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These 2 Department Store Stocks Got Pummeled Last Week

By Adam Levine-Weinberg – Nov 19, 2018 at 9:06PM

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But one is much more likely to make a comeback.

Last week was an ugly week for department-store stocks. Retail stocks have rallied this year, leading to high expectations among investors. As a result, the market has reacted negatively to even the slightest disappointments in department stores' third-quarter earnings reports.

Nordstrom (JWN 24.79%) and Dillard's (DDS -1.09%) felt the biggest impact from this phenomenon. Dillard's stock plunged 19% last week; Nordstrom plummeted 22%.

DDS Price Chart

Nordstrom and Dillard's Weekly Stock Performance data by YCharts.

Let's take a look at the Q3 results that Dillard's and Nordstrom reported last week -- and whether the sharp declines in their share prices were justified.

Dillard's posts another subpar earnings report

Last quarter, Dillard's posted a solid 3% comp-sales increase. However, weaker second-quarter results caused it to enter the period with too much inventory. As of the end of Q2, inventory was up 5% year over year, even though comp sales rose just 1% in the second quarter.

This inventory overhang weighed on Dillard's gross margin last quarter, particularly during the first month of the fiscal quarter. Retail gross margin fell 87 basis points (0.87 percentage points) year over year. As a result, Dillard's adjusted earnings per share plunged to $0.16 from $0.41 a year earlier.

Considering that analysts had on average expected Dillard's EPS to reach $0.56 last quarter, it's not surprising that the stock tumbled. However, there were some bright spots in the earnings report. For one thing, results improved as the third quarter progressed. Additionally, Dillard's ended the quarter with inventory up just 2% year over year on a comparable basis, which puts it in position to be more successful during the holiday quarter.

Nordstrom investors get some unwelcome surprises

Comp sales rose 2.3% at Nordstrom last quarter: a slowdown relative to the 4% increase it achieved in the second quarter. Its off-price division delivered a stellar 5.8% comp-sales gain, but this was offset by a modest 0.4% increase for the full-line side of Nordstrom's business.

The entrance to a Nordstrom Rack store, with a full-line Nordstrom store in the background.

Nordstrom's off-price business gained momentum last quarter. Image source: Nordstrom.

The timing of Nordstrom's big Anniversary Sale -- which mainly fell during the second quarter this year -- had a significant negative impact on its full-line results last quarter. Management noted that for the second and third quarters combined, Nordstrom posted a respectable 2.5% uptick in full-line comp sales. Nevertheless, investors were clearly disappointed by the slowdown in Nordstrom's full-line growth.

Additionally, Nordstrom took a $72 million pretax charge last quarter, after discovering that since 2010, it had mistakenly charged too much interest to some Nordstrom credit card holders with delinquent balances. This charge represented the cost of providing refunds for the extra interest charges and other fees.

Aside from this one-time charge, Nordstrom's EPS came in at $0.67, $0.01 ahead of the average analyst estimate. However, some analysts and investors seemed to worry that the revelation about charging too much credit card interest could mean that Nordstrom will report lower credit card earnings going forward.

One of these stock-price declines was much more logical than the other

Dillard's doesn't provide forward guidance. However, analysts have been lowering their full-year earnings estimates since the recent earnings report. The stock trades for a modest 11 times its projected 2018 earnings, but that may not make it a bargain, given that the company hasn't been investing much in initiatives that could drive long-term sales growth.

By contrast, Nordstrom slightly increased its full-year adjusted EPS guidance range last week. The stock now trades for 14 times the midpoint of the company's 2018 EPS forecast.

While that is a more generous earnings multiple than the one that Dillard's carries, Nordstrom has invested heavily in recent years to lay the foundation for future sales growth. The company estimates that its "generational investments" will reduce its pretax profit by $150 million this year. However, the losses should diminish significantly by 2020, and these initiatives are likely to collectively break even by 2022 while adding billions of dollars to Nordstrom's top line.

Between now and then, Nordstrom plans to buy back more than $3 billion of stock. It ended last quarter with more than $1.1 billion of cash on its balance sheet, up $455 million year over year. Thus, Nordstrom is well positioned to take advantage of the recent plunge in its stock price by quickly ramping up its share-repurchase activity. That will add to the company's EPS growth momentum, which should eventually get the stock moving higher again.

Adam Levine-Weinberg owns shares of Nordstrom. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.

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