Nordstrom: Too Far, Too Fast

 

Nordstrom reported a better than expected Q2 and shares are flying.
But was Q2 really that good?
What about JWN’s new earnings multiple?

Nordstrom (NYSE:JWN) has been a typical department store stock in the past couple of years; unbridled optimism and unrealistic expectations gave way to a torrent of poor sentiment and analyst expectations that tanked. This drove JWN shares down by more than half and it also led me to get bullish after Q1 earnings with the stock at just $38. We are up a very nice 34% since that call and after a better than expected Q2 report, it seems investors are warming up to the idea of owning JWN again. But is there more left in the tank here or is the big rally we’ve seen going to be it?
Nordstrom has struggled with sales and margin levels just like virtually any other department or apparel store of late because there is simply too much capacity. This is something that has been a discussion point for some time as the list of chains that can maintain some sort of comp sales level that is acceptable for investors gets shorter and shorter as time goes on. JWN has certainly struggled with comp sales in the past which has then negatively impacted margins, two of the biggest reasons why the stock was down in the $30s. So what happened in Q2?

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Total sales were down fractionally but comp sales fell again, this time by 1.2%. That’s a very manageable decline and in comparison to some other big box stores, it is downright bullish. But Nordstrom is a tale of two stores that happen to be consolidated into one company and that is where things get interesting. The full-line stores’ woes are well documented, as are the successes of the Rack concept. Retailers of all stripes – including competitor Macy’s (NYSE:M) – have gone to different versions of the outlet concept where full-line merchandise is liquidated. The Rack stores have been wildly successful but some would argue that is happening at the expense of the full-line. But is that necessarily bad? After all, if the margin dollars come in the door, why does it matter where they’re coming from?

RELACIONADA: Nordstrom Second Quarter 2016 Earnings Exceeded Expectations

That seems to be the attitude investors are taking on the Q2 report as the full-line comp was -230bps but the Rack comp was +530bps on the way to an 11.2% gain in total sales for the latter. The full-line stores continue to struggle with the shift of consumers towards off-price shopping [TJX Companies (NYSE:TJX), Ross (NASDAQ:ROST) and others are seeing tremendous success] but for Nordstrom, it is picking up some of that business with Rack. Indeed, the Rack concept is the only growth plan for Nordstrom right now and why not? It’s been a terrific success. Yes, the legacy stores are suffering but kudos to management for finding a way to keep some of those fleeing customers, even if it is at an outlet store instead.

Gross margins fell 101bps to 34.3% in Q2 as JWN continues to operate with very low product margins, a point I’ve called out in the past. The culprit for falling product margins in Q2 was clearing of dead inventory as well as higher occupancy expenses but those things are transitory. The occupancy expenses will be leveraged when new stores come into their own in a few quarters as sales levels ramp up and (hopefully) clearing of dead inventory doesn’t become a recurring event. It certainly looked to me like JWN was taking some lumps in Q2 in order to pave the way for a better second half but of course, time will tell. For me though, I’m not disheartened by the loss of margin in Q2 because I think it is temporary.

SG&A was up 212bps during the quarter to 29.8%, partially due to the benefit of the credit card portfolio sale in last year’s comparable quarter and partially because Nordstrom’s Anniversary sales event is in Q3 this year, not Q2. We’ll find out if that is true when JWN reports Q3 earnings but for now, the massive boost is due to the credit card portfolio gain last year; again, this is noise and should be ignored. The headline SG&A number is ugly for sure but when it is due to a one-time gain in last year’s quarter, it is meaningless. Nordstrom has been busy cutting costs and those efforts are certainly bearing fruit despite flat overall sales.

The thing is that despite the fact that I feel comfortable explaining away a lot of the weakness in Q2, JWN is not a cheap stock. With the post-Q2 report rally, JWN is now going for a full 19 times next year’s earnings, a sizable sum by any measure. For a retailer in particular, that is a huge multiple and one that I’m not entirely sure I’m okay with. When JWN was in the mid-$30s it was pretty easy to spot the value but in the low-$50s, I’m not so sure.

I believe in the Rack concept and I think management’s strategy to go after that customer with its growth dollars is the right one. I also think that JWN’s sales and margin issues are likely temporary but for 19 times earnings, you can buy a lot of growth elsewhere. Even next year analysts are only looking for 10% EPS growth, hardly worthy of a 19 multiple on this year’s earnings. The amazing thing is that Macy’s is going for just 12 times this year’s earnings despite the fact that the stories are very similar. Granted, Macy’s isn’t executing as well as Nordstrom is but again, it isn’t like Nordstrom’s earnings are flying into the stratosphere.

Thus, despite the fact that I like many things about Nordstrom, it has come too far, too fast for me to be comfortable owning it. The rally from the bottom earlier this year has been epic but for me, it is time to move on. I think JWN still has some growth ahead of it but I also think the stock has already priced in that growth and possibly more. JWN doesn’t deserve a 19 multiple in my view so I’ll be looking elsewhere.

Fuente: Seeking Alpha


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