At first glance, Nordstrom's (NYSE:JWN) second-quarter earnings report looked awful. Sales plunged more than analysts had expected -- and far more than most other consumer discretionary retailers have reported -- and the company's net loss was slightly wider than expected.
However, the pressure on the fashion giant's sales and earnings was driven by a combination of timing factors, coronavirus-specific headwinds, and management's conservative approach to managing through the pandemic. As these headwinds lift over the next several quarters, Nordstrom is well positioned to recover and gain market share.
The headline numbers
Nordstrom posted net sales of $1.8 billion for the second quarter of fiscal 2020, down a full $2 billion (53%) from the prior-year period. This fell well short of even the most bearish Wall Street analyst's estimate. Full-line sales plummeted by 58%, and the off-price business didn't fare much better, with sales down 43% year over year. To nobody's surprise, store-based sales fell dramatically. Yet digital sales also declined 5% year over year.
Meanwhile, gross margin fell to 20.9% from 34.5% a year earlier. Combined with the impact of dramatically lower sales, this led to an adjusted operating loss of $347 million, compared to operating income of $216 million in Q2 2019. Nordstrom reported an adjusted net loss of $1.54 per share -- slightly worse than the average analyst estimate -- down from earnings per share of $0.90 in last year's second quarter.
The one bright spot in the hard numbers was that Nordstrom generated $187 million of cash from operations last quarter. This return to positive cash flow enabled the company to pay down $300 million of its revolving credit line borrowings.
Nordstrom is healthier than it seems
Clearly, Nordstrom has been hit hard by the COVID-19 pandemic. Yet the results seem worse on the surface than they really are.
First, Nordstrom delayed its biggest promotional event of the year -- the Anniversary Sale -- from July until August due to the pandemic. This alone reduced sales by about 10 percentage points, including a 25-percentage-point impact to digital sales, pushing that volume into the third quarter.
Second, Nordstrom's stores were closed for about half of the quarter, on average. Furthermore, the company's store base is heavily concentrated in coastal markets that have been hit especially hard by the pandemic. In California -- home to about a quarter of Nordstrom's stores -- most indoor malls were forced to shut down again in mid-July after reopening in late May or June. While exterior-facing tenants like Nordstrom can remain open, the loss of traffic from the rest of the mall still hurts.
Third, Nordstrom aggressively reduced its inventory in the early days of the pandemic to avoid being caught with too much stock if demand was slow to return. This caused it to miss out on some sales last quarter. However, this move supported merchandise margins and allowed Nordstrom to bring in fresh goods late in the quarter. That, in turn, should bolster sales in the third quarter. So far, trends have moved in the right direction in August.
Nordstrom can bounce back
Nordstrom was especially vulnerable to the pandemic because it doesn't have a significant home business, causing it to miss out on the biggest growth category for rival department stores. (Apparel and shoes accounted for 75% of sales last year, with beauty and accessories taking another 22%.)
Additionally, within apparel and shoes, Nordstrom has always been a destination for dress-up clothing. This naturally puts pressure on sales when people aren't going to work and large events like weddings are canceled. Nordstrom's lean inventory position has allowed it to pivot toward more casual and active styles in recent months, but it will remain at a disadvantage compared to many apparel retailers until the pandemic eases.
That said, when people do go back to work and large social events resume, Nordstrom could benefit from pent-up demand for dressier items. And there will be a whole lot less competition. Lord & Taylor, Neiman Marcus, Brooks Brothers, and Tailored Brands (parent of Men's Wearhouse and Jos. A Bank) are some of the major upscale chains that have filed for bankruptcy this year and are closing lots of stores.
Nordstrom has significantly reduced overhead costs this year, which should support a speedy profit recovery once demand returns in a meaningful way. Results will likely remain quite weak by historical standards in the near term, but investors who are willing to be patient and can tolerate some risk may be rewarded for betting on Nordstrom's eventual recovery.