The Highest-End Retail Market Is Poised for Gains

High-end retail is resilient against a weak economy, but it should also perform well in a rebounding economy.

Jan 13, 2014 at 4:41PM

While it's no secret that Macy's is one of the best picks in the department store space, on up the affordability ladder is high-end retailer Nordstrom (NYSE:JWN). Nordstrom's high-end customers have helped keep the company in the black during the financial crisis. However, as the economy rebounds, more consumers should have a higher level of discretionary income to spend at the top-tier department stores.

Nordstrom sells a variety of high-end items, from shoes, apparel, and cosmetics to accessories. It has more than 260 stores across 35 states. Again, its key focus is on the upscale market. The major department stores have a number of competitors, including the likes of Kohl's (NYSE:KSS) and even (NASDAQ:AMZN). One of the potential benefits is that the major retailers should have an advantageous calendar. This includes an additional day in the Christmas shopping season for 2014.

Meet the new Nordstrom
However, one of Nordstrom's biggest company-specific growth opportunities lies in the expansion of its store base. This should help the company, continuing to drive its top line. In addition, for its Rack stores, it plans to double its current number by 2016 to 230.  Beyond that, Canada is another growth opportunity for the company.

Its fiscal third-quarter earnings per share came in at $0.69, which beat consensus and comes as revenue was up 2.8% year over year. The real victory of the third quarter was that its credit card business is seeing a reversal, marking an inflection point. All in all, delinquency rates were down month over month in November, the first time since July.

Nordstrom has also been upping its IT spending, which has led to a better mobile and web experience for its customers. Beyond that, Nordstrom has also put in place a new company-wide inventory management system. This has helped the company keep inventory levels down from historical highs, with its days of inventory at 61 days as of fiscal 2013 end. In addition, the number of days of sales outstanding is down from recent-year highs to 62 days.

Winning the retail battle
Nordstrom has a new loyalty program in place that should help continue to drive traffic. Its latest initiative is the Fashion Rewards Program, which has 3.7 million active accounts already. While Amazon continues to be a great place to shop, with more than 160 million visitors to the site per quarter, it doesn't appear to be the best investment. Its valuation is quite rich, and it continues to sacrifice earnings for revenue. Sales for Amazon have grown at an average of 35% annually over the last three years; meanwhile, operating income has declined at an annual rate of 15%. 

Kohl's is an intriguing play, given it caters to the lower- and middle-income consumers. As a discount retailer, it appears to be a great investment. However, many of Nordstrom's shoppers have the money to continue shopping at the high-end store. In addition, if the economy and employment numbers continues to rebound, we may well see shoppers actually trading up from Kohl's to Nordstrom.

Kohl's does trade at only 13 times earnings, but its PEG ratio is upwards of 2.6. Meanwhile, Nordstrom trades at 16.4 times earnings, putting its PEG at 1.5. What's more is that Nordstrom's return on equity is nearly 40%, while Kohl's is less than half that.  

Foolish bottom line
Granted Amazon continues to take market share from certain brick-and-mortar retailers. And the discount retailers, which includes Kohl's, saw consumers trade down to them during the economic slowdown. But as the economy rebounds, the higher-end retailers should come back in favor.

Most notably, Nordstrom has been ramping up its operations to capture more market share, which includes a new loyalty program and continuing to increase its store count. Internally, it's managing inventory better than ever and has margins that are near decade highs. It appears that Nordstrom will be a solid investment over the interim.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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