The big takeaway from our first batch of department store earnings? Turnarounds take time

Key Points
  • Despite better-than-expected earnings and sales from both Kohl's and Macy's, the stocks were both left tumbling on Thursday.
  • Department store chain Dillard's struggled this quarter with excess inventory.
  • No department store has raised its outlook for the full year, leaving Wall Street questioning the industry's future ahead of a key holiday shopping season.
  • Wall Street still awaits results from department store chains Nordstrom, J.C. Penney and Sears this quarter.
Pedestrians walk by Macy's flagship store in Herald Square in New York.
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Department store chains Kohl's, Macy's and Dillard's reported second-quarter earnings on Thursday, offering a much-needed checkup on retail's health, heading into the busiest shopping periods of the year.

And overall it's a mixed bag of results, with many questions left unanswered.

With talk of a retail apocalypse hitting malls and their anchor boxes hardest, department stores have been trying to inch back to growth, putting in place their own turnaround strategies. But meaningful payoffs take time, Wall Street learned Thursday.

Despite beats from both Kohl's and Macy's on quarterly earnings and sales, the stocks were last falling more than 6 percent and 9 percent, respectively, on the news.

The latest steps of progress for department stores are still just "small drops of success in a vast ocean of challenges," GlobalData Retail Managing Director Neil Saunders said in a note to clients.

Dillard's, which missed Street expectations on both the top and bottom lines, said that significant markdowns led to a disappointing loss during the latest quarter, as the retailer had to deal with excess inventory. Dillard's stock was last falling more than 14 percent.

For Macy's, a recent laggard compared with peers, "the list of things to do is long ... it cannot be delivered overnight," Saunders added. "There is now a real chance of a turnaround, but it has to be actively worked for."

A key metric for retail stocks, same-store sales, was what analysts and investors were watching most closely Thursday morning. And Kohl's, Macy's and Dillard's all posted comparable sales declines.

, another department store set to report earnings after the bell, is the only company that analysts expect this quarter could be able to post positive comps, aided by its off-price division.

As a sign of how much work there is to be done in the department store sector, Nordstrom is also in talks to go private to get out of the limelight as a publicly traded retailer. Once private, it will be free to invest in the business and not worry as much about quarter-to-quarter performance.

Department stores across the board have been struggling to lure shoppers to stores, as more and more purchases are being rung up online. To combat this trend, retailers are closing unprofitable stores to make a leaner brick-and-mortar footprint, trying to keep inventory light, and often using promotions to drive excitement around shopping. But should markdowns and heavy promotional expenses continue, profits will be hurt.

Macy's second-quarter gross margins fell to 40.3 percent from 40.9 percent one year ago, while Kohl's margins dropped slightly to 39.4 percent from 39.5 percent.

This suggests expenses are creeping up as sales aren't enough to cover them. Heavy promotional efforts further weigh on margins.

Macy's turnaround efforts, spearheaded by new CEO Jeff Gennette, include rolling out an off-price brand to compete with the likes of TJ Maxx, Ross and Nordstrom's Nordstrom Rack.

Macy's Backstage currently adds about 6 percent in incremental sales to the 38 full-line Macy's stores where it operates today, management told analysts and investors on Thursday's conference call. By the end of the year, Macy's said, it will decide how it's going to expand the off-price chain within its stores.

"We believe that this strategy, which offers simplified pricing, a treasure-hunt environment and lower price points, is resonating with many of our customers and adding to the Macy's experience," CFO Karen Hoguet said on its earnings call.

Macy's will also be launching a new loyalty program this fall, along with a new marketing strategy ahead of the holiday shopping season.

Kohl's, meantime, is focused on carefully managing its inventory and cutting expenses. Though its same-store sales have now fallen for six straight quarters, management sees an opportunity to grow revenue through the retailer's latest partnership with Under Armour.

"Under Armour, in particular, continued a very strong performance and beat the sales plan across almost all categories," CEO Kevin Mansell said on Thursday's earnings conference call.

The deal with Under Armour doesn't appear to be cannibalizing other key vendor relationships, like Kohl's deals with Nike and Adidas, Jefferies analyst Randal Konik said in a note to clients.

"We sense that the momentum continues into 3Q, and see ongoing [opportunity] through the addition of new brands, strengthening of private brands, and expansion of omni-channel initiatives," Konik said.

He raised his price target on Kohl's stock to $50 per share from $48, citing early signs of progress taking shape. Kohl's shares were last trading around $39.40 apiece.

Kohl's same-store sales declined 0.4 percent in the latest quarter, but management hinted on Thursday that "early reads on back-to-school are good." The marketing plan that Kohl's launched in July will continue through the holiday season, the company added.

Macy's CEO Gennette told CNBC in an interview that its uniform business, its juniors dress business and its active apparel categories are "quite strong" and "hot" this back-to-school season. Looking to the holidays, Macy's will always be promotional, he added, but the company wants to "clean up" any overlapping promotions that it has.

Some will wait for more answers this holiday season before deciding on the fate of department stores.

"We appreciate management's [long-term] initiatives to drive the business including marketing, merchandising, omni capabilities, and real estate monetization, but near-term fundamentals matter most to us, which are challenged with declining comps and deteriorating margins," Jefferies' Konik said about Macy's.

He said he's holding out for "stabilization" and a lift in comps, which Macy's new loyalty program could help achieve.

Heading into Thursday's earnings reports, Wall Street was expecting a 0.9 percent earnings decline year-over-year for 112 retailers surveyed, according to Retail Metrics' Ken Perkins.

Following mixed results from the department store chains, that forecast remains unchanged at a decline of 0.9 percent, Perkins said in a note to clients. Notably, J.C. Penney reports earnings before the bell on Friday, and Sears Holdings has yet to set a date for its release.

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