How Nordstrom Inc.'s Growth Strategy Is Changing its Business

In the light of a retail environment that has troubled J.C.Penney and others, Nordstrom is investing to transform how it makes money. Will it work?

May 25, 2014 at 1:00PM

Investors in upscale retailer Nordstrom (NYSE:JWN) have enjoyed a spectacular week with the stock rising nearly 15% after its recent results. The market took heart from Nordstrom's overall trading performance and the announcement that it is seeking a partner for its credit card receivables. It appears that all is going well for Nordstrom, but how do the results tie in with its long-term strategic plans? This is an important question, because Nordstrom will look like a different business in a few years' time.

Nordstrom's long-term plans
The retail sector has been bedeviled with some unusual conditions because of the protracted and moderate nature of the recovery. The bottom end has continued to struggle, while the high end has done relatively better. Meanwhile, the mid-range department stores have suffered as middle-class shoppers traded down with their lack of exposure to the higher-end shopper. Anyone who doubts these trends need only take a look at how J.C. Penney (NYSE:JCP) has suffered in recent years. J.C. Penney's investment proposition now relies solely on the successful execution of its turnaround strategy. 

Nordstrom's full-line stores sit somewhat in between the mid and high range, and the environment has necessitated a significant restructuring of its growth priorities. The good news is that -- unlike J.C.Penney-- Nordstrom has been investing early and aggressively.

Indeed, a breakout of its same-store sales growth reveals how Nordstrom is evolving.

Nordstrom

Source: Nordstrom Presentations

The market got excited by the total comparable-sales increase of 3.9%. However, as the chart demonstrates, it's a tale of declines at Nordstrom's full-line stores (down 1.9% on a comparable basis) being more than offset by increases at its discount store, Nordstrom Rack, and its direct sales and online operations.

Dealing with reality
The chart above illustrates the reality in the retail marketplace. Simply put, consumers have become accustomed to seeking out bargains, and Nordstrom is finding it hard to generate sales growth with its full-line stores. In response, the company plans to make $3.9 billion in capital expenditures (mainly in Nordstrom Rack and IT infrastructure to support Nordstrom's online activities) in the next few years in order to generate "high single-digit sales growth and mid-teens ROIC". 

Nordstrom isn't quite there yet, because its current forecast for 2014 sales growth is just 5.5%-7.5% and it has a return on invested capital, or ROIC, of 13.3% over the last four quarters. In fact, its ROIC actually declined from 14% in the same period of last year, but it's understandable if the investments it's making in new Nordstrom Rack stores and e-commerce will take a little time to generate returns.

A look at Nordstrom's net sales by channel demonstrates the shift in revenue toward Nordstrom Rack and its online and direct sales channels.

Nordstrom

Source: Nordstrom Presentations

Moreover, a look at its sales per square foot demonstrates the greater profitability of its Nordstrom Rack stores, although -- just as with the full-line stores -- their sales per square foot declined in 2013.

Nordstrom

Source: Nordstrom Presentations

Meanwhile, total sales per square foot are rising due to the success of its online and direct-selling operations.

Will Nordstrom's strategy work?
All told, the strategy makes perfect sense and is a realistic realignment of where Nordstrom can generate profit growth going forward. The recent results were merely an extenuation of ongoing trends and highlight the shifts taking place in the business. Retailers like J.C.Penney are being forced to undergo radical structural transformations, but Nordstrom already has the growth platforms (Nordstrom Rack, direct, and online) on which it can invest.

Moreover, the announcement that Nordstrom is seeking a partner for its credit-receivables business was warmly received, because it helps to de-risk the company from an activity that many feel is non-core. It will also allow Nordstrom greater financial flexibility for accelerating investment in its growth program. The market reacted the most to this news, because even though the company beat earnings estimates in the quarter Nordstrom left its full-year sales and EPS guidance unchanged.

How to evaluate Nordstrom
This question is not as easy as it might seem to answer. For example, the capital-expenditure program will affect free cash flow, and the investment program and increased depreciation will affect earnings. Under these circumstances, I would argue that enterprise value, or EV, to revenue would probably be the best valuation method for Nordstrom.

JWN EV to Revenues (Forward 1y) Chart

JWN EV to Revenues (Forward 1y) data by YCharts

The chart indicates that Nordstrom is trading toward the high end of its EV/Revenue band for the last few years.

Where next for Nordstrom?
On a valuation basis, the stock is not looking particularly cheap right now. In addition, the decline at its full-line stores continues in terms of sales per square foot and same-store sales. Moreover, it's also not clear if Nordstrom Rack is somewhat cannibalizing growth at the full-line stores. 

All of this suggests a note of caution over the stock. Nordstrom's growth strategy is the right one and it's working in terms of generating top-line sales growth, but the market seems to have priced in success here. Any disappointment with Nordstrom Rack's growth and the market will be quick to punish the stock.


Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Lee Samaha 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers