Shares of Nordstrom (NYSE:JWN) traded slightly lower after the department store retailer reported holiday quarter numbers that were largely mixed. Broadly speaking, earnings were strong, while revenues weren’t, and the fiscal 2019 guide implies that this trend of weak top-line performance but strong bottom-line performance will persist for the foreseeable future. Investors weren’t sure how to react to that news. Initially, JWN stock popped a few percentage points. Then, it reversed course, ending Friday trading the red.
In the big picture, continued weakness in JWN stock is a near-to-medium term buying opportunity. Four months ago, this was nearly a $70 stock. Now, it sits below $50. The 65-stock Invesco S&P 500 Equal Wt Cnsm Disc ETF (NYSEArca:RCD) is up 11.4% since early December while Nordstrom stock is down 4.8%.
What’s changed? Not enough to warrant a 30% discount in the Nordstrom stock price. To be sure, the quarter wasn’t great. The full-price business is slowing and margins remain under pressure. But, its full-price retail is slowing because of tougher comps, and is stable in a long-term window.
Margins are also expected to stabilize next year, thanks to full-price business improvements and cost cutting measures. Meanwhile, the off-price business is firing on all cylinders, and digital sales growth remains robust.
Overall, while there are some signs of weakness, the overall JWN growth narrative remains largely healthy today. Yet at current levels, Nordstrom stock isn’t priced for healthy, a disconnect that can’t last for much longer. The retailer’s numbers will improve throughout 2019. As they do, JWN stock will bounce back, and the shares will likely end the year close to $60.
A Mixed Big Picture
The Nordstrom narrative can be summed up in four words: good, but not great.
In 2018, Nordstrom was staging a huge comeback as the broader retail scene stabilized after years of losing share to the e-commerce market. Nordstorm led the pack in finding its footing via a robust omni-channel presence and unique value prop as a medium-to high-end retailer. That proposition enabled the Seattle-based operator to drive consistently positive comp sales growth at both its full- and off-price stores. Wall Street bought into this idea that Nordstrom was back to its normal self, pushing JWN stock to near $70 a share.
Unfortunately, that isn’t what’s happening because Nordstrom continues to operate in a world where consumers can buy clothes from its neighbor Amazon (NASDAQ:AMZN) and other e-commerce retailers. Granted, Nordstrom is a medium-to high-end retailer with mitigated product portfolio overlap with other retailers. But, there is still some overlap, and that means that the retailer will continue to feel some competitive friction for the foreseeable future.
This is what investors are seeing in the numbers now. As the lap got tougher in late 2018, comparable sales growth slowed. But, comps are still up on a two-year basis and are expected to be narrowly positive again next year. In other words, growth isn’t on a runaway train to new highs, but rather on a slow and steady path higher.
Overall, the Nordstrom narrative is a mixed bag. You have a retailer that clearly has staying power on the retail scene thanks to its unique value prop and product portfolio. But, staying power doesn’t equal robust growth and because competition is as intense as ever, stamina over the next several years will translate into relatively muted top- and bottom-line growth. Still, that’s good enough to warrant buying JWN stock at currently depressed levels.
Nordstrom Stock is Undervalued
The math behind buying JWN stock at current levels is pretty simple.
You have a company that has a red-hot off-price business that has been, still is, and will continue to fire on all cylinders thanks to its ability to integrate reasonable prices with good quality. Meanwhile, the full-price business is slowing thanks to tougher laps. But, those laps get easier later in 2019, so growth should come back into the picture. Importantly, this business should remain a tepid grower over the next several years.
Gross margins will get hit early in the year thanks to full-price weakness. But, as that business stabilizes in late 2019 and in the long term, gross margins should stabilize, too. The SG&A rate has been consistently rising. That, too, will end as generational investments phase out and the company continues to pull costs out of the system.
So, in the big picture, Nordstrom should be able to grow sales at a tepid 1-2% rate over the next several years, while stabilizing EBIT margins in 6-7% range. Those growth assumptions, coupled with share buybacks, pave a path for Nordstrom to hit $5 in EPS by fiscal 2025, up from the current $3.32. Based on a market-average 16x forward multiple, that equates to a fiscal 2024 price target for JWN stock of $80. Discounted back by 7% per year (3 points below my normal 10% discount rate to account for the yield), that gives you a fiscal 2019 price target of roughly $57.
Bottom Line on JWN Stock
The Nordstrom story isn’t great. But, it isn’t awful either. Right now, JWN stock is priced for awful. This disconnect cannot last forever. Nordstrom’s numbers will improve throughout 2019 as the lap gets easier. As those numbers improve, Nordstrom stock will rise, and prices close to $60 look achievable by year end.
As of this writing, Luke Lango was long JWN and AMZN.