Nordstrom (JWN +0.00%) has long been considered the gold standard for department stores. But despite its steady focus on innovation and superb customer service, the fashionable retailer still suffered a slowdown in sales growth and a decline in its earnings power between mid-2015 and 2017.
Last month, Nordstrom executives presented a plan to drive steady growth in sales, profitability, and free cash flow over the next five years. Investors shrugged it off, though, leaving Nordstrom stock within the trading range around $50, where it has spent most of 2018.
Nordstrom year-to-date stock performance. Data by YCharts.
However, on Thursday afternoon, Nordstrom reported very strong results for the second quarter of fiscal 2018. The company's sales and earnings beat is giving investors confidence that Nordstrom is finally getting back on track.
Sales and earnings surpass expectations
Like many other fashion retailers, Nordstrom experienced slow sales during the first quarter due to unseasonable weather in parts of the U.S. Comp sales inched up just 0.6%, even though the company faced an easy year-over-year comparison. Meanwhile, Nordstrom's operating margin contracted slightly.
Nordstrom turned things around in the second quarter. Comp sales rose 4%, with solid growth on both sides of the business -- full-price and off-price. Total revenue increased 7.2% year over year, reaching $4.07 billion. Analysts had been expecting just $3.96 billion of revenue.
The strong sales performance caused profitability to exceed management's expectations. Pretax income would have been flat year over year, excluding a $30 million benefit related to the timing of Nordstrom's Anniversary Sale. Still, that was a solid result, given the massive investments Nordstrom is making to drive future growth.
Nordstrom posted better-than-expected sales and earnings results last quarter. Image source: Nordstrom.
Furthermore, Nordstrom continued to benefit from a lower tax rate due to federal tax reform. Earnings per share surged to $0.95 from $0.65 a year earlier, cruising past the average analyst estimate of just $0.84.
Good results in online and off-price
Comp-sales growth came in about 2 percentage points ahead of internal forecasts last quarter. While Nordstrom's traditional mall-based full-line stores face secular challenges due to changing shopper habits, its early investments in e-commerce and off-price stores are paying off.
Off-price comp sales rose 4% in the second quarter, a level of growth last seen in 2016. The Nordstrom Rack chain has improved its inventory management this year, which is now enabling it to present fresher merchandise to customers, boosting growth. Total off-price sales rose 7% in the quarter.
E-commerce also remains a point of strength for the company. Digital sales surged 23% year over year, reaching a record 34% of total sales last quarter, up from 29% of sales in the second quarter of fiscal 2017.
Looking ahead
Nordstrom's performance last quarter validated the plan management presented at the July investor day event, which calls for gradually harvesting the benefits of a heavy investment cycle that's just winding down.
Nordstrom raised its full-year sales and earnings forecasts on the back of its strong Q2 results. It now expects fiscal 2018 net sales -- which doesn't include credit card revenue -- of $15.4 billion-$15.5 billion (up from $15.2 billion-$15.4 billion previously), 1.5%-2% comp-sales growth (up from a 0.5%-1.5% increase), and earnings per share (EPS) of $3.50-$3.65 (up from $3.35-$3.55).
Free cash flow also appears to be growing faster than expected, reaching $388 million in the first half of fiscal 2018 compared to $239 million in the year-earlier period. (Part of that increase relates to the timing of the Anniversary Sale, though.) Nordstrom's projection that annual free cash flow will reach $800 million by 2020 -- revealed at investor day -- is already looking very conservative.
One open question is when Nordstrom will start to ramp up share buyback activity again. At investor day, management estimated that the company will spend $3.7 billion on buybacks by the end of 2022. However, it spent less than $100 million on buybacks in the first half of fiscal 2018, despite ending the period with more than $1.3 billion of cash and cash equivalents.
Share repurchases represent a key piece of Nordstrom's plan to boost EPS growth. Based on the market's positive reaction to the Q2 earnings report, it looks like Nordstrom will have to execute those buybacks at higher prices.
