2023-10-16 09:23:46 ET
Summary
- Nordstrom shares have performed poorly in 2023, but the company could see a surge in earnings driven by increased use of weight loss drugs.
- Dramatic weight loss could lead to a surge in apparel spend among those taking the drugs, benefiting Nordstrom.
- Nordstrom has significant operating leverage, so a modest increase in sales could drive a significant increase in earnings.
- Management recently acknowledged that current earnings guidance/expectations could be conservative.
- A share price re-rating could be accelerated by short covering as bears become cognizant of upside risk. Nordstrom has a nearly 20% short interest.
Nordstrom ( JWN ) shares have performed poorly thus far in 2023, down over 10% year-to-date as fears of weaker consumer spending have plagued retailers. Despite Nordstrom's shortcomings (which I laid out in my January article ), I believe the company could see a multi-year surge in earnings driven by increased use of weight loss drugs like Ozempic and Wegovy. While the verdict is still out on the ultimate uptake of these 'miracle' drugs, recent food ( XLP ) and medical device ( IHI ) share price action indicates investors are expecting a meaningful economic impact from these drugs.
I see Nordstrom as a stealth beneficiary of widespread weight loss drug use as:
- Dramatic weight loss (10-20% of body mass) means that clothes no longer fit and portend the need for complete wardrobe replacement driving a potential surge in apparel spending among those taking the drug.
- The high out of pocket cost of drugs like Ozempic (typically not covered by insurance for weight loss and have an 'out of pocket' cost of ~$900 per month) suggest most users are relatively high income earners. Nordstrom caters to high income earners ($150k+ earning households) and is well positioned to benefit from this trend.
- Like most retailers, Nordstrom has significant operating leverage - with a largely fixed cost base, earnings should increase dramatically with a pickup in revenue.
- Nordstrom shares are heavily shorted with short interest at nearly 20% .
If we see a meaningful uptake in the use of these drugs ( 40%+ of the US population is considered obese ), Nordstrom could see a 70+% increase in EPS (shown below) which could drive a 100%+ increase in the stock price.
A Potential Weight Loss Driven Multi-year Earnings Boom
I see Nordstrom as an underappreciated potential beneficiary of the surge in weight loss drug usage. When a person loses 10-20% of their body weight, clothing simply no longer fits, necessitating complete wardrobe replacement. Moreover, as weight loss typically continues over the course of 12-15 months, weight-loss drug users may actually replace their wardrobes multiple times as they gradually slim down toward their goal weight.
As these drugs currently are generally not covered by insurance when used for weight loss and have a relatively high out-of-pocket cost (~ $900 per month ), initial uptake is likely to be seen amongst higher income consumers which overlaps with Nordstrom's core customer base.
Additionally since these drugs must be taken perpetually to maintain weight loss , it is inevitable that many folks will ultimately cycle off of these drugs (due to cost, side-effects, etc) in which case they may regain much of the lost weight (and sometimes more), sending them on yet another clothing shopping spree.
It is also worth noting that we could see insurance coverage of some or all of the cost of weight loss drugs as the health benefits (many diseases and chronic conditions which are very costly to treat are linked to obesity ) outweigh the costs. In addition, there are several potential competitors such as those being tested by Altimmune ( ALT ) and Viking Therapeutics (VKTX) which could drive down prices and further expand the market. Of course, there is also the likelihood that over the medium-term, usage expands as GLP-1 drugs go off patent, lowering cost and driving increased penetration. This could create a multi-year boom for apparel retailers like Nordstrom.
Operating Leverage-A Modest Rise in Sales Could Drive a Surge in EPS
The retail business model has tremendous operating leverage, whereby changes in revenue have an outsized impact on bottom-line results. This is due to a large fixed cost base which includes: Rent, Labor, e-Commerce costs (website and warehouse operations). Below, I illustrate how a modest (7.5%) increase in sales can produce a 70% increase in operating profit:
Illustrative Operating Leverage Model (Author Estimates)
As you can see, because of the fixed cost nature of the retail business model, the impact of a rise in revenue is magnified at the operating profit line. With an interest expense burden of $110 million per year (fixed rate, long-term debt), this is further magnified at the EPS level (i.e. the 71% operating profit would produce a nearly 80% increase in EPS).
Presently, analysts forecast Nordstrom to earn about $2 per share in the current year (presumably this has no benefit for a weight-loss driven sales boom). Were we to see a sales increase of just 7-8%, I believe 2024 EPS could be north of $3.50 per share, implying that Nordstrom trades at just 4x EPS.
Historically, Nordstrom shares have traded for 7-15x EPS. If Nordstrom simply maintains its current 7x P/E ratio, the stock could trade up to $25 per share (+78%). Of course, positive earnings momentum frequently leads to higher P/E multiples. Should shares re-rate to 12-15x EPS, implying a share price of $40-$50 (180-260% upside).
Current Results / Additional Reasons for Optimism
Last month, Nordstrom participated in the Goldman Sachs' retail conference and gave an update on its business. Some of the things I found encouraging include:
CEO presentation at GS Retail Conference (Nordstrom Conference call Transcript)
- Executing on Nordstrom Rack store count growth. One of my gripes with Nordstrom management had been its historical hesitancy in expanding its Nordstrom Rack store footprint. As you can see from the above commentary, management is focused on expanding the store count (which I believe could ultimately double).
- Nordstrom has cleared excess inventory as well as getting trendy items into stores -Nordstrom struggled with this throughout 2022. This bodes well for gross margins and operating profitability.
- Higher income customers showing greater resilience - this is a trend seen across retail over the past 12-18 months whereby lower income consumers have suffered the brunt of inflationary pressure which has led to less discretionary purchases (necessities have consumed a greater percentage of household income).
- Management recently acknowledged (shown below) conservatism in current guidance as year-to-date sales trends have exceeded initial expectations:
Current Results commentary (CEO Presentation at Goldman Sachs Retail Conference)
Conclusion
While the jury is still out on the ultimate uptake and impact of this new class of weight loss drugs, I see Nordstrom as an unappreciated potential beneficiary as I believe that if a meaningful percentage of Americans lose a significant amount of weight, it is inevitable that this will be accompanied by a surge in apparel sales. With an affluent customer base, I see Nordstrom as being well positioned to benefit from this trend with the potential for outsized growth in earnings and share price appreciation.
For further details see:
Nordstrom: Weight Loss Drugs Could Drive EPS Much Higher