Many retail stocks have been crushed by the COVID-19 pandemic, with department stores and other apparel-focused retailers being particularly hard hit. Nordstrom (NYSE:JWN) has been no exception. Shares of the retail icon have plummeted about 58% year to date.

Off-price retail stocks also plunged in the early days of the pandemic. However, they bounced back quickly, as investors concluded that they would gain market share in the aftermath of the pandemic. For example, shares of No. 2 U.S. off-price retailer Ross Stores (NASDAQ:ROST) are down just 21% year to date.

JWN Chart

Data source: YCharts.

Yet Nordstrom itself operates a substantial off-price business, consisting of Nordstrom Rack and HauteLook. In punishing Nordstrom stock this year, investors appear to be forgetting about the value and long-term potential of the company's off-price operations.

Off-price stocks bounce back -- but not Nordstrom

While off-price retail has grown rapidly in recent years, the segment was hit especially hard by the COVID-19 pandemic. Most off-price stores were classified as non-essential and forced to close in mid-to-late March. Aggravating matters, off-price retailers have typically focused on attracting customers to their stores with a "treasure hunt" experience while de-emphasizing e-commerce.

In fact, Ross Stores doesn't have an e-commerce business at all. That didn't stop it from more than doubling its revenue over the past decade, with sales surpassing $16 billion in fiscal 2019. However, sales plunged 51.5% last quarter, as the pandemic forced it to shut all of its stores around the middle of the quarter.

Nordstrom has been rather unique in investing to build an off-price e-commerce business. In early 2011, it acquired flash-sale site HauteLook. Nordstrom later expanded its online off-price business by launching the nordstromrack.com e-commerce site. By 2018, the online off-price business was generating $1 billion of annual revenue. These investments helped partially cushion its top line last quarter. Nordstrom reported that off-price sales slumped 45.2% in Q1.

While that was hardly a good result, it was noticeably better than Ross Stores' performance. Nevertheless, while Ross Stores stock rallied over the past three months -- recouping some of its losses from earlier in March -- Nordstrom stock has barely budged.

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

Image source: Nordstrom.

Nordstrom Rack has value

Last year, Nordstrom's off-price business generated $5.2 billion of revenue, 34% of the company total. While off-price revenue didn't grow in fiscal 2019, that was due in part to moves designed to improve profitability, such as eliminating unprofitable promotions and removing some low-price items from the retailer's online inventory. And despite those headwinds, off-price sales trends improved as the year progressed, including a 1.8% sales increase in the fourth quarter, compared to a 1.3% decrease in the first half of fiscal 2019.

Nordstrom Rack will become increasingly important to the company going forward. For one thing, the Rack chain is likely to have particularly good deals in the near term, as the pandemic has created abundant merchandise availability.

Meanwhile, Nordstrom recently decided to close 16 full-line stores and its three upscale Jeffrey boutiques, which will shrink the mature full-price business. In many cases, it will be able to use nearby Nordstrom Rack stores for full-price order pickup, returns, alterations, and similar services. That will drive more traffic to Rack stores, potentially helping to accelerate their sales growth.

Ross Stores' market cap currently exceeds $32 billion, equal to about 2 times fiscal 2019 sales. Nordstrom's off-price business deserves a lower multiple, based on what appear to be lower margins. But even with the multiple equal to sales, the business would be worth $5.2 billion, nearly double Nordstrom's $2.7 billion market cap.

Debt isn't a big concern

Some bearish investors might argue that despite the value of the company's off-price business, Nordstrom has too much debt to be an attractive investment. Indeed, debt surpassed $4 billion at the end of last quarter.

However, that figure includes $800 million drawn from the company's revolving credit facility to increase financial flexibility. Nordstrom ended the first quarter with nearly $1.4 billion of cash. Once business conditions stabilize, the company will be able to repay its credit-line borrowings with excess cash.

Furthermore, Nordstrom's real estate is likely worth billions of dollars. (In April, it was able to raise $600 million of secured debt by pledging its Seattle flagship, five other stores, and six distribution centers as collateral.) As the company closes full-line stores, it should be able to cash in on the real estate value of some of them, raising cash that can be used to pay down debt.

Nordstrom's full-line stores are located in the best malls in North America and busy downtown locations. The company also has a massive full-line e-commerce business. As a result, Nordstrom is likely to maintain a successful full-line business for many years to come, notwithstanding the negative trends impacting department stores as a whole. Yet even if this weren't true, between the real estate value of the full-line segment and Nordstrom Rack's long-term growth potential, Nordstrom stock would still be dramatically undervalued.