Thesis
Nordstrom Inc. (JWN) has seen the start of a great recovery in 2010. The company is projected to increase its yearly sales by 5-6% as the company has seen a return of its luxury shoppers and the beginning of its fruitful expansion of the Nordstrom Rack line. During the economic downturn, luxury retailers and high-ticket items across the board were easily looked over. Yet, as signs of an economic recovery have continued to sprout up for the American economy, luxury retail has begun to start to get its feet underneath it. Nordstrom is the leading retailer in luxury retail with twice as many stores as competitors Saks and Neiman Marcus. The company has seen growth in its revenue operating income over the past two years, and sales are up significantly so far in 2010. Nordstrom looks to open twelve new stores in 2010, and seventeen already planned for 2011.
Fourteen out of the seventeen stores in 2011 will be Nordstrom Rack locations, and the development f the Nordstrom Rack line is the first place of significant growth for Nordstrom. The development of the Rack store has allowed Nordstrom to tap a new market since the breadth of its luxury markets and locations are already established. The Rack store has been criticized by some because it is thought to take away from the image and sales of the full line, but the Rack truly does not cross the same shopping circles. The Rack appeals to a different market and sells a different line. Only 25% of the inventory at Rack stores come from Nordstrom’s full line. So, similar goods are not available at both stores. It is more similar to the successful Gap/Old Navy difference that have mid-end to low-end differences. The company, further, swears by the two-store concept as a way to maximize their potential and has seen success with it ever since its conception.
Through its duality of high-end to mid-end clothing, the company faces sever competition. Yet, the company has been able to create itself a small economic moat through its luxury shopping experience that is well established. Yet, in the luxury scope, the company faces competition from other high-end retail department stores, such as Neiman Marcus and Saks. Nordstrom does possess the most market share in the industry with many more stores than both companies. They additionally now have more second line stores than Saks’ Off 5th with more than seventy Rack stores.
Yet, the most crucial aspect of Nordstrom’s economic moat comes from the company’s customer service capabilities. Known as “The Nordstrom Way,” the company is continually ranked for their exceptional customer service. A late story by MSN
Money about the top ten companies in the USA that treat customers right ranked Nordstrom fifth in the country for customer service. Customer service goes a long way in retail, especially on the department store front to differ a company from similar products at other companies. These companies sell relatively similar products, and a company’s ability to get ahead through customer service is a significant portion of retail success.
2010 truly has been the year of Nordstrom’s return. The company has had same-store sale increases of 6.3%, 7.6%, 14.1%, 3.7%, 7.5%, 16.8%, and 10.3% from August – February in 2010, respectively. Additionally, the latest results from August came out with a 6.3% increase year-over-year while department stores as a whole only rose 0.4%. The number of affluent households grew in the first five months of 2010 for the first time since 2007 from 10.6 million to 11 million. These gains will continue to grow and will directly help Nordstrom. Further, American Express Travel Insights commented that luxury spending increased 20% in Q1 of 2010 and 9% in Q2. These increases are expected to continue into 2011, which is further sign that in the retail sector Nordstrom is truly at the top of the line.
Coming out of the recession, Nordstrom looks very strong with their two-pronged department store approach, growing revenue, strong free cash flow, and a P/E ratio of only 15.89. The industry average for P/E ratios is 15.30, so the company appears very fair valued. Continued strong earnings and a positive outlook should help this company exceed the average, especially since the company seems to be functioning at an above average level. Further, Nordstrom is a company with .png)
exceptional free cash flow. In its latest quarter, the company was able to register $297 million of FCF even with its increasing capital expenditures and expansion project. The company has an FCF margin at 12%. This is exceptionally better than Saks (3%), Macy’s (3%), and Dillard’s (5%). This margin is obtained all the while the company is planning to open 30 new stores in two years…amazing.
The risk would be that the company is seeing a risky debt ratio or heavy dilution of shares. The company’s current ratio in 2008 was 2.1%. In its latest quarter, the company obtained a current ratio of 2.4%. The company has not seen a significant increase in liabilities while increasing its assets. This is able to be obtained through smart cash flow management and a high FCF margin. The changes in working capital do somewhat reduce free cash flow, but it is free because it is free to be used. It is supposed to be used for development and expansion. These increases will also taper off (the company is currently only planning two new stores in 2012).
Finally, the company has seen improvements in a number of key financial ratios. Efficiency ratios are getting better. The company has improved their asset turnover ratio every year since 2008. The company has improved their inventory turnover ratio every year since 2001. The sales channel and distribution channels are getting stronger each year. One worry is the company has taken on a lot of long-term debt in 2008 to help launch a strong campaign to build more stores, but the long term debt ratio to current liabilities has reduced since 2008. Finally, the company has increased its free cash flow to sales ratio back over 10% in 2010.
Nordstrom Inc. is one of the most financially sound and responsible companies in the retail sector. It has margins and ratios that challenge technology companies despite being in one of the slowest sectors in America. The company has great potential moving forward. Its recent 20% swing in the last couple months has diminished the company’s upside, but there is still room to grow.
Valuation
My fair value estimate for Nordstrom is $45 per share based on discounted cash-flow analysis. The company has seen incredible growth in its operating income in the past two years plus the trailing term, averaging 7.5% year-over-year, which is quite large for such an established company. These growth rates may come down slightly, but they should decline no more than to 5% in the next five years. The company can maintain 5%+ with their approach to both luxury and “masstige.” The company should be able to break $900 million in operating income in 2011 and $1 billion in 2013. With continued competition, questions about the risk of blurring lines between full line and Rack lines, and growth of the Rack line backfiring, these growth estimates are modest at best. Operating margins should continue to be in the low-single digit range over the next five years, and the company continues to increase its efficiency each year, which should help.
JWN is a buy below $33, and it is a sale above $52.
Risk
Risk is low with Nordstrom. The company is over 100 years old and has begun to reinvent itself for great growth coming out of the recession. Competition does remain, and there is risks coming from the increase of second tier stores. Risk of any struggle in the growth out of the recession could threaten the company. They will need consistent growth to see continual growth.
Good Investing,
David Ristau
