Nordstrom: On The Sidelines For Now

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About: Nordstrom Inc. (JWN)
by: JP Research
Summary

Revenues, earnings, and guidance beat consensus.

Margins disappoint, leading to a share price sell-off.

On track to achieve long-term growth objectives.

Risks from changing investor preferences and negative investor sentiments.

Current share price accurately reflects the risk/reward dynamic.

American chain of luxury department stores, Nordstrom (JWN), recently posted its third quarter results. Nordstrom delivered comparable sales (same-store sales) of +2.3%, beating analyst estimates and raised its guidance for 4Q18. Nordstrom's standout service, competitive pricing, and seamless shopping experience differentiate it from other department stores. However, the stock saw a 9% correction after the close on the back of declining margins and negative investor sentiments.

(Source: Google Finance)

While we do think Nordstrom is on track to achieve its long-term growth targets, we believe this has already been adequately discounted in the price. We remain cautious given macro uncertainty with valuations at 6.7x EV/EBITDA slightly above peers.

Mixed Reaction to 3Q18 Results

Revenue came in at $3.748m for 3Q18, growing 3.3% Y-o-Y. Although sales outpaced consensus in 3Q18, EPS of $0.67 beat only few analysts' estimates. Comparable sales in the reported quarter rose 2.3%, driven by a strong performance of the off-price business (particularly Rack.com/HauteLook). The off-price business seems to have a competitive edge given its scalable online presence with strong branding. It was also encouraging to see the management raise guidance for 4Q18, with revenues now expected at $15.5-$15.6b and EBIT forecast at $935-$960m. Comparable sales are now expected to grow at 2% compared to the earlier forecast of 1.5-2%.

Despite these positive developments, Nordstrom's stock fell 9% after hours. This suggested that investors expected an even better 3Q18 performance. The impact of Anniversary sales fell into 3Q18 which left the investors confused as 2Q18 comparable sales appeared overstated and the management made no effort to flag this for investors while reporting 2Q18 performance. The stock decline could also be attributed towards lower gross margins which declined 1.37% Y-o-Y to 33.3% in 3Q18. Although the management noted that the decline in gross margin was due to a change in the revenue recognition standard which boosted gross margins for 2Q18, the management had not clarified the same while reporting 2Q18 results.

On track to achieve long-term strategy

Nordstrom's strategy focuses on three key elements which are leveraging the company's brand strength, providing excellence services, and offering compelling products to its customers. Nordstrom remains on track to achieve its long-term revenue target of $20b by 2020. The company has been focusing on store-expansion to grow market share, prioritizing its investments in key North American markets. The opening of new stores is expected to not only attract customers but also boost the top line via synergies across other channels. The company also made significant progress towards its targets by opening three Rack stores in Canada and is on track to open the targeted six outlets for 2018. Overall, Nordstrom expects sales of $1b from Canada by 2020.

Nordstrom is also committed towards making investments in the technology space by improving e-commerce and digital networks, supply-chain channels, and marketing initiatives. 3Q18 results reflect significant progress towards this strategy with 20% growth in digital sales.

Key risks to the business include:

Although Nordstrom is on track to achieve long-term growth objectives, it also faces several major risks:

  1. Over-reliance on the Anniversary sale: In recent years, it is observed that the quarter with the Anniversary sale tends to be the best performing quarter. This demonstrates that customers respond well to promotional sales, however, sustaining that traffic appears to be increasingly challenging.
  2. Negative investor sentiments: Nordstrom's 3Q18 results were negatively impacted by a credit card charge. The charge was on account of an interest related error which hurt investor sentiment. Although the management expects to refund less than 4% of the credit card holders, with amounts of less than 100 USD, the charge remains a threat to near-term profitability. The management also shared limited information related to the impact of the change in the revenue recognition standards on gross margins while reporting 2Q18 results.
  3. Higher expenses in the short term: Nordstrom is making significant investments in the technology space to improve e-commerce and digital networks. These investments are directed towards gaining market share and tackling the shift in consumer preferences (from the traditional brick and mortar system to online shopping). Although this strategy bodes well in the long term, rise in supply chain costs and delivery expenses may lead to higher expenses in the following quarters.

Thus, while Nordstrom is on track to achieve its long-term growth targets, we believe that this is reflected in the current share price, particularly given the risks from changing consumer preferences and negative investor sentiments. Nordstrom currently trades at 6.72x EV/EBITDA. This seems fair, given that comparable companies such as The Gap (GPS) and L Brands (LB) trade on EV/EBITDA ratios of 4.57x and 5.66x, respectively.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.