Please ensure Javascript is enabled for purposes of website accessibility

Why I'm Sticking With Nordstrom, Despite Terrible Q1 Earnings

By Adam Levine-Weinberg - May 17, 2016 at 9:55AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Nordstrom's Q1 earnings report was ugly on the surface, but the company's woes are probably temporary.

There's no doubt that Nordstrom's (JWN -1.75%) Q1 results were shockingly bad. While sales still rose 2.5% year over year in Q1 due to Nordstrom's aggressive store expansion, comparable store sales declined 1.7%. Meanwhile, earnings per share plunged from $0.66 to $0.26.

Investors have dumped the stock, sending it down more than 20% in the past week. Nordstrom shares have now lost about half of their value since last summer.

JWN Chart

Nordstrom Stock Performance, data by YCharts

However, Nordstrom's underlying business is a lot healthier than it appears. As a result, I expect sales growth to accelerate again and earnings to rebound in dramatic fashion during the next few years. Here are three reasons why I remain confident in Nordstrom's future.

Full-price sales remain strong

The first and most important reason for confidence is that full-price sales in Nordstrom stores remained quite strong last quarter. Much of the broader concern about department stores is that the rise of Amazon.com (AMZN 3.15%) -- and e-commerce as a whole -- is driving a vicious cycle of discounting.

"There is now going to be no end to discounting because all the players must dance as long as the music is playing. And it will ultimately drag everything down with it, including brand image, potentially quality and essentially the value of all things," wrote retail consultant Robin Lewis last year.

This may be true for certain brands with broad distribution that have become commoditized over time. Promotions have become rampant for some big brands that Nordstrom sells, putting pressure on both revenue and profitability.

Nevertheless, Nordstrom executives noted that regular price sales remained solid last quarter, both in stores and online. Nordstrom's customers are still willing to pay full price for unique, compelling merchandise. Last quarter's sales and earnings miss came from the company's need to mark down promotional and clearance items even further than usual.

Nordstrom's customers are still willing to pay full price for high-end brands. Image source: The Motley Fool.

By de-emphasizing these commoditized brands and doubling down on exclusive and limited-distribution brands, Nordstrom should be able to reinvigorate its core business. That's exactly what it plans to do.

Nordstrom Rack sales trends improve

While Nordstrom's full-price business was undermined by this intense discounting for certain brands, the Nordstrom Rack off-price business performed well in Q1. Comp sales increased 4.6% year over year in the off-price market, up from 3.6% in Q4 2015 and 2.4% in Q3 2015.

It's true that this comp sales growth came from the e-commerce channel, which is significantly less profitable. In-store comp sales declined 0.8% year over year for Nordstrom Rack. But this is a very respectable result given that Nordstrom has also been expanding the Rack store base at a double-digit rate in recent years. These new Nordstrom Rack stores are still producing strong sales volumes. As a result, total off-price sales rose 11.8% year over year in Q1.

Nordstrom's off-price sales are still growing at a double-digit rate. Image source: The Motley Fool.

As the Rack expansion cools off over the next few years, in-store comp sales should turn positive again. Meanwhile, as the off-price e-commerce business matures, its profitability will continue to improve. Both trends point toward an earnings rebound for Nordstrom's off-price segment.

Focusing on e-commerce profitability over sales

Finally, many investors are alarmed by the sharp slowdown in sales growth for Nordstrom's full-price e-commerce business. Sales rose just 3.1% last quarter, compared to 19.8% a year earlier.

However, this isn't a sign that Nordstrom is unable to compete with Amazon.com's nascent retail efforts. It just shows that Nordstrom isn't going to compete on Amazon's low-margin terms. Over the past few months, company executives have become increasingly candid about the need to focus more on profitability than growth in the e-commerce business.

Nordstrom invested aggressively in its e-commerce business in recent years. These efforts have made it one of the top 10 online retailers in the U.S., both by sales and by shipments. Yet some of this growth came from adding items to its e-commerce site that weren't profitable.

In the past year, Nordstrom has started to remove these unprofitable items from its website. This has led to a temporary slowdown in growth. Yet Nordstrom is clearly still generating underlying growth in its e-commerce business to offset the lost sales from these unprofitable items.

By 2017, Nordstrom should be lapping the impact of its strategy shift. That should drive a return to growth -- at higher margins than before.

This too shall pass

In the past few quarters, Nordstrom's revenue and earnings have been hurt by stiff competition from online retailers like Amazon as well as traditional department stores. Many investors seem to have concluded that the company is doomed.

However, it's important to remember that Nordstrom's revenue grew more than 9% year over year in the first half of 2015. So far, the sales slowdown is a blip, not a trend. As Nordstrom reduces its exposure to underperforming brands and removes unprofitable items from its website, the company's earnings performance should improve dramatically.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Nordstrom, Inc. Stock Quote
Nordstrom, Inc.
JWN
$20.76 (-1.75%) $0.37
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$109.56 (3.15%) $3.35

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/04/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.