The S&P 500 jumped on Monday after Pfizer announced promising results from its ongoing clinical trial of a COVID-19 vaccine candidate. Based on the first interim efficacy analysis of the vaccine candidate, it appears to be more than 90% effective. The drugmaker could apply for emergency use authorization in the U.S. within weeks.
Department store stocks were among the biggest beneficiaries of this news. Shares of Macy's (M -2.68%), Kohl's (KSS 1.49%), and Nordstrom (JWN 0.96%) -- the three largest U.S. department store operators -- all skyrocketed 17% or more on Monday.
Department store stock performance. Data by YCharts.
Yet in the short term, an ongoing surge in COVID-19 cases in the U.S. could weigh heavily on holiday retail traffic. Some states and cities could order new temporary store closures. Let's take a look at whether investors should take advantage of this rally to sell any department store stocks they may hold.
The initial pandemic shutdowns crushed department stores
In March, the fast-moving pandemic forced most nonessential retailers, including department stores, to close their physical stores. Consumer demand shifted toward essentials, while apparel sales plunged. Retailers that normally sell a lot of business and special-occasion attire -- such as Nordstrom and Macy's -- faced an additional headwind, as people directed their remaining apparel spending toward casual and comfy items for staying at home.
While Macy's, Kohl's, and Nordstrom all have successful e-commerce businesses, they still rely on their stores to generate the bulk of their sales. Moreover, the cost of shipping items to customers' homes makes digital sales less profitable than in-store sales. Finally, March's abrupt change in sales trends meant that all three chains grappled with inventory gluts this spring.
As a result, department stores posted terrible financial results in the first half of fiscal 2020. Macy's racked up an adjusted net loss of $881 million. Kohl's adjusted net loss totaled $534 million, and Nordstrom lost $776 million.
Image source: Macy's.
This time it's different
It's hard to compare the current state of the pandemic to March, as testing has improved significantly over the past eight months. However, the number of people hospitalized with COVID-19 cases has doubled since late September, putting it within 5%-6% of the prior peaks seen in April and July -- and there's no sign that the surge in hospitalizations is leveling off. This could make investors nervous that department stores are in for a repeat of their terrible spring-season results.
However, two things have changed. First, department stores have cleaned up their inventory and are planning for lower demand. As of early August, inventory was down 29% year over year at Macy's, down 26% at Kohl's, and down 24% at Nordstrom. With tightly managed inventories, department stores shouldn't have to take huge markdowns as they did in the first quarter if sales trends deteriorate again.
Second, department stores will be better able to respond to potential lockdown measures this time around. For example, Macy's and Kohl's quickly rolled out curbside pickup for online orders earlier this year. (Nordstrom already offered curbside pickup.) Retailers have also developed new cleanliness procedures during 2020 that will likely give some customers enough comfort to continue shopping in stores even as COVID-19 case numbers rise again.
The comeback will continue
Department store shareholders shouldn't expect smooth sailing over the next few months. The 2020 holiday season will probably be rough for department stores, with weak store traffic and not enough e-commerce growth to fully offset lost in-store sales and profits.
Still, even after racking up big gains on Monday, department store stocks are down more than 50% from where they traded a year ago. This leaves plenty of upside for investors if these stocks fully recover from the pandemic in the years ahead.
The big concern is that the pandemic may have permanently changed consumer shopping patterns toward discounters and e-commerce. While shoppers may not go back to precisely their 2019 shopping habits, skeptics may be underestimating consumers' desire for normalcy -- including activities like in-person shopping. As some spending moves permanently to discounters and pure-play e-commerce companies, Macy's, Kohl's, and Nordstrom stand to gain share from weaker department stores and specialty retailers that are going out of business or shrinking dramatically. Finally, all three have implemented big cost cuts this year.
Even after a big jump on Monday, department store stocks have substantial upside as the U.S. recovers from the COVID-19 pandemic over the next couple of years. For shareholders who can tolerate some risk, there's no need to sell now.
