Nordstrom, Inc. (NYSE:JWN) tumbled ahead of its fourth-quarter earnings report Thursday, but JWN stock is headed in the right direction once more after a better-than-expected result.
The short story: Profits looked good, revenues are still going, margins are showing signs of stabilization and cash flows are about to get a nice boost. Yet the valuation of JWN shares remains depressed, leading me to believe that Nordstrom stock is going to head higher.
A lot higher.
The Margin Story Is Getting Better
First, the headline numbers: Nordstrom earnings for Q4 came to $1.37 per share, easily beating estimates of $.122 per share. Revenues of $4.2 billion were up 2.4% year-over-year, but did fall shy of estimates for $4.37 billion.
On the margin side, though, the story keeps getting better.
Similar to Macy’s Inc. (NYSE:M) and Kohl’s Corporation (NYSE:KSS), JWN saw gross margins expand healthily in the quarter. Nordstrom, though, is significantly outperforming its mall peers. Retail gross profit rate increased more than 100 basis points in the quarter, versus 90 basis points at Macy’s and 33 basis points and Kohl’s. This is due to management’s strong execution.
Firstly, JWN is getting a handle on inventories. Sales growth outpaced inventory growth at Nordstrom by 500 basis points in Q4. Secondly, the company is putting an emphasis on private label brands. This provides a shield against mall-wide promotional activity. Going forward, gross margins should begin to experience some level of stabilization and maybe even steadily expand.
Operating expense growth also really came down this year. Because the transition to a multi-channel business model required significant investment, JWN’s operating expenses grew at 9% per year from 2010 to 2015. The investments paid off, and Nordstrom’s e-commerce business now represents a fourth of overall sales (versus 8% in 2010).
More importantly, though, this early digital success has been followed by less aggressive spend. Operating expenses only grew 4% this year. JWN management implied opex would grow at a lower rate over the next several years.
In other words, the “big” spending era seems to be over. That means we might start to see some opex leverage over the next several years. Opex leverage plus buybacks would flow into earnings growth greatly in excess of 3 to 4% per year.
Again, that isn’t bad considering that JWN stock is trading at less than 15 times earnings.
The Nordstrom Brand
The Nordstrom brand continues to underperform while Nordstrom Rack continues to outperform. This underscores the price sensitivity of the average JWN customer. That isn’t great against the backdrop of intense price competition from other retailers.
There are, though, several near-term catalysts which could re-spark growth in the full-priced business.
- Nordstrom is rolling out a new “reserve merchandise” mobile feature in 2017 to help drive full-priced sales. The Seattle pilot had tremendous success at a select few JWN stores, so there is upside for sales in 2017 behind greater mobile commerce engagement.
- Nordstrom’s buy-online, pick-up-in-store program had a great 2016 with sales volume growth of 45%.
- The Canada business is only at $300 million in sales out of a $1 billion opportunity.
- JWN experienced 55% year-over-year growth this year in its Rewards member base to 7.8 million customers.
Overall, JWN management is guiding for 3 to 4% revenue growth this year. That is an appropriate multiyear compounded growth rate. In other words, Nordstrom should be able to grow revenues around 3% to 4% per year over the next several years.
That isn’t bad for a “going-out-business” department store. Especially considering that JWN stock trades at less than 15 times trailing earnings.
Bright Cash Flow Future
The end of the “big” spending era is also a significant boost to JWN cash flows. Despite margin compression and slower revenue growth, JWN posted exceptional cash flow metrics in 2016. Nordstrom’s operating cash flow was $1.6 billion, far above the trailing 5-year average of $1.2 billion. Meanwhile, free cash flow was $550 million, also significantly higher than the trailing 5-year average.
There are a couple things at play here.
To adjust to lower sales growth, JWN management is keeping inventories down. This is significantly boosting operating cash flows. Moreover, Nordstrom decreased capital expenditures by 20% year-over-year. Both of these cash flow tailwinds are here to stay. JWN management is committed to tight inventory control, and capex will equal 4% of sales over the next several years versus 5% historically.
All together, the company is positioned to see a strong boost in cash flows over the next five years.
Bottom Line on JWN Stock
Nordstrom sports a 3.3% dividend yield and only trades at 14.5 times trailing earnings. Revenue growth is positive, and will remain positive into the foreseeable future given robust e-commerce growth. Margins will stabilize in the near future, and earnings have a promising growth trajectory. Most importantly, the company is set to return more cash to shareholders than ever before.
The stock traded around $60 per share just 2 months ago. The story today is a lot stronger than it was two months ago. From an investor standpoint, this is a good set-up for significant share price appreciation over the next several months.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
