Nordstrom (JWN -6.77%) stock has held steady following its third-quarter earnings release. However, this wasn't the usual solid quarter investors have gotten used to seeing.
In addition to comparable sales turning negative, down 0.9%, there were two big warning signs in the report. First, comparable sales at Nordstrom Rack stores dropped by 5%, the worst performance in several quarters, and e-commerce sales at Nordstrom.com increased by just 7.5% during the period.
Let's take a closer look at each of these figures and see why investors should be concerned.
Losing faith in off-price
Like its competitors, Nordstrom's full-line stores have struggled with same-store sales consistently falling -- 5.2% through the first three quarters of the year. That's following a 6.4% decline last year.
However, unlike many of its peers, Nordstrom has enjoyed brick-and-mortar growth thanks to its off-price chain, Nordstrom Rack. Discount stores have been a sweet spot in retail for several years with leading players like TJX Companies, the parent of T.J. Maxx and Marshalls, Ross Stores, and Burlington Stores significantly outperforming other apparel retailers. For a while, Nordstrom Rack was doing so as well -- comparable sales at Rack had been essentially flat through 2015 and 2016 as the company rapidly expanded the concept, but the sudden 5% decline calls into question that strategy.
Year to date, Nordstrom has opened 15 Rack stores, growing the total to 232, nearly double the number of its full-line stores. If comparable sales at its off-price chain continue to fall, the company will likely have to scale back those openings or risk hurting profits.
Management noted that e-commerce and physical sales at the Nordstrom Rack are increasingly becoming blended, and off-price e-commerce growth continues to be strong, up 26.3% in the third quarter, but the drop in comps inside Rack stores shows the concept may be getting stretched.
An e-commerce question mark
Elsewhere, the company posted just 7.5% growth in Nordstrom.com sales, also its slowest pace in several quarters. Management blamed that on returns from the Anniversary Sale over the summer, saying that without it, e-commerce growth on its main site would have been in the mid-teens. However, with brick-and-mortar sales already falling, investors should expect e-commerce growth at least in the mid-teens considering that's how fast online sales are growing in the broader economy. To make things worse, general & administrative expenses increased 170 basis points in the most recent quarter, due to increased technology and supply chain investments, showing that e-commerce is likely generating a lower margin than physical retail sales for the company.
Just to keep up with competitors, Nordstrom should be growing online sales in the mid-teens, and e-commerce has previously been a strength of Nordstrom as it makes up nearly a quarter of total revenue. If both e-commerce and Rack sales slow, Nordstrom will be left with little means to grow sustainably.
The company is experimenting more than its peers with the new Nordstrom Local store that offers personal service and perks like manicures and curbside pickup planned for major markets next month.
While those ideas may be promising, the performance of the business will continue to be determined by core components like Nordstrom Rack and the online channel. Keep an eye on those two segments over the holiday season. If those numbers continue to lag, Nordstrom investors could be in trouble.
