TJX - Nordstrom: Another Disappointing Quarter Downgrading To 'Hold'

2023-03-08 12:07:52 ET

Summary

• With disappointing results for Q4 and FY2022, and extremely weak guidance for 2023, it is getting harder to remain optimistic about Nordstrom's shares.
• Nordstrom is also closing its Canadian operations, which were not profitable.
• The valuation remains very undemanding, but it has to be weighed against the risk of a recession arriving soon and further sales deterioration.

While Nordstrom ( JWN ) is trading with a very attractive valuation, it is getting harder and harder to remain optimistic about the shares. One of the few positive things we see is that the company ended the year with a much cleaner inventory. Inventory levels are down ~15% compared to the previous year and in line with 2019 levels. Other than that we see very little reason for optimism, with the company delivering poor earnings and weak guidance.

There was a time when Nordstrom was a top performing stock, but since it peaked in 2015 it has been underperforming the S&P 500 index ( SPY ) and the Consumer Discretionary ETF ( XLY ) by an enormous margin. Given the extremely low valuation we thought there was a possibility the company would at least significantly reduce the gap, but given the disappointing operational performance that is looking less likely to happen.

Q4 and FY2022 Results

In Q4 the company delivered net sales of $4.2 billion and earnings per share of $0.74. Due to discounting in order to clean up the inventory, profitability suffered in Q4 and FY2022. The company also had said that it had noticed customers starting to pull back spending in late June of 2022, primarily in Nordstrom Rack, and that this trend continued through the holiday season. Nordstrom Rack's performance was particularly disappointing, with sales in Q4 declining ~8% y/y. Nordstrom explained that part of the reason for this disappointing performance was that they raised the minimum order amount to receive free ship-to-store delivery.

Canadian Operations

In a surprising announcement, Nordstrom revealed plans to close its Canadian business, basically admitting defeat in this market. The reason provided by the company was that it is seeking to simplify its operations and increase its focus on its core US business. Still, the company admitted that the Canadian business has not been profitable and that it didn't see a realistic path to sustainable profitability.

In 2022 Nordstrom's Canadian business delivered sales of ~$400 million, which is only a very small percentage of the company's total sales. It will be expensive, though, to exit this market, and Nordstrom is guiding for a one-time pre-tax charge of $300 million to $350 million in Q1 of 2023. This will reduce first quarter and full year earnings per share by roughly $1.40 to $1.60.

Financials

For the last couple of years Nordstrom has been delivering razor thin operating margins, considerably below its targets.

During the earnings call one of the best questions came from an analyst asking if the company believes it can eventually hit its profit margin targets, and what would it take to get there, especially the target of reaching a 6%+ operating margin. This is what the CFO Michael Maher replied:

We believe that those targets remain achievable in a normalized environment with sort of sustainable low single-digit top line growth we believe we can achieve better margins than we did on comparable revenue beforehand. We're not quite in a normalized environment at this point. We talked about some of the macro headwinds we're seeing right now on consumer spending and also the inflationary pressures.

But we took a meaningful amount of our overhead costs out back in 2020, as you might recall. We continue to drive meaningful efficiencies in our supply chain, which is now the largest element of our SG&A. And we've been driving down our buying and occupancy as a percentage of our sales as well, which, as you know, is a component of gross profit for us.

So really, the last element in that equation for us is once we're in sort of a normalized macro environment where we can generate and sustain low single-digit top line growth, we believe we're positioned to achieve those long-term EBIT margin target.

Growth

The company is saying that it needs to grow its top line to be able to deliver better profit margins. Unfortunately growth has been lacking, despite retail sales growing at a decent pace in the US during the last year.

This leads us to believe that Nordstrom and several of its peers have been losing market share. As can be seen below, the revenue growth performance for Macy's ( M ), Kohl's ( KSS ), Nordstrom, and Dillard's ( DDS ) was rather disappointing in the fourth quarter.

Some of Nordstrom's competitors, however, are increasing sales. Some examples include TJX ( TJX ) and Ross Stores ( ROST ). On the positive side, Nordstrom is planning to open 20 new Rack stores this year, which should contribute ~100 bps to growth this year. Nordstrom also shared that 3 recent Rack store openings are beating their plan and outperforming the fleet average.

Balance Sheet

Nordstrom ended the year with debt/EBITDA leverage of ~3.1x, still above its target of less than 2.5x. It has ~$1.5 billion in available liquidity, including $800 million available on its revolving line of credit.

While we believe the balance sheet is in decent shape, we think the company should put more effort into further strengthening it.

Guidance

We found guidance for 2023 very disappointing given that the company expects revenue to decline 4% to 6% y/y. This negative growth is expected despite ~1.3% positive impact from having a 53rd week in fiscal 2023, which should add ~$200 million in sales. It also includes a ~2.5% negative impact from the wind down of its Canadian operations.

Valuation

With a recent share price of ~$19.4 and FY2023 adjusted earnings guided to $2.0 per share at the midpoint, the forward price/earnings ratio is below 10x. While that looks quite cheap, it is difficult to get too excited with negative revenue growth and razor thin profit margins. If the economy enters a severe recession it could easily result in the company delivering negative earnings next year. Nordstrom also does not look particularly cheap compared to its main peers, which show very low forward p/e ratios too.

Nordstrom does have an attractive dividend yield of almost 4%, which when combined with share repurchases results in an even more attractive net common payout yield.

Risks

Shares currently have a very high short interest, and the company's Altman Z-score is below the 3.0 threshold. A big risk to investors is a potential recession in 2023, which might be enough to push the company's margins into negative territory. While the valuation remains undemanding, we are not convinced the risks outweigh the potential rewards.

Conclusion

With disappointing results for Q4 and FY2022, and extremely weak guidance for 2023, it is getting harder to remain optimistic about Nordstrom's shares. The valuation remains very undemanding, but it has to be weighed against the risk of a recession arriving soon and further sales deterioration. After reviewing the most recent results we are updating our rating to 'Hold' from 'Buy' previously.

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