Nordstrom (NYSE: JWN) has been struggling to find its niche in an increasingly competitive industry. Sales were down in both the Off-Price and the Full-Price businesses and gross profit deleveraged as well. Nordstrom is investing in cost-saving initiatives such as supply chain improvement and big data to improve its overall bottom line. The company, however, is struggling in the middle-class market. Luxury consumers would rather shop at the original luxury outlets since they are believed to provide better service, while working-class consumers would rather shop at discount stores since they provide better deals. Since November of last year, Nordstrom has shed nearly 50% of its value going from a high of ~$67 to now ~$33. This is a considerable drop and Nordstrom could still turn things around. And with Nordstrom’s high free cash flow yield of 10.79%, it shows Nordstrom does have a solid bottom line. Additionally, with a P/E ratio of only 11.26 Nordstrom is affordably priced. However, until more color is provided in the third quarter about the Anniversary Sale and the approaching holiday season it may be better to hold off investing.
In the second quarter, total sales were down 5.1%, Full-Price was down 6.5%, and Off-Price was down 1.9%. Gross profit decreased 50 basis points from occupancy deleverage and the SG&A rate increased by 26 basis points. However, the merchandise margin rate improved from Q1 and the company ended the quarter in a solid inventory position. Compared to the previous year, SG&A was down 4% due to expense savings. Expensive savings have reached $100 million, which is ahead of its annual goal of $150 million to $200 million. These expensive savings initiatives include realignment of stores, supply chain improvement, technological advancements, and lower discretionary spending.
These initiatives will contribute permanent reductions to the cost structure and will reduce long-term costs. In Q2, the EBIT margin of 5.7% deleveraged slightly by 47 basis points over last year, which shows an improvement from Q1. And for the rest of the year, Nordstrom expects a 2% sales decline, versus the previous outlook of 2% decline to flat growth. Sales for the second half are expected to be flat reflecting a 400-basis point improvement from the first half.
The Anniversary Sale reported soft sales this year due to merchandise selection issues. While there was a higher sell-through of anniversary products relative to last year, there was a lack of depth surrounding top brands and curation of top items. During the Anniversary Sale, sales from buy-online order-pickup more than doubled, with almost half coming from first-time users. My only issue with the Anniversary Sale was the length was far too long. The Anniversary Sale spanned nearly a month, from early access to regular sales, which may have caused people to lose interest. With the prolonged length of the sale, the company needed to spend more marketing dollars promoting the sale and more resources maintaining the sale, which hurt the bottom line.
And while the desire to please top-level customers is smart, the need for seven levels in a loyalty program is unnecessary. The loyalty program needs to be simplified in a way that not only pleases top-level consumers but also doesn’t disgruntle regular consumers.
Nordstrom derives 60% of its revenue from its Top 10 markets, the largest one being Los Angeles. Customers were offered 7x more options for next day pickup, which has contributed to sales from order pickup to triple in July. Additionally, the Buy Online Pick Up in store feature has been implemented across 16 stores in the L.A. area. The company is also working to increase traction for its online business in New York.
Nordstrom is struggling in the middle-class market. Luxury consumers do not want to shop for brands like Burberry at Nordstrom since they won’t get the same level of service as they would at the Burberry store, and working-class consumers don’t want to shop at Nordstrom since they believe they will get better deals elsewhere. Nordstrom simply brings nothing desirable to the table for any level of consumer. However, Nordstrom’s employment of tailors brings the customer service element that is desired by luxury consumers. If Nordstrom could implement more features like that, and effectively market them to that audience, then it could gain dominance in that sector. On the other hand, if Nordstrom introduces more discount merchandise maybe at a slightly lower quality in its Off-Price it could compete with retailers such as T.J. Maxx.
While Off-Price delivered solid profitability, earnings were down for the quarter. Nordstrom’s reduction in flash events significantly reduced online traffic to the Nordstrom Rack and Hautelook websites. However, the number of flash events will be increasing in the second half. Since the Off-Price business targets working-class consumers who have a variety of discount options (T.J. Maxx, Ross, Marshalls, etc.) it is important for Nordstrom to make itself competitive in their eyes. Especially since they are coming in at the higher end of the discount spectrum. The Off-Price business is extremely competitive and while flash sales may hurt the bottom line, they draw in consumers and increase the rate of repeat customers. Flash sales are a necessary part of customer acquisition, which could greatly benefit Nordstrom, considering the 6.5% sales drop for Off-Price.
Nordstrom’s online business is booming, considering the success of the Buy-Online Pick-Up In-Store feature. The joining of these two businesses not only leverages the digital platform but also brings attention to stores. Nordstrom’s consistent struggles with store sales could be lessened with this new feature which drives consumers into stores. Nordstrom now needs to leverage its storefronts to keep consumers in stores by using eye-catching displays, bright colors, etc. Once the consumer is in the store, the store needs to entice them to look around at what is actually in the store. Luckily, Nordstrom has listed store improvement as one of its expense-saving initiatives.
Nordstrom is no doubt struggling in the new era of competitive retail. While the e-commerce business is strong, store sales are failing to meet expectations. And while Nordstrom is investing in initiatives to improve its bottom line, the company first needs to drive consumers into stores. Since last November, the stock has shed more than half its value making it an attractive buy. Compared to Macy’s (NYSE:M), Nordstrom looks expensive, with a far higher P/E ratio and while Macy’s does have a slightly higher free cash flow yield, there is something to be said about Nordstrom’s potential for sales, specifically with its Off-Price business. These indicators make Nordstrom an attractive buy, however, until more color is provided on the Anniversary and holiday sale predictions I would hold off on investing.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.