Dive Brief:

• Moody's cut its forecast for department store profits after a "bleak" second quarter for the sector, according to a report released Tuesday and emailed to Retail Dive. The ratings agency now forecasts a 15% overall drop in operating income for the sector in 2019, after previously predicting a 10% decline.
• Perhaps even worse, the sector's bad Q2 and predicted profit decline followed several department stores' "heavy investing to improve inventory efficiency and to build their online capabilities," Moody's analysts led by Christina Boni wrote in the report.
• Despite those efforts, "sales remain tepid at best," inventory overhangs have depressed margins, comps are sagging and risk remains that department stores' performance will fall short of guidance for the year, according to the Moody's analysts.

Dive Insight:

Department stores can't blame their troubles solely on the economy or broader industry trends. The department store business itself is troubled. Q2 threw that into relief, as Target and Walmart hit their stride following years of heavy investment into their stores as well as digital and omnichannel capabilities. 

It's not just the mass merchants that performed well in Q2. Moody's analysts pointed out that department stores also continue to lose market share to discounters and off-pricers, with major off-price players logging a strong Q2 marked by sales growth. 

Department stores might as well have operated in a parallel reality during the period. Dillard's, J.C. Penney, Kohl's and Nordstrom all posted negative comps in Q2, according to data compiled by Moody's. Nordstrom's Anniversary Sale, normally a boon, was soft, according to the report. And the only department store covered by the analysts to report positive comps, Macy's, posted an anemic 0.3% increase. Top-line sales, meanwhile, fell for the entire cohort while margins decreased for all but Penney. 

"Off-price continues to drive apparel sales by resonating with millennials and continuing to experience improving traffic," Boni and her team wrote. "Department stores, in contrast, continue to lag and suffer from the general malaise that has surrounded ladies apparel."

The analysts did note that sales trends at department stores improved in June and July, after a "tough" May. 

Looking ahead, Boni and her team believe "there is a real risk companies are not planning inventories conservatively enough for another weak quarter of sales, which could exacerbate the promotional environment." Tariffs pose yet another risk. 

To boost profitability, department stores will need to make their stores more productive, the analysts wrote. That can be done by reducing store sizes, opening smaller replacement stores, subleasing excess space or adding new categories and business lines within existing space.