half of fiscal 2020. Macy's was one of many retailers to report a slow start to the back-to-school season. Furthermore, it's reasonable to expect that store traffic will be dramatically lower this holiday season compared to last year. Amazon's upcoming Prime Day, which starts on Oct. 13, could capture the lion's share of consumers' holiday shopping dollars before the season starts in earnest. Hefty shipping surcharges during the peak holiday shopping season could dent Macy's profit on the orders that do come in.

That said, Macy's has built conservative assumptions into its guidance. It is planning for comp sales to fall more than 20% year over year in the second half of fiscal 2020. That forecast includes an assumption that digital sales will increase at a "high teens" rate.

While a double-digit sales decline seems inevitable, Macy's has a good shot at outperforming its guidance despite the headwinds it faces, just as it did last quarter. COVID-19 case counts have moderated since peaking in July, supporting sequential improvements in store traffic. Meanwhile, online sales rose 25% in July, making high-teens growth seem like a beatable projection for the second half of the year -- especially since Macy's faces an easy year-over-year comparison this quarter. Finally, the timing of Prime Day may give Macy's an opportunity to participate in an early holiday shopping spree, avoiding shippers' surcharges.

The exterior of a Macy's store.

Image source: Macy's.

In short, expectations are extremely low right now. That potentially sets the stage for future earnings beats, which could propel Macy's stock higher.

The balance sheet is better than it appears

Worries about the balance sheet are also weighing on Macy's stock. Earlier this year, the company raised $4.5 billion of new financing, leading some pundits to opine that Macy's was mortgaging its future and only temporarily staving off collapse. However, these fears are misplaced.

The vast majority of the money Macy's raised came in the form of an undrawn credit facility. At the end of last quarter, Macy's had $5.4 billion of debt on its balance sheet -- up by $704 million from a year earlier. However, it also had $1.4 billion of cash, a figure that was up by $721 million year over year. Net debt was flat.

Furthermore, Macy's had a $599 million income tax receivable at the end of the second quarter, related to carrying back 2020 losses to offset taxes paid in previous years. It expects to receive that cash in the third quarter of 2021. (The amount could potentially grow depending on Macy's financial results for the second half of 2020.)

It's true that Macy's sharp swing from profits to losses this year means it cannot support as much debt as it had a year ago. Nevertheless, Macy's debt load is an overblown concern. As business returns next year and the company collects its massive income tax refund, the department store giant should have plenty of excess cash to start reducing its debt again.

Comeback potential is there

While Macy's faces severe short-term headwinds, the COVID-19 pandemic is thinning out the competition, particularly purveyors of dressy clothing. As people start returning to the office and going to weddings, funerals, and other formal gatherings in greater numbers, Macy's could gain market share from weaker rivals. The availability of a coronavirus vaccine will also remove what has clearly been a major damper on store traffic.

Skeptics are right to point out that Macy's faced plenty of challenges before the pandemic. A stock recovery is far from being a sure thing for Macy's.

That said, the company still has a lot going for it, including a well-regarded brand, a big e-commerce business, excellent real estate, and substantial cost-cutting opportunities. With Macy's stock trading for just two times its pre-pandemic earnings per share, even a partial earnings recovery post-pandemic -- combined with a return to debt reduction -- could drive a massive rally over the next few years.