Less than a year ago, U.S. luxury retailers appeared to have the wind at their backs. Strong GDP growth, a rebound in international tourism to the U.S., and rising stock prices were all supporting a return to growth for the likes of Neiman Marcus and Hudson's Bay (HBAYF) subsidiary Saks Fifth Avenue.
Unfortunately, industry conditions began to sour in late 2018. Moreover, competition is intensifying, particularly in New York City, where Neiman Marcus opened a new store earlier this year and Nordstrom (JWN) is set to open a flagship location in October. This is putting heavily indebted Neiman Marcus in a precarious position.
Neiman Marcus starts to underperform again
Following a pair of disappointing years, Neiman Marcus returned to growth in its 2018 fiscal year, the 52-week period ending on July 28, 2018. Comparable sales rose in each quarter of fiscal 2018, increasing 4.9% on a full-year basis. Furthermore, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) rebounded to $477 million from $434 million a year earlier. (That said, adjusted EBITDA was far higher in fiscal 2015, at $711 million.)
Unfortunately, growth has been slowing over the past few quarters. Comp sales rose 2.8% in the first quarter of fiscal 2019 but inched up just 0.7% in the second quarter. As a result, adjusted EBITDA -- which still grew strongly in the first quarter -- fell 9% on a like-for-like basis in Q2.
Last week, Neiman Marcus revealed that the slowdown worsened in the third quarter. Comp sales fell 1.5%, ending a streak of six consecutive gains. Furthermore, adjusted EBITDA plunged 12% to $127 million.
Neiman Marcus blamed the sales decline on weak demand for some of its key brands, as well as poorly executed promotions. Increased stock market volatility and a reversal in international tourism trends -- due to the strong dollar and U.S.-China trade tensions -- also likely weighed on sales. But rival Saks Fifth Avenue is weathering these headwinds much better. It achieved a 2.4% comp sales gain last quarter, following a solid 3.9% increase in the previous quarter.
Competition is heating up in Manhattan
Neiman Marcus is already stumbling, but it will face even greater challenges ahead. Most notably, the luxury retail market in Manhattan, where the company operates Bergdorf Goodman men's and women's stores -- and, since mid-March, a Neiman Marcus store -- is becoming a lot more competitive.
Saks Fifth Avenue is nearing the end of a multiyear, $250 million renovation of its Manhattan flagship store. Earlier this year, it reopened the store's main floor, following extensive updates. New jewelry and shoe departments will open over the next year or two.
Meanwhile, Nordstrom is set to open its first full-line store in Manhattan in October. Nordstrom has already invested more than $300 million in this future flagship location, aiming to make it the company's best store. The retailer will also open Nordstrom Local service hubs in two other Manhattan neighborhoods, providing added convenience for customers.
The Saks flagship and the new Nordstrom flagship are both less than half a mile from Bergdorf Goodman. As a result, the heavy investments that Hudson's Bay and Nordstrom are making in New York could make it hard for Bergdorf Goodman to hold onto its customers.
The balance sheet is still a mess
Neiman Marcus' massive debt load will make it hard for management to execute a turnaround. While Neiman Marcus was recently able to restructure its debt, this maneuver primarily extended the maturities of its borrowings, rather than reducing the company's leverage.
To be fair, adjusted EBITDA remains solidly positive, so Neiman Marcus is in no imminent danger. However, with close to $5 billion of debt, the company does not have much flexibility to match rivals' investments. Even if Hudson's Bay's top shareholders succeed in taking that company private, the Saks parent would still have dramatically less debt than Neiman Marcus.
Based on recent sales trends, adjusted EBITDA is likely to fall to a new low in fiscal 2019 and could decline further next year. Neiman Marcus will barely be able to cover its interest expense from EBITDA, let alone fund meaningful capital expenditures. This could lead to underinvestment in the years ahead, causing Neiman Marcus' competitive position to weaken further.
Filing for bankruptcy to reduce the company's debt load likely would have been the best way to preserve Neiman Marcus' long-term health. Instead, the retailer's private-equity owners have embarked on a risky strategy of kicking the can down the road. If profitability continues falling, Neiman Marcus could find itself beyond saving within a few years.