Nordstrom Inc. Is a Top Pick, but Only for Patient Investors

Nordstrom may be falling out of favor on Wall Street, but it's a great opportunity for long-term investors.

Feb 24, 2014 at 12:34PM

Following several years of very strong growth, Nordstrom (NYSE:JWN) came back to earth in 2013. Nordstrom's EPS nearly doubled between 2008 and 2012, but adjusted EPS rose just 6.5% last year. The company's guidance calls for a low single-digit EPS gain in 2014, suggesting that faster earnings growth is not imminent.

Some investors -- and many Wall Street analysts -- are starting to get frustrated now that they are not seeing immediate results from Nordstrom's growth plan. However, this is a big opportunity for patient, long-term investors. Over the next five to 10 years, Nordstrom's current investments are likely to pay off in the form of much higher earnings, leading the stock higher.

A year of slower growth
Nordstrom came into 2013 with a three-year streak of double-digit revenue growth. However, same-store sales increased just 2.5% in 2013, and total sales rose 4.9% year over year, excluding the 53rd week in the prior fiscal year. Nordstrom's full-line stores were a big drag on overall revenue growth, posting a 2.1% same-store sales decline in 2013.

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Same-store sales for Nordstrom's full-line stores declined last year.

To some extent, the weaker growth in 2013 was a natural consequence of having fully recovered from the Great Recession by the end of 2012. Nordstrom was far from being the only retailer to miss expectations in 2013. Slow economic growth in the U.S., federal spending cuts, and higher taxes were all headwinds during the year.

Nordstrom is looking for a slight pickup in growth in 2014, with revenue up 5.5% to 7.5% on a same-store sales increase of 2% to 4%. However, the company's profit margin will be pressured by growth investments in new stores and technology.

Big growth plans
While Nordstrom's sales growth has slowed recently, the company's plans call for high-single-digit long-term sales growth, which is quite good compared to the average public company. Nordstrom has three key growth drivers: 1) e-commerce, 2) expanding the Nordstrom Rack off-price concept, and 3) entering Canada.

Nordstrom has already been very successful in e-commerce, and it just completed its third straight year of growing sales at least 30%. Online sales now account for about 14% of revenue. Nordstrom plans to invest more than $1 billion in technology in the next five years. Part of that investment will go toward improving the online and mobile customer experience to further boost sales in that channel.

Nordstrom Rack is another key growth driver. In August 2012, the company announced plans to more than double its Rack store base from 110 to approximately 230 locations by the end of 2016. Nordstrom Rack stores earn a significantly higher return on invested capital than full-line stores, and they cater to younger customers, both of which are good for Nordstrom.

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Nordstrom Rack is in the midst of a major expansion.

Nordstrom Rack has already made a down payment on its growth plans and ended 2013 with 140 stores. Nordstrom is scheduled to open another 27 Racks this year, and it has already signed leases for some of its planned 2015 openings as well. Altogether, Nordstrom expects to derive 50% of its sales from Nordstrom Rack and online sales within five years -- up from 38% today.

Canada is the last major growth driver for Nordstrom. The company has repeatedly stated that the Canadian market is a $1 billion opportunity that could potentially support eight to 10 full-line stores and 15 to 20 Nordstrom Racks. Nordstrom will open its first Canadian store later this year, and it has another five full-line store openings planned in the next three years.

For the next several years, Nordstrom expects to lose money in Canada because of pre-opening expenses and the need to build customer awareness. Nordstrom is projecting a pre-tax loss of $35 million in Canada for 2014. However, Nordstrom Canada has stellar store locations in six of the top 11 malls in all of North America. By 2017 or 2018, when the initial group of stores will all be open, Canada should be making a significant contribution to Nordstrom's earnings.

Foolish bottom line
Nordstrom investors seem to be getting frustrated due to the recent slowdown in the company's growth. Over the next several years, profit growth may remain modest because of Nordstrom's heavy investments in improving its technology platform, opening new Rack stores, and entering Canada.

However, each of these initiatives is likely to pay big dividends starting in about three years. Patient investors can take advantage of the market's shortsightedness by buying Nordstrom shares today and holding them for the long term in order to benefit when today's higher costs become tomorrow's higher sales.

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Adam Levine-Weinberg 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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