Nordstrom Remains Best-in-Class Growth Story
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Recently, Nordstrom (NYSE: JWN) reported 2Q12 EPS of $0.75 which was a penny above consensus estimates. Nordstrom delivered a solid quarter driven by strong sales momentum across all channels and, despite a one week shift in the Anniversary Sale, SSS were up 4.5%. 2Q results were a clear indication of why Nordstrom remains a best-in-class growth story. Management upgraded FY12 EPS guidance to $3.40 to $3.50 and raised FY12 SSS guidance to 6%-7% from 4%-6%. We believe the company has a near-term catalyst in its August SSS results and ample long-term growth prospects with effective merchandising and technology/direct channel investments, greater penetration for the Rack business, improvement in the women’s category, partnership with Topshop and Topman, and eCommerce growth.
Near-term catalyst in August same store sales growth
The Anniversary Sale is historically the Company’s largest sale of the year; it started one week later in July relative to last year and an additional week of the sale shifted from July into August. As a result, management expects same-store sales to be up in the high-single-digits in Q3; significantly better than the 4.5% SSS increase in Q2. We believe the company is likely to report double-digit same store sales growth in August and that will prove to be a catalyst for near-term stock appreciation.
Encouraging expansion updates
Given the strong performance of the Nordstrom Rack business and availability of quality locations, the Company is planning to further accelerate the expansion of this business. Over the last four years, Nordstrom has more than doubled the number of Nordstrom Rack locations to its current total of 110 stores. The initial plan for 15 Rack openings during 2012 remains intact, and 24 stores are now expected to open in 2013. The Company plans to have over 230 Rack stores by the end of 2016. Management is in the process of rolling out mobile POS capabilities to Rack locations to speed customer checkout and improve the customer experience. These types of initiatives demonstrate Nordstrom’s commitment to customer service across all channels. We view the ramp-up of Rack store growth as encouraging as multiple synergies exist between the Rack and Full-Line department stores for both Nordstrom and the customer, and it will allow Nordstrom to quickly exploit the strength of that division and benefit from the strong fundamentals in the off-price space.
Operating margins should improve in the near term
E-commerce remains a strong growth opportunity for the Company, supported by the 40% YoY increase in direct sales in 2Q12. Looking ahead, the Company expects to leverage its investments in 2H12 (55-75 bps in 3Q12 and 45-65 bps in 4Q12). Management has taken into account greater-than-anticipated fulfillment costs from online-to-store and store-to-store orders, which should partially offset SG&A rate leverage. Over the past 12 months, operating margins have declined due to incremental investments in necessary parts of the business. As the Company begins to lap these incremental expenses, we expect profitability to improve in 2H12.
Sustainable competitive advantage on many fronts
We see Nordstrom as a “best in class” retailer driven by superior merchandising expertise, strong execution, first mover advantage in its Omni-channel initiative and demographic and geographical sweet spot positioning.
Nordstrom offers differentiated assortments with an unmatched level of customer service in the department store industry. The company has yet to fully penetrate certain geographic markets that will offer future growth (e.g. Northeast, Midwest), as well as the potential to be an industry consolidator as its competition weakens. We believe Nordstrom has a more flexible operating expense model (i.e. commissioned sales force) than its peer group, which allows it lower SGA as sales decline.
Nordstrom also offers affordable luxury as it is well positioned between the moderately priced department stores like JC Penney (NYSE: JCP) and high-end department stores like Saks (NYSE: SKS). The company is trading at a forward P/E of 14.28, at a premium to JC Penney (forward P/E = 11.25), which we believe is justified following continuous market share losses and poor sales trends at JC Penney. However, the company is trading at a 31% discount to Saks, which we find inappropriate given Saks’ flattish expected EPS growth in FY12 as compared to Nordstrom’s 10.5%. Thus, we feel there is good upside potential at the current valuations and recommend it a good investment.
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