Nordstrom Marked Down

Do investors love Nordstrom (NYSE:JWN) as much as shoppers do? Not if you believe the 360-plus Fools who follow the stock in our Motley Fool CAPS research database. Behold:

But that could be changing. This week, the luxury retailer best known for its unlimited return policy and personal service reported earnings that easily exceeded the Street's estimates and its own reduced third-quarter guidance.

Revenue increased 5.3% to $1.97 billion. Earnings, after excluding a $20.9 million gain on the sale of its Faconnable business, improved by 13% to $0.59 per share. (Management had predicted a range of $0.50 to $0.53.)

"Black Friday" or black Friday?
Now for the bad news. Same-store sales, or comps, were up just 2.2% during the quarter and are now expected to rise just 3%-4% for the full year. While the company's target customer is less effected by the slowing economy, management remains conservative with its outlook for the holiday season.

On the bright side, Nordstrom is entering the holidays with healthy inventory levels, a crucial point that makes the company stand out among many of its competitors. Management believes it is "well positioned" at current inventory levels, even if customer traffic is slow.

But I also wouldn't be overly impressed. Nordstrom, like Zale (NYSE:ZLC) and Saks (NYSE:SKS), cautioned that the fourth quarter may not be as black as some might like. Accordingly, management lowered its full-year earnings forecast for the second time since August, to $2.78-$2.82 a share. Ouch.

When Santa's sleigh is back in the shop ...
Yet, so far, investors are finding few flaws with Nordstrom's Q3 report, sending the stock up 5% over the last few days. For the most part, I agree.

But I'm even more impressed with how management is taking a long-term view of its business. Nordstrom has a five-year plan to commit $3 billion to capital improvements. Roughly 80% of that is for new stores, remodels, and relocations.

Critics will rightly point out that Nordstrom doesn't have anywhere near $3 billion in the bank. Nor does it have the $2.5 billion now committed for repurchasing shares. You know what that means: time to break out the corporate credit card.

And it'll be a spending spree, if history serves. Here's why. Through Q2, Nordstrom had roughly as much debt as it had produced in earnings before interest, taxes, depreciation, and amortization (EBITDA) over the prior 12 months. Chief Financial Officer Mike Koppel now wants to double that ratio, to two times EBIDTA.

There's your buyback. And your capital spending account.

But is Koppel nuts? Possibly, but the numbers favor his decision. Look at how Nordstrom compares to retailing peers in terms of liquidity (higher is better):

Nordstrom also has a history of maintaining a healthy balance between long-term debt and equity -- an indicator that management is capable of using leverage to create returns for shareholders.

OK, but where the sale?
Finally, let's talk valuation. Here, I like Nordstrom because it trades for roughly the same PEG ratio as Macy's and at a steep discount to Saks. Yet it has a stronger balance sheet than either and is, historically speaking, by far the most efficient deployer of capital.

How can it not command a premium price? Answer: It can't. Not forever, anyway. Someday, Mr. Market will realize his mistake and mark up Nordstrom once more. When he does, today's investors won't be seeing black. They'll be seeing green.