Better Buy: Nordstrom vs. Macy’s

The last few years have been tough for the retail industry. After retail stocks boomed in the years immediately following the 2007-2009 recession, the last three years have seen them, as measured by the SPDR S&P Retail ETF (NYSEMKT: XRT), trail the broader market.

However, whether because of the tax act passed late last year, or something else, consumers are starting to shop again. And that is starting to benefit traditional department stores like Nordstrom (NYSE: JWN) and Macy's (NYSE: M). Both retailers have posted growth in comparable-store sales and have a strategy to increase their business online, where more people are choosing to shop.

Let's review where these companies stand to find out which is the better buy.

Nordstrom has all the bases covered

The challenge for retailers is figuring out how to blend the in-store shopping experience with online and mobile. Nordstrom is one retailer that seems to have this down pat.

Since fiscal 2010, online sales have increased from 8% of total sales to 26% as of the end of fiscal 2017. What's most impressive is that 9 million out of its 33 million active customers over the last year have shopped using multiple channels that Nordstrom offers, which reveals management's foresight on customers' shopping preferences.

Nordstrom has a sophisticated inventory tracking system that allows a customer to order from anywhere -- such as home, mobile, or a store -- and have that order fulfilled and delivered from anywhere Nordstrom holds inventory, whether it's a store, vendor, or fulfillment center. This is helping Nordstrom move inventory a little faster, as indicated by an uptick in its inventory turnover ratio in 2017 to 4.67, up from 4.53 the year before. The faster inventory moves out the door, the better management can control costs by not having to discount slow-selling merchandise.

Metric TTM as of Q1 2018 2017 2016 2015 2014
Net sales $15,334 $15,137 $14,498 $14,095 $13,110
Operating margin 6.1% 6.1% 5.6% 7.8% 10.1%
Earnings per share $2.73 $2.59 $2.02 $3.15 $3.72

Management is continuing to think of innovative ways to enhance digital shopping. It just acquired BevyUp, an app that makes online shopping feel less lonely by linking up two people to shop together online; they can communicate through various tools like text messaging and video chat. It's a clever idea that will no doubt maintain Nordstrom's progress with e-commerce, which has already been going very well.

Weighing down sales growth lately have been Nordstrom's full-price stores. But sales at its off-price stores grew 9.9% last year and they have been the company's best performers. Management plans to continue expanding its base of 243 Rack stores, which help attract younger shoppers to the brand.

As the above chart shows, while the top line has grown consistently in recent years, the bottom line has been weighed down by investments in off-price stores and digital channels. Operating margin declined from over 10% five years ago to as low as 5.6% in fiscal 2016. Last year saw operating margin expand to 6.1%, which could be the beginning of further margin improvement.

Management is beginning a new phase of its strategy to deliver better earnings growth by expanding operating margins back toward double digits. If it succeeds in expanding margins, earnings per share could grow at a double-digit rate over the next five years -- which, coupled with a modest P/E ratio of 14 times expected earnings, would very likely lead to nice share-price gains.

Macy's is turning a corner

The story at Macy's has been completely opposite from Nordstrom. While Nordstrom has been steadily improving its online shopping experience for several years, fine-tuning its inventory management, and expanding off-price stores to drive growth, Macy's has been reducing its store count as it has struggled with weak traffic trends.

One problem for Macy's is that it's built an image of a promotional-sales brand, which has a rocky history in retail, particularly with department stores. In contrast, Nordstrom runs a very limited number of sales events during the year, and it partners with fashion brands at every point of the price spectrum.

Despite these issues, Macy's successfully got its business going in the right direction last year as management focused on making improvements across physical stores and e-commerce. After reporting a comparable-store sales decline of 2.2% in 2017, Macy's had positive 3.9% comps for the first quarter of 2018. Management expects this trend to continue for the full year.

Metric TTM as of Q1 2018 2017 2016 2015 2014
Net sales $25,028 $24,837 $25,778 $27,079 $28,105
Operating margin 7.3% 7.3% 5.1% 7.5% 10%
Earnings per share $3.96 $3.77* $1.99 $3.22 $4.22

Additionally, as Macy's has closed many stores to improve growth, it's been able to cash in on its prime real estate locations, generating $1.3 billion in cash from real estate sales over the last three years. These proceeds have been used to pay down its high debt load, which has decreased from $7.2 billion in February 2014 to $5.8 billion as of May 2018.

Which is the better buy?

Macy's appears to be turning the corner, but I still see it in a weaker position than Nordstrom. That's not only because of Macy's debt, but also because of Nordstrom's much superior position in e-commerce -- where future retail battles will be won and lost.

While Macy's hasn't been able to grow the top line (which has hovered around $25 billion in recent years), Nordstrom has grown net sales 24% cumulatively over the last five years, which clearly reflects Nordstrom's more dynamic strategy in winning customers at every point of sale, both in-store and online.

Nordstrom's stock is more expensive than Macy's, trading for 14 times forward earnings, compared to Macy's forward P/E of 11. I believe this reflects Macy's lack of top-line growth, higher debt load, and inconsistent operating history. For investors looking for the less risky stock that can still deliver long-term growth on the top and bottom lines, I think Nordstrom is the better buy.

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John Ballard has no position in any of the stocks mentioned. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.