Filed Under:
Tickers in this Article: JWN, DDS, M, WMT, TGT
For investors looking to buy stock in a clothing retailer, it would normally be a no-brainer to consider stalwarts like Wal-Mart (NYSE: WMT), Target (NYSE: TGT), well-known dollar stores, or other discount merchandisers.

But things aren't normal, and they haven't been for years.

Since the economy just can't seem to shift into a higher gear, I'd avoid Wal-Mart and the other types of clothing outlets I just mentioned. Their sales come mainly from middle- and lower-income consumers, the people who have suffered most in the years since the financial crisis and who continue to see their spending power dwindle.

Rising costs, stagnant or shrinking wages, and lousy or non-existent benefits are squeezing these groups hard, Wal-Mart and other discounters could well be facing years of erosion in revenue and earnings growth rates.

At this point, for example, Wal-Mart's sales are growing at only about 3% a year, from around $406 billion in 2009 to just over $473 billion now. That's pretty anemic compared with 2004 through 2008, when sales rose at a healthy 7.9% clip. The way things are going, I wouldn't be surprised if annual sales and profits at Wal-Mart and a lot of other discounters stagnated completely or even began to contract.

In this economy, I'm much more optimistic about a far smaller but well-established and more specialized apparel outlet with more-profitable customers. At this company, sales have actually accelerated since the financial crisis, climbing almost 8% a year from about $8.6 billion in 2009 to nearly $12.5 billion currently. That's even better than the solid 6% growth rate of 2004 through 2008.

A key reason this company has been doing so much better is that it caters to higher-end customers who base their purchasing decisions mainly on quality, fashion and service -- not price. And they can shop that way because, well, they're generally better off than middle- and lower-income consumers. 

The company I'm referring to is Nordstrom (NYSE: JWN), which began as a shoe retailer in Seattle in 1901. Today, it positions itself as a provider of "affordable luxury" -- high quality without too much extravagance.

  
 Flickr/Nicholas Eckhart 
 The company currently has locations in 35 states, including 117 full-line stores and 132 smaller Nordstrom Rack outlets. 
The company currently has locations in 35 states, including 117 full-line stores and 132 smaller Nordstrom Rack outlets, which offer lower-priced clearance items. Besides name-brand men's and women's shoes and fashions, it offers name-brand cosmetics, accessories and children's apparel. Its main competitors include Macy's (NYSE: M), Saks Fifth Avenue and Dillard's (NYSE: DDS).

A number of measures suggest Nordstrom should outpace the pack in coming years. For instance, sales per square foot of store space, a key measure of efficiency in retail, is about $400 for Nordstrom, compared with just $173 for Macy's and $118 for Dillard's. At $350, only Saks Fifth Avenue's sales per square foot approach Nordstrom's.

A big reason for Nordstrom's superior efficiency is rapid inventory turnover, which helps minimize the need for markdowns to keep merchandise moving. Nordstrom turns over its inventory about six times a year -- much faster than most competitors. Macy's, for example, averages barely three inventory turns a year.

Nordstrom's margins clearly reflect its efficiency advantages. For instance, the trailing 12-month operating and net margins are about 11% and 6%, respectively, compared with just 3% and 0.4% for the department store industry as a whole. Return on equity (ROE), a measure of a firm's ability to generate profits on money invested in the company, is a whopping 40% at Nordstrom, compared with barely 2% for the overall industry.

  
 Flickr/DanielDerrick 
 Sales per square foot of store space, a key measure of efficiency in retail, is about $400 for Nordstrom, compared with just $173 for Macy's and $118 for Dillard's.  
Nordstrom also leads its industry by a large margin in return on assets (ROA), a measure of management's ability to earn a profit on a company's existing asset base. ROA is derived by dividing net income by total assets: For Nordstrom, that's $759 million divided by $8.1 billion, which equals 9.4% -- nearly 19 times the industry average of 0.5%.

Even though the company is at the top of its industry, the price-to-earnings (P/E) ratio for its stock -- just shy of 17-- isn't terribly elevated. Indeed, the industry average is a frighteningly high 156, and even the overall market is more richly valued with a P/E ratio of almost 19. 

Risks to Consider: Industry-beating inventory turnover and sales per square foot may be hard to maintain in the face of increasing competition. Saks Fifth Avenue, for example, is starting to emulate Nordstrom's affordable luxury business model, and Macy's has been looking to attract more high-end customers by upgrading its merchandise.

Action to Take --> Like much of the market, Nordstrom has been on an amazing run recently: JWN is about 18% this year and a jaw-dropping 540% during the past five years. At around $63, JWN is near its five-year high -- but I still consider it a "buy." Consensus estimates project earnings per share (EPS) will rise an average of 11.7% a year for the next five years, from a current $3.76 to about $6.50 in 2018. Assuming the P/E ratio stays where it is, JWN could pop nearly 75% in that time, to near $110.

comments powered by Disqus

Trading Center