For the past year or so, luxury department store company Neiman Marcus has been teetering on the brink of bankruptcy. The combination of a broader retail downturn and the botched rollout of a new inventory management system has led to sharp sales declines and big losses.
On Tuesday morning, Neiman Marcus reported that its sales downtrend slowed somewhat last quarter. However, profitability remains under pressure, and Neiman Marcus is still underperforming key rival Nordstrom (NYSE:JWN). Furthermore, the likelihood of a competitor like Hudson's Bay (TSX:HBC) buying Neiman Marcus seems to be fading.
Sales slide again -- and profit plunges
During Neiman Marcus' fiscal third quarter (which ended in April), comparable sales fell 4.9% year over year. This was somewhat better than the 7.3% comp sales decline it reported for the first half of the fiscal year.
This was still in the lower part of the range for department stores, though. Hudson's Bay reported a similar comp sales decline in its U.S. stores: Saks Fifth Avenue and Lord and Taylor. On the other hand, comp sales fell just 0.8% at Nordstrom last quarter. Even excluding Nordstrom's growing off-price business, its comp sales declined 2.3%.
Meanwhile, profitability continued to plummet at Neiman Marcus. The company reported a net loss of $24.9 million last quarter, compared to a $3.8 million profit a year earlier. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) fell to $135.9 million from $173.2 million. Year to date, adjusted EBITDA is down more than 25% relative to the prior year.
Gross margin erosion has been a key driver of Neiman Marcus' profitability challenges. The company has had far too much inventory in recent quarters. As a result, its year-to-date gross margin has slipped to 32.7% from 34.4% a year earlier. Gross margin plunged again last quarter, falling to 34.3% from 36.4% in the prior-year period.
Tough times will continue
On Neiman Marcus' earnings call on Tuesday morning, CEO Karen Katz noted that sales trends continued to improve in May. She also highlighted the strength of the company's online business, which now generates more than 30% of sales.
That said, the company continues to have significantly too much inventory and faces a highly competitive promotional environment. Furthermore, it is struggling beneath the weight of nearly $5 billion of debt. As a result, Neiman Marcus incurs nearly $300 million of interest expense annually, whereas its annual operating income is currently less than $100 million.
A few months ago, Neiman Marcus indicated that it was considering "strategic alternatives," including a potential sale of all or part of the business. Industry sources quickly zeroed in on Hudson's Bay as the potential suitor. However, Hudson's Bay is struggling with losses and sales declines in its own U.S. business. It also had trouble finding a way to buy Neiman Marcus without assuming all of its debt. As a result, that potential deal has fallen apart.
On a stand-alone basis, Neiman Marcus may be able to stabilize its business in the next year or two. But even if it does, the company's massive debt burden will make it extremely hard for Neiman Marcus to return to profitability in the foreseeable future.
What it means for Nordstrom
Last week, Nordstrom announced that the company's founding family is interested in taking the company private in a leveraged buyout. Based on Neiman Marcus' recent struggles, some analysts have warned that this would be a terrible idea.
However, Nordstrom wouldn't need to take on nearly as much debt (relative to the size of the company) as Neiman Marcus. The Nordstrom family already owns more than 30% of the company, and it's looking for a private equity partner to contribute another $1 billion to $2 billion of equity. With free cash flow on the rise, Nordstrom could probably support the increased leverage that would come with a buyout.
Neiman Marcus' experience does offer one key lesson, though. A big debt load may be fine under normal circumstances, but it leaves little room for error. If Nordstrom piles on more debt, it won't be able to afford any missteps in the next few years.