Summary
- Nordstrom shares have declined 29% over the past year as the company has suffered from a promotional retail environment and rising costs.
- Roughly 1/3 of Nordstrom's revenue comes from its off-price Nordstrom Rack business which has the potential to increase its store base by 50%.
- At $16.70, Nordstrom trades for just 7.3x 2022e EPS, 4.4x trailing EV/EBITDA and a 4.5% dividend yield.
- The Nordstrom family owns ~30% of the company and is managed by Erik and Peter Nordstrom. I view this negatively given their entrenchment and the company's underwhelming performance.
- Despite an attractive valuation, my concerns about the low likelihood of operational improvement and value realization under the current ownership/management structure keep me on the sidelines.
Nordstrom ( JWN ) shares have been a perennial laggard over the past decade. The company has suffered from declining mall traffic, expensive efforts to modernize its store base and build an e-commerce business, and more recently weak retail environment.
That said, significant value exists here as Nordstrom has a meaningful off-price business (30% of revenue) with the potential for further unit growth. Further, the company has a formidable online business (35% of total revenue) and a large portfolio of owned stores in Class A malls.
Today I will review the positives and negatives of an investment in Nordstrom shares. Ultimately, despite some attractive characteristics and a low valuation (discussed below), my concerns about the low likelihood for operational improvement and value realization under the current ownership/management structure keep me on the sidelines.
Positives
- Nordstrom Rack is well positioned and growing. Nordstrom Rack is an off-price retail concept featuring high end merchandise (90% of brands sold at Nordstrom are available at Nordstrom Rack) at discounted prices. The company operates just ~250 Nordstrom Rack stores (vs. 1,700 or so Ross and ~2,700 for the TJX/Marshall's dynamic duo). While Rack can't achieve these types of store counts given its higher price points and smaller market, an eventual footprint of 400-500 stores is possible, implying pretty decent growth potential here. Off-price retailers Ross ( ROST ), TJX ( TJX ), and Burlington ( BURL ) trade at 1.4-1.9x revenue. Were Nordstrom Rack to be valued at just 1-1.2x current revenue, it would be worth the entire share price (after deducting debt).
- ~35% of Nordstrom's total revenue comes from e-commerce. Both Nordstrom (full price) and Nordstrom Rack have excellent e-commerce capabilities with a seamless online shopping experience and timely fulfillment capabilities (2-4 day delivery).
- Following a decade plus of department store closures, Nordstrom's in-mall positioning has improved as the company faces less direct competition. High-end department stores Saks, Niemen-Marcus, and Bloomingdales have scaled back their bricks and mortar footprint leaving Nordstrom as the last up market department stores left in many malls.
- Nordstrom owns a large portfolio of real estate in Class A malls including 11 million square feet of retail property (own building, lease land) and another 5 million square feet where both the building and the land are owned.
- Potential for rebound in results - 2022 has been a tough year characterized by higher levels of promotion (too much inventory) across apparel retail as well as elevated global freight costs which have hampered gross and operating margins. With freight rates having come down over 70% from their peak level and retailers (including Nordstrom) poised to enter 2023 with less inventory, it is likely we could see improvement in profitability. Even a 100-150 basis point improvement in profitability could cause EPS to jump from an expected $2.30 in 2022 to $3-3.50 in 2023-24.
- Even on somewhat depressed current results, as shown below, Nordstrom trades inexpensively at just 7.3x 2022e EPS, 4.4x trailing EV/EBITDA and a 4.5% dividend yield. The company's current P/E multiple is at the low-end of its 10 year range (7-16x).
Nordstrom Valuation (Company Filings; Author Estimates)
Negatives
As evidenced by its 22% short interest, there are several negative aspects in considering Nordstrom:
- Recent results have been poor. Everything has been going in the wrong direction lately -as we saw in 3Q22 with sales contracting, gross margins shrinking and negative operating leverage contributing to a barely profitable quarter. While Nordstrom initially guided toward $3.15-$3.50 in 2022 EPS, as of 3Q22, guidance is now just $2.30-$2.60. With a looming recession, it is possible things could get even worse in 2023.
- The company has been a laggard in growing its Nordstrom Rack business (growth stalled out in 2017-2018 before a more recent effort to grow the store base). This is disappointing given that off-price retail is one of the few physical retail categories to show persistent growth over the past decade.
- Nordstrom has consistently failed to meet investor expectations over the past several years. Following large spending initiatives from 2015-2019 which same capital expenditures balloon to $900 million (versus sub $500 million today), the company has not delivered growth in revenue or improvement in profitability. EBITDA and EPS remain well below levels achieved from 2015-2019.
- While the overall environment for department stores is challenged, Nordstrom's share price has significantly underperformed department stores like Kohl's ( KSS ), Macy's ( M ), and Dillard's ( DDS ) over the past decade. I see Nordstrom's poor performance as resulting from entrenched family management - the failure to seize the opportunity to grow Nordstrom Rack and the prolonged period of unproductive capital expenditures occurred on the Nordstrom family's watch. The Nordstrom family's 30% ownership (and role in top management) as an obstacle for disruptive positive change. While I believe there is ultimately value here, my concern is that Nordstrom is a 'value trap' and that there is no clear path for shareholder value maximization.
Conclusion
Despite some attractive characteristics and a low valuation, I have decided to pass on Nordstrom stock given my concerns about the low likelihood for operational improvement and value realization under the current ownership/management structure.
For further details see:
Nordstrom: Cheap But I'm Not Buying