The retail industry had a rough 2020, but you wouldn't know it when looking at the SPDR S&P Retail exchange-traded fund, which delivered a return of 79% over the last year. Two retail stocks have outperformed that benchmark recently. Shares of American Eagle Outfitters (AEO 4.59%) and Nordstrom (JWN 2.48%) have more than doubled off their 2020 lows, as both companies show signs of emerging from the pandemic on a stronger footing.
Here's why these two retail stocks could deliver more gains in 2021.
1. American Eagle Outfitters
American Eagle stock was underperforming the broader market entering 2020, but the business performance was telling a different story. In fiscal 2019, the company reached a record $4.3 billion in revenue, driven by 20 consecutive quarters of comparable-store sales growth.
Investors were probably disappointed with AEO's performance on the bottom line, where earnings per share weren't improving enough to push the stock price up. However, management is targeting a 10% operating margin by 2023, with revenue reaching $5.5 billion. The margin improvement would translate to a 15% compounded annual growth rate in operating income.
Management expects flattish revenue growth from the flagship American Eagle brand, which continues to control the No. 1 spot in the market for jeans among 15- to 25-year-olds. But the growth engine has been Aerie, where revenue increased by 34% in the fiscal third quarter.
Investments in American Eagle will go toward improving profitability for that brand, but Aerie is expected to double revenue to $2 billion by 2023. Aerie is continuing to maintain momentum by leveraging the popularity of its line of women's intimates to expand into new categories, such as activewear.
The stock trades at a forward price-to-earnings (P/E) ratio of 18.2, which could be a steal for a business that could see double-digit growth in profits over the next three to five years.
While it might not seem like an ideal time to invest in department stores, Nordstrom is making strides to transition its business to a digital-first model. During the holidays, 54% of Nordstrom's sales came from the digital channel, and management expects digital sales to make up around half of the business over the long term.
Nordstrom's recovery from the pandemic has been slower than some investors would have liked to see, with net sales down 22% in the nine-week period ending on Jan. 2. But that's the nature of navigating an unprecedented environment for retail. To Nordstrom's credit, digital sales grew 23% during the holidays, and management expects to report a positive operating profit when it reports fourth-quarter earnings on March 2.
There are better days ahead for this best-in-class department store. Management expects to add $2 billion to $3 billion of incremental sales over the next three to five years. For perspective, Nordstrom's total net sales were $15.1 billion in 2019. Part of management's plan is to better integrate physical and digital inventory to expand selection in the off-price Nordstrom Rack business, while also delivering more personalization across the business.
Investing in personalization is a huge opportunity since spending goes up five times when customers use order pickup, alterations, or personalized styling offered by Nordstrom.
Nordstrom also has a growth opportunity in home and beauty. These categories experienced strong sales growth recently, totaling more than 25% of online sales in the third quarter. Overall, management sees the home business growing by five times its current size in the next three to five years.
Nordstrom's digital-first strategy is showing promise and could gain further momentum in a healthy consumer-spending environment. The stock currently trades at just 10.5 times free cash flow, which leaves the door open for a rising share price, as management works to improve the company's profitability.
Finding value in retail
The pandemic muddied the waters of the retail landscape, but investors pay a high price for a cheery consensus. American Eagle Outfitters and Nordstrom are not going anywhere and could be great values at current price levels.