Thursday, September 20, 2012

Nordstrom Equity Analysis




n the retail sector there are few companies whose management stands out from the rest. In the mid-market, I think V.F. Corp $VFC has outstanding management and at the higher end, Nordstrom Inc. $JWN also has excellent leadership. What these companies have in common is a drive towards adjusting to the retail reality by investing in things like e-commerce initiatives and changing their offerings in order to deal with the new ‘age of austerity.’ Consumers are getting ever more price conscious, and it is essential for retailers to adjust. In this article I want to focus on the latest results from Nordstrom and put them in the context of the ongoing development of the business and the retail landscape.

I previously wrote about the company in an article linked here which gives a good overview of the strategic direction being taken. I like writing these articles because in doing so, I can create good objective benchmarks for analyzing how companies are developing their businesses. I hope readers find them useful too. Going back to the original article, I outlined the correlation between Nordstrom’s revenue and gross profits and the growth in US net household wealth. We can monitor that in line with the overall economy and that profit driver is largely a strategic consideration.

For the detail of how Nordstrom is managing its company operationally, I previously highlighted a few things that I think investors should be looking for with Nordstrom. It’s time to run the check list.

  • Expanding the roll out of Rack stores, Nordstrom’s reduced price stores
  • Expanding online presence, including integrating the Hautelook acquisition and, expanding on the Bonobos partnership
  • Taking advantage of increasing credit quality via Nordstrom Bank and its customer cards



Nordstrom Rack Stores

In adjusting to a slower consumer environment, Nordstrom has been busy rolling out its chain of reduced price stores named ‘Nordstrom Rack.’ It opened 18 new Rack stores in 2011 and another 15 are planned for 2012.

In these results, Nordstrom confirmed the rollout for 2012 and outlined a plan to create 24 new Rack stores for 2013. A graphical depiction of the plans is shown here:




The Rack stores are a growing share of Nordstrom’s revenues and management talked of results that ‘exceeded our expectations.’ Moreover, plans are in place for significant investment in technology in these stores. For example, mobile point-of-sales devices are being added in order to improve the customer experience. In addition, management claimed that the extra Rack stores would only cause a minimal increase in capital expenditures and it appears that these stores are scalable.

Naturally, when any retail company increases the number of its reduced price stores, there is the risk of a negative effect on the overall brand. This is something to keep an eye on but, so far, the Rack stores appear to be complementary to the full price stores. Moreover, they should enable better inventory management in the future and they are a reflection of the times.

With initiatives like free shipping for e-commerce, Nordstrom continues to create a feeling of a high quality of service, and this sort of thing resonates with consumers. I’ve heard other retailers refer to free shipping as being effectively a discount, but they aren’t selling discretionary items to a customer base that values service. Nordstrom is.

Regarding the brand, Nordstrom stores are run along classic lines. There is little of the Abercrombie & Fitch $ANF approach about them. It’s not the kind of store that is going to create a fad out of pumping perfume, loud music and young fashion models in order to create the sensory experience and ambiance of a night club for its shoppers. Whilst that may be a good thing for Abercrombie & Fitch, it is not the sort of thing that would keep Nordstrom customers happy. Brand protection is paramount and Nordstrom does it well.

Check: It’s a thumbs up for the Rack plans.



Integration of Acquisitions and Online Presence

The Direct business saw sales increase by 40% in the quarter following a 44% increase in the previous quarter as the investments in e-commerce initiatives are starting to payoff. As for the acquisition integrations HauteLook’s sales increase for this year is forecast to be between 50% and 60%, and according to the management is running at or slightly above plan. It is reasonable to expect synergies to be created in terms of merchandising and infrastructure and investors have cause to be positive here.

Rather like VF Corp, expanding the online presence is important to Nordstrom, but I think they will find it easier. VF Corp is expanding online into new geographic territories while Nordstrom is a US centric company. In addition, cultural differences count for a lot in retail and the US is a far more mature and more e-commerce savvy region than any other. Nordstrom should find things easier.

That said, inventory growth overall was a little high in the quarter and it is expected to run a little faster in the near term--but don’t be alarmed. Although this sounds like a classic case of working capital difficulties caused by management chasing sales in the short term, there are two plausible reasons. First, inventory ran up because the company was preparing for the anniversary sale (which fell in fiscal Q3 this year so is not in the Q2 results) and because of the Rack expansion plans. If you open new stores you have to have something to sell in them!

Check: The acquisitions are bedding well and the e-commerce initiatives are driving strong growth and creating a differentiation from other stores via the free-shipping policy.



Credit Card Revenues and Metrics

Credit card revenues only made up 3% of revenues in the quarter so why am I obsessing about them? The simple reason is that the metrics around these revenues are a good indication for the wider economy and for trends within Nordstrom’s customer base. The news is good.

Annualized net-write offs as a percentage of average credit card receivables decreased to 4.8% from 7.2% last year and 30 day delinquency rates on credit card receivables were as low as 1.9%.

In case you haven’t heard it yet, American households are really cleaning up their balance sheets. While this is creating some severe price resistance within consumer goods, it is also producing an environment of slow but sustainable growth. It is up to the retailers to adjust to it. As we have seen recently with Coach $COH, this aspect is causing competitors to try to grab market share in new territories. I suspect Nordstrom has more flexibility than Coach. The latter is trying to protect its brand offering of ‘affordable luxury’ while Nordstrom can shift its merchandise offering to the new reality of what consumers want, while continuing to offer them a high level of service.

Check: Credit card indicators are suggesting that the consumer is in shape to start to expand discretionary spending and Nordstrom is making the right moves