2023-12-27 05:47:12 ET
Summary
- Nordstrom Inc. is recommended as a buy, as I expect that it will meet its FY24 guidance and see a rerating of its valuation.
- Recent results show steady growth improvements, with EBIT beating consensus estimates.
- Improved inventory positioning, operational enhancements, and strong EPS growth are expected to drive the company's growth and valuation.
Overview
My recommendation for Nordstrom Inc. (JWN) is a buy rating as I continue to see JWN's meeting its FY24 guidance. As it achieves this, I expect the market to rerate valuation upwards, moving towards JWN's pre-covid average forward PE. Note that I previously rated JWN with a buy rating as I expected sales to improve throughout the entire FY24 (as management guided), with gross margins improving accordingly.
Recent results & updates
Slowly but steadily, JWN is improving its growth trends. JWN reported 3Q24 revenue of $3.32 billion, implying a 6.4% decline (a 150bps sequential improvement). While revenue missed consensus expectations, JWN saw EBIT of $77 million, beating consensus estimate of $55 million. The beat was largely driven by lower markdowns (contributing 180bps of margin expansion). This beat led to a net EPS result of $0.25, coming in more than 2x consensus estimates ($0.12). The stock reacted very favorably to this set of results, reinforcing my view that the market is paying attention to growth recovery. Looking at other operating metrics, I believe they continue to point to healthy growth momentum. Within Rack banner sales, JWN continues to see better brands driving higher sell-through and success in new stores (JWN managed to open 11 Rack stores in 3Q24). Full-line banner sales, while down 9% annually, were mainly due to the wind-down of Canadian exposure.
Looking ahead into 4Q24, management full-year guidance implies 4Q24 revenue growth of 3.7% at the midpoint, which is a massive growth acceleration vs. 3Q24. I expect this growth acceleration to come true, which should trigger further positive stock price action as the market gets convinced that JWN growth is reaching normalcy. There are several points that indicate 4Q24 is going to be a strong quarter. Firstly, JWN has the right inventory assortment going into the holiday season. This should attract more customers, as customers typically react positively to new products and designs. Specifically speaking about products and designs, there was clear positive feedback from the consumer base as JWN saw annual improvements across the majority of its categories in the quarter. This gives me confidence that JWN inventory positioning for 4Q24 should be strong as well.
We managed our inventory well, as evidenced by the positive sales-to-inventory spread while leaning into pockets of demand. As we enter the holiday season, our teams have worked hard to deliver the right assortment and engaging experiences for our customers. From: 3Q2024 earnings call
Additionally, JWN is enhancing its Free 2-Day Shipping capabilities to offer faster delivery, conversion, and return rates, and it is investing in promotions like the 5x points promotion for Nordie Club loyalty members. Both of these latter points are aimed at improving the customer experience, which I see as a key aspect of JWN business that is hard to quantify. I would illustrate it in this world: the happier the customer is with JWN (specifically the end-to-end purchase journey), the more they will revisit the store, which drives growth.
Other than top-line growth, I also think that JWN earnings are in good shape to accelerate compared to last year, sustaining the 20+% EPS growth momentum. Firstly, 4Q24 is going to see an easy gross margin comparison when compared to 4Q23. 4Q23 gross margin came in at 35%, which is lower than all the year-to-date quarters so far. Suppose 4Q24 gross margin remains steady vs. 3Q24; this implies ~230bps annual improvement in gross margins. Secondly, JWN should also start to see positive results from their consistent search for efficiency gains within SG&A (they saw 50bps tailwind in 3Q24) and inventory optimization. Suppose they see another 50bps tailwind in 4Q23. Combining these two, earnings margins are set to expand by more than 280bps (vs. last year) before any topline growth acceleration, which should drive sales leverage benefits. I would also point out that JWN's investment in improving the customer experience has huge implications for long-term margin expansion. As customers repeat their purchases and visits to JWN (a better user experience should lead to recurring purchases, assuming products meet their preferences), it will significantly reduce JWN's cost of customer acquisition [CAC] and heavily expand the customer lifetime value [CLTV]. Under this framework, the JWN CLTV-to-CAC ratio should expand, which means each customer's unit economic becomes much more profitable for JWN.
Valuation and risk
JWN share price movement has tracked my previous price target nicely, which I take as strong evidence that the market is viewing JWN business performance favorably. That is to say, if JWN continues to perform at this rate, especially if it meets guidance like I expected, JWN's valuation should continue to revert back to normalized levels.
My growth and earnings assumptions have not changed for JWN. I still believe JWN can grow as guided (mid-point of 5% growth), and earnings will expand. The key variance in my updated model is that I expect JWN to trade up to 12x forward PE once it shows the market can grow as guided. This increase in valuation is basically a mean reversion in JWN's trading multiple. Pre-covid, JWN used to trade at an average of 15.5x forward PE. It is unlikely that JWN will see its valuation trade up to 15x, as it still needs to convince the market that growth can be sustained at mid-single digits (pre-covid growth rate). Meeting FY24 revenue guidance is the first step. At 12x forward PE, my target price for JWN is $31.65. While this represents a rather huge upside, I point readers to JWN's 5-year stock chart. JWN used to trade as high as $67.75 back in 2018, where it was growing at mid-single digits, had a net margin of 3%, and was trading at 15x forward PE.
The near-term risk is that traffic has been soft, and management has noted there is excess inventory remaining in the designer category. The former could be an emerging red flag that JWN is not able to hit FY24 guidance, and the latter could mean potential gross margin compression as JWN needs to markdown prices to clear inventory.
Summary
I continue to recommend a buy rating for JWN. Recent results indicate steady growth improvements, and notably, EBIT beat consensus estimates, which I believed prompted a positive stock response. I believe JWN will be able to meet its FY24 guidance given its improved inventory positioning and operational enhancements (that improves customer experience) like enhanced shipping and loyalty promotions. All of these should drive strong EPS growth. As JWN growth recovers, I also expect valuation to revert back to historical average.
For further details see:
Nordstrom: Meeting FY24 Guidance Should Drive Valuation Upwards