Privately held Neiman Marcus reported its fourth-quarter results for fiscal 2018 last week. The recently ended fiscal year marked a return to sales growth for the luxury retailer.
But although Neiman Marcus delivered its fourth consecutive quarterly comp sales gain, its growth rate is slowing again. Meanwhile, profitability remained weak in fiscal 2018 -- and the company needs to continue investing heavily to keep up with better-funded rivals, such as Nordstrom (JWN 0.20%) and Hudson's Bay's (HBAYF) Saks Fifth Avenue chain. That will make it hard for Neiman Marcus' private equity owners to exit their ill-advised investment.
Neiman Marcus has been under pressure
A pair of private equity firms bought Neiman Marcus for the lofty sum of $5.1 billion in 2005. They managed to flip the company to Ares Capital Management, another private equity firm, and the Canada Pension Plan Investment Board for $6 billion in 2013. That situation left Neiman Marcus with a massive debt load, which totaled around $4.7 billion as of mid-2015. (For comparison, annual revenue has been less than $5 billion in recent years.)
Things went from bad to worse over the next two years. In addition to the industry pressures affecting all department stores, Neiman Marcus was hit by a slowdown in the broader luxury market, as the strong dollar cut down on international tourist traffic to the U.S. and reduced those tourists' spending power. The botched rollout of a new inventory management system added to the company's woes.
As a result, comp sales fell 4.1% in fiscal 2016, while gross margin plunged. That drop caused adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to plummet to $585 million from $711 million a year earlier.
The misery continued in fiscal 2017, as comp sales declined 5.2% and adjusted EBITDA fell all the way to $434 million. Total debt was still near $4.7 billion at year's end, giving Neiman Marcus a dreadful leverage ratio of nearly 11 times EBITDA. Furthermore, the downturn in profitability forced Neiman Marcus to cancel its plan to raise capital through an IPO.
A comeback -- but it's slowing
The health of the luxury market has improved over the past year, allowing Neiman Marcus to get comp sales growing again. During the first three quarters of fiscal 2018, comp sales surged 5.7% year over year. The strong sales gain drove margin expansion, boosting adjusted EBITDA to $421 million, compared with $386 million in the first three quarters of fiscal 2017.
Comp sales growth slowed to 2.3% last quarter. On the bright side, adjusted EBITDA continued to recover. For the full fiscal year, adjusted EBITDA reached $477 million. Of course, that is still far below Neiman Marcus' level of earnings from fiscal 2015 (or even fiscal 2016).
Furthermore, the growth slowdown came despite a strong consumer environment. Nordstrom posted a 4.1% comp sales gain in its full-line business last quarter. Meanwhile, Saks Fifth Avenue remained the main growth driver for Hudson's Bay. Saks, Neiman Marcus' most direct competitor in the luxury market, posted a stellar 6.7% comp sales increase last quarter.
This situation suggests that Neiman Marcus' apparent sales momentum earlier in fiscal 2018 may have owed more to easy year-over-year comparisons than to a genuine turnaround.
The competitive environment won't get any easier
The vast majority of Neiman Marcus' adjusted EBITDA goes toward paying its annual interest expense, which currently exceeds $300 million. All the rest, and then some, is needed for investments in the business. Neiman Marcus plans to spend between $170 million and $190 million on capex in fiscal 2019.
That still may not be enough to keep up with Nordstrom, which has been spending an average of around $700 million annually on capex. Much of that spending has gone toward technology, supply chain, and fulfillment capabilities. Meanwhile, Saks Fifth Avenue benefits from being under the Hudson's Bay umbrella, which encompasses several other department store chains.
In addition, Nordstrom will open its main Manhattan flagship store next fall. The site is just a few blocks away from Bergdorf Goodman, a luxury department store owned by Neiman Marcus, which accounts for a meaningful proportion of the company's revenue. It's possible that the new Nordstrom store will help Bergdorf Goodman by bringing more retail traffic to the area, but Nordstrom will also be a fierce competitor going forward.
Finally, Neiman Marcus' mall-based stores could continue to face pressure from declining mall traffic. There have finally been some signs of improvement at Neiman Marcus in the past year, but the outlook is still dim because of the company's massive debt load.