Question

many celebrated economists have linked the recent novel covid 19 pandemic to the great depression of the 1930s. one of the havoc this pandemic has caused is the general decline in the value of most stocks. as a student of corporate finance what cardinal concept in finance will you attribute this to and what are the critical issues involved in this concept

Answer 1

The novel coronavirus pandemic is causing havoc around the world. Financial markets in the U.S. are in turmoil, and for a good reason. The pandemic has caused cities, states, and countries to take drastic action to limit the spread of COVID-19.

Macy's (NYSE:M) was already facing difficult circumstances before the outbreak. Now, due to COVID-19, it has decided to close all its retail locations through March 31. Its e-commerce sites will remain open.

Due to the pandemic, the shift from brick and mortar to online shopping is likely to accelerate significantly. The retail apocalypse may reach the climax this year as the coronavirus causes people to avoid going out to spend. Macy's, with its 776 locations across the U.S., will face a massive decrease in sales should the containment efforts be prolonged.

Will more stores need to close?

Macy's has too many locations serving too few visitors. Fortunately, it has already started traveling down the path of reducing this number. In its most recent earnings conference call, the company announced it will be closing 125 stores over the next few years. If the closures go as it plans, it will still have 651 stores in operation.

The problem for Macy's and its shareholders is that these actions may not be enough. For a company the size of Macy's, the need for an additional sudden reduction of a large magnitude would not be easy, and will likely cause significant unintended expenses.

Importantly, this is not somewhere an investor wants to be -- facing a once-in-a-lifetime risk, without the potentially big payoff to make it worthwhile.

Investment in upgrades not likely to pay off

To entice customers to visit its stores, Macy's committed to upgrading locations. The choice is bearing fruit. Renewed stores are generating more sales than the rest of the fleet. However, the decision expected years of enhanced revenue, which are likely to be lower than initially estimated because of the coronavirus.

What makes matters worse is that the investments made are unlikely to have any value outside of Macy's. It cannot recoup the cost of new paint, light fixtures, changed carpets, and so on if it needs to close an upgraded store.

Overall, it seems more likely now that the expense undertaken in upgrading stores will not return the cost of capital. The good news is that this was done in only 150 of its locations. Management was planning on upgrading another 100, but those plans may be scrapped because of the pandemic.

It will survive the pandemic

Macy's, with its strong balance sheet, is almost certain to make it through these difficult times. The same is not true for all retailers, especially those with lots of debt. You may think competitors going bankrupt will mean less competition for Macy's. While that may be true in the long run, the immediate consequence of bankruptcies is liquidation sales.

Macy's will then need to decide if it's going to lower prices to stay competitive, or stay the course and risk losing a chunk of sales to liquidating competitors. Whatever it decides, the outcome will be negative and uncertain.

What this means for investors

The coronavirus is worsening the trend of people turning away from shopping in-store, which was a problem for Macy's even before the outbreak. Even if it handles this effectively, the other side of the crisis is not a world where shoppers return to stores in large groups. Shareholders are in a position where the company's revenue will either decline dramatically for an extended time or return to being relatively flat after a big drop.

Finally, the recipe for investing success does not include putting your money in situations where outcomes can be either terrible or below average. It's time to sell this consumer discretionary stock and reconsider the company after the pandemic has run its course.