On Tuesday, Macy's (M -0.30%) reported that sales dipped 1% and adjusted earnings per share (EPS) fell 22% year over year last quarter. The department store giant also reduced its full-year earnings guidance, due to the negative impact of high inflation on discretionary demand and a growing industrywide inventory glut in certain merchandise categories.

Nevertheless, Macy's stock jumped after the earnings report, ending the day with a 4% gain. In the current economic environment, investors were expecting even greater sales and earnings pressure. Macy's earnings report highlighted how management's moves to improve the company's performance are paying off.

A better-than-expected quarter

While Macy's sales and earnings declined compared to the second quarter of fiscal 2021, the company had benefited from a demand boom last spring, powered by government stimulus efforts and the gradual reopening of the economy. As a result, management had anticipated that the company's financial results would take a step backward last quarter.

In the quarterly guidance provided three months ago, Macy's estimated that net sales would decrease to between $5.48 billion and $5.55 billion: down from $5.65 billion in Q2 2021. It also called for adjusted EPS to fall from $1.29 a year ago to between $0.84 and $0.94. On average, analysts expected the results to wind up near the low end of those ranges, with sales of $5.49 billion and adjusted EPS of $0.85.

Instead, Macy's posted adjusted EPS of $1.00 on net sales of $5.6 billion. So while sales and earnings retreated from the highs of 2021, the pullback was milder than expected.

Notably, Macy's Q2 sales remained 1% above the company's 2019 performance, and adjusted EPS far exceeded the $0.28 recorded in Q2 2019. The upscale Bloomingdale's brand drove the top-line growth, recording 5.8% comp sales growth last quarter on top of 11.5% growth over 2019 in Q2 2021. Aggressive cost cuts during the pandemic powered the huge jump in EPS.

Guidance comes down anyway

Even though Macy's beat its guidance last quarter, the company reduced its full-year forecast on Tuesday. The company now expects net sales of $24.34 billion to $24.58 billion this year: down by $120 million from its prior outlook. It also slashed its adjusted EPS guidance range from $4.53 to $4.95 to a new range of $4.00 to $4.20.

The exterior of Macy's Manhattan flagship store.

Image source: Macy's.

Management explained that sales trends for the Macy's brand decelerated significantly starting in late June. Furthermore, the retailer still has more work to do to clear out aging inventory in "pandemic" merchandise categories like activewear, casual apparel, and home furnishings.

Thus, Macy's updated forecast assumes weaker sales trends and gross margin pressure from its inventory reduction efforts in the second half of fiscal 2022. It also includes some additional margin for error in case demand trends worsen further in the coming months.

Good enough news

Even after reducing its full-year forecast, Macy's is on track to generate adjusted EPS well above the $2.91 it posted in 2019, despite lower expected asset sale gains. That stands in stark contrast to many of its biggest rivals in the department store space.

Looking ahead, it wouldn't be surprising if some of the current demand and inventory management issues seep into 2023, leading to ongoing earnings pressure. On the other hand, the company has a number of initiatives under way to help it stabilize its sales and earnings. These include testing new small-format store prototypes, rolling out Toys R Us shops in all Macy's stores, and launching a new curated e-commerce marketplace.

Even after rising 4% on Tuesday, Macy's stock trades for less than five times the company's updated 2022 earnings guidance. That leaves ample upside for long-term investors if Macy's can continue posting earnings results well above pre-pandemic levels.