Does Nordstrom Inc. Have a Need for Speed?

With a big earnings win last week, is Nordstrom on the path to big gains and big risks?

May 21, 2014 at 10:20AM

Between the middle of May 2013 and the middle of this month, Nordstrom's (NYSE:JWN) stock rolled along like a sturdy four-door sedan. It had some ups and downs rolling over scenic hills, but as of last week it had risen just 4% over the past 12 months. Then Nordstrom released its first-quarter results, and the stock shed its safe, practical exterior to reveal a sports car hiding underneath.

So what changed for Nordstrom, and can it keep the pedal to the floor or are we headed back to the sedan?

The two sides of luxury retail
There are two kinds of luxury retailers: the timeless classics seller and the new and trendy upstart. Nordstrom falls into the first category, while companies like Michael Kors (NYSE:KORS) land in the second. From a sales perspective, the distinction is clear: Nordstrom put up a 3.9% increase in comparable sales in its first quarter, which is a respectable gain compared to retail in general. Kors, though, increased comparable sales by 27.8% in its last reported quarter.

Customers at the moment are willing to shell out for trendy items. The consuming world has an obsession with fast fashion, and the companies that can appeal to the "here and now" nature of our demands will come out on top.

Nordstrom is not that kind of company. It sells the trendy styles, but it also relies on sales from classic lines that don't fly off shelves. In hopes of moving further into the fast-fashion business, Nordstrom has been pushing hard on its Nordstrom Rack brand, which sells lower-priced, trendier items.

Rack has been a fast grower, but it's also putting pressure on Nordstrom's margins. The business is seen as a discount -- that's a loose use of the term -- seller when compared to Nordstrom's main stores. In this most recent conference call, CFO Mike Koppel said that half of the 124-basis-point decline in gross margin last quarter was attributable to Rack's expansion, as Rack added 27 stores since the same period a year ago.

The benefit of avoiding trends
While it may seem Nordstrom is in a tight spot compared to hotter brands, its broad sales base may actually be a blessing. By definition, trends come and go. Kors has ridden its success to new highs, but its stock has only been trading for two-and-a-half years. That's not to say the business is going to suddenly disappear, just that there are bumps ahead.

Nordstrom will faces obstacles, too, but taking a sedan over a speed bump is a little smoother than doing the same thing while driving a Formula One car. Nordstrom pays a dividend, puts up solid gross margins each quarter, and has a lot planned for its Rack line in the near future.

With a price-to-earnings ratio of about 18, the stock is also priced in line with many other retailers. Kors, on the other hand, is priced like that Formula One car, with a P/E ratio of 31. This past week, Nordstrom got a boost by exceeding expectations, but that's probably not a sign of long-term acceleration. Instead, the market is just catching up with a business that has been slowly growing over the last year. Expect that slow but steady growth to continue, even as bumps appear in the road.

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Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Michael Kors Holdings. 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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