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With the rumors of a Saks (NYSE:SKS) - Neiman Marcus merger floating in the market, investors have once again started playing close attention to luxury retail companies. Even without M&A activity the sector looks fundamentally good. With the stock market rising, and increasing income levels of wealthy customers as economic recovery gains traction; luxury retailers are poised for a good growth. Nordstrom (NYSE:JWN) is one such luxury retailer that is investing in the business to capture this growth opportunity.

The company has increased its capital expenditure in fiscal year 2013 to $750-790 million from $450 million last year. It has invested in the Direct Channel with technological enhancements and in store expansions. Nordstrom plans to enter Canada in 2014 and will look to expand its store base in both full line stores and Rack stores. Its loyalty program membership has increased in the last quarter and will drive sales growth for the year. In the Women's apparels segment, Topshop merchandise will be extended to additional stores with lower price points. Now, let's discuss these initiatives in detail.

Direct Channel with technological enhancements will drive sales growth

Direct Channel is the online and mobile channel of the company and it was one of the growth drivers for it last year. In the first quarter this fiscal year its direct sales increased by 25% on top of the 44% growth last year. It has invested $240 million for technological enhancements this year. It has taken initiatives of Mobile POS devices for faster check out, added features on its website and direct inventories to fill online orders. Its investment in technology will provide better online and mobile experiences for customers who contribute 30% to the total sales.

Rack stores and Canada Expansion provide long-term growth opportunity

Rack Stores are small format stores of the company, which are sized around 37000- to 40000-square feet. About 80% of the assortment of goods in these stores comes directly from the vendors and this helps it to generate higher EBIT margin than the full line stores. It has plans to open 24-25 Rack stores in this fiscal year and will look to expand the store base to 230 stores by FY 2017. It will enter Canada this year and has announced the proposed opening of five full line stores in Canada. In the long term, it has plans to expand 8-10 full line stores and 10-15 Rack stores in the country. It will look for sales penetration of 10% of the total sales from the country.

Fashion Rewards and Topshop merchandise will attract price-sensitive customers

The Fashion Rewards program is a major loyalty program of the company and its active members increased to 3.5 million last quarter from 2.9 million last year. They contributed 36% of the total sales and increased 15% sales in the quarter. Topshop merchandise with more accessible price points in the women's apparel has helped it to outpace the company average. It has plans to extend Topshop merchandise to 42 stores in the latter part of the year. Its Fashion Reward program and Topshop merchandise will attract fashion conscious but price sensitive customers to its stores.

Peer Analysis

In the departmental stores segment, the two major peers of Nordstrom are Macy's Inc. ( M) and Saks Inc. Macy's has taken an initiative of localizing its offerings with segmentation of stores under its My Macy's strategy. Its online channel has been a good growth driver for it with a 40% growth rate. It has plans to extend its online order and delivery facility to 500 stores from the current 292 stores this year. It is focusing more on the impulsive, active and young, "millennial" customer base with new brand launches and brand extensions. It has launched QMack and Maison Jules brands and extended the brand Bar III to attract these customers in the latter half of the year.

Saks' stock price has been on the slope in the last one month after it reached its highest point. It jumped to its highest point after the news of Goldman Sachs' appointment flashed in the media. It has focused on its online channel and will be investing in it to drive customers towards the Omni-channel network. It also has plans to launch OFF5TH.com website for OFF 5 th stores. It has re-launched the SaksFirst loyalty program and also eliminated the minimum threshold limit. Its loyalty program and increased discounts under promotional events will drive customers to stores.

Company

P/S

1 Year Fwd. P/E

Op. Margin

Nordstrom Co.

1.05

13.62

10%

Macy's

0.73

10.47

6.81%

Saks

0.69

25.94

5.35%

Source: Google Finance and Yahoo Finance

Nordstrom has reported the highest operating margin of 10% among the three mentioned peers with 1-year forward P/E of 13.62. Macy's has achieved a P/S ratio of 0.73 with lowest forward P/E of 10.47%. Saks has the lowest P/S ratio of 0.69 but with the highest relative forward P/E of 25.94 among peers.

Conclusion

Nordstrom has invested in the technological enhancements and improved its Direct Channel. Its Rack stores expansion along with its entry into Canada will drive long-term growth of the company. Fashion Rewards and Topshop merchandise will drive price sensitive customers to the stores. It has a long-term growth potential with good fundamentals in place. So, I recommend a "buy" for long-term investment.

Source: Why Nordstrom Is A Good Bet In The Luxury Retail Sector