Without a doubt, department stores have been disrupted by e-commerce. Yet Nordstrom (NYSE:) has managed to continue growing, despite e-commerce threats.
However, growth has typically been in the low single digits the past several years. Although the stock is well off its all-time highs, there isn’t enough evidence to suggest that Nordstrom will be able to outperform an index fund in the long run. I am neutral on Nordstrom stock.
Nordstrom is a fashion retailer that sells apparel, shoes, accessories, beauty, and home goods. The company operates 358 stores in the U.S. and Canada. Nordstrom saw a big hit to its top and bottom lines during COVID-19, as sales plummeted 31%, with a net loss of $690 million for the period ending on January 2021. However, sales are recovering, with the second quarter results being only 6% shy of Q2 2019. (See Nordstrom stock charts on TipRanks)
Large retailers such as Nordstrom need to carry a lot of inventory in order to satisfy customer demand. Storing billions of dollars worth of inventory can be quite expensive. Therefore, the speed at which a company can move inventory and convert it into cash is very important in predicting success. To measure Nordstrom’s efficiency, we will use the cash conversion cycle which shows how many days it takes to convert inventory into cash. It is calculated as follows:
CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
It takes 76 days for Nordstrom to move inventory, which is relatively good compared to its retail competitors. In addition, the company is able to convert its inventory into cash in 14 days. This is also good compared to its competitors.
Growth Catalysts & Risks
It is unlikely that the rise of e-commerce will put an end to all brick-and-mortar retail stores. Instead, it will simply force them to improve their operations and customer experience. Nordstrom appears to be taking the right steps towards improving its operations. The company now expects about half of its revenue to come from digital sales channels. Nordstrom is also leveraging its physical locations to offer pick-ups. In fact, in-store pickups increased 52% compared to 2019.
Furthermore, the company is working on improving customer experiences by opening up smaller stores (known as Nordstrom Local) with a focus on services. Some of the services offered include personal stylists, manicures, pickup for e-commerce, returns, alterations, gift wrapping, shoe repairs, etc. This shows that Nordstrom is aware of how to take on e-commerce and is taking the right steps in its attempts. So far, the strategy appears to show promise. On average, Nordstrom Local customers spend 2.5 times more the amount of a regular Nordstrom customer.
However, it is important to remember that Nordstrom is highly leveraged, with a debt to equity ratio of 1,756% and debt to EBITDA of 3.7 times. Given that Nordstrom is sensitive to business cycles and that uncertainties about COVID-19 continue to linger, such a debt load is not very comforting. This is especially true since profit margins are only in the low single digits during times of economic booms. Nonetheless, management has highlighted that it plans on reducing leverage to 2.5 times debt to EBITDA, which should give investors a little more comfort.
Wall Street’s Take
Turning to Wall Street, Nordstrom has a Hold consensus rating, based on 2 Buys, 3 Holds, and 3 Sells assigned in the last three months. The average Nordstrom price target of $37.13 implies 37.1% upside potential.
Although Nordstrom’s stock price has taken enough of a beating in the past several years to potentially label it a value stock, there are better opportunities elsewhere. With single-digit profit margins during good times and a high leverage ratio, the stock is unlikely to outperform an index fund in the long run.
Disclosure: At the time of publication, Stock Bros Research did not have a position in any of the securities mentioned in this article.
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