Can Nordstrom Inc. Buck the Downward Trend in Retail?

Last quarter,Nordstrom(NYSE: JWN) was one of the few department store companies to grow its earnings per share. To a large extent, this success has to do with its diversification away from full-line stores.

In this episode ofIndustry Focus: Consumer Goods, Vincent Shen is joined by senior contributor Adam Levine-Weinberg as they consider Nordstrom's key growth initiatives. The Nordstrom Rack off-price chain represents a particularly intriguing long-term growth driver.

A full transcript follows the video.

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This podcast was recorded on Feb. 28, 2017.

Vincent Shen: All right, let's turn our attention to Nordstrom, which seems to be the one company that was able to get a bit of a boost from its most recent report. It's obviously still running into issues like a lot of the department stores but some bright spots as well.

Adam Levine-Weinberg:Yeah. I think Nordstrom's results definitely showcase the difference between department stores and off-price stores. Nordstrom really is a mix between a department store and an off-price store. You have the famous Nordstrom full-line stores, which are known for great service, they are pretty expensive, generally speaking. Those have been running into trouble lately, despite maintaining a really great reputation. On the other hand, you have Nordstrom Rack, which is this fast-growing chain of off-price stores that's really driving all of Nordstrom's revenue growth. If you look in the fourth quarter, you had a comp sales decline at Nordstrom of 0.9%. But in the full-line stores themselves, not counting online, comp sales were actually down 6.8%. So, Nordstrom is seeing just as big declines in traffic at their full-line stores as other department stores, and in some cases even bigger. That 6.8% decline is not a one-time thing, that was basically their trend for the whole year.

On the other hand, you saw a 10.9% full year increase in off-price sales at Nordstrom, including both the Nordstrom Rack stores and their online off-price business. That drove a really substantial chunk of revenue growth. So, for the fourth quarter, adjusted EPS was up year over year to $1.27 from $1.17 a year earlier. So, that definitely set Nordstrom apart from a lot of its department store competitors, the earnings growth. On the other hand, for the full year, earnings were down with EPS of $3.04 compared to $3.32 a year earlier. Like a lot of the other department stores out there, Nordstrom is again expecting an EPS decline in 2017, along with roughly flat comp store sales, which will almost certainly be comprised of a decline in the full-line business, and another solid increase in the off-price Rack.

Shen:Sure. Let's take this to a 10,000 foot view. What do you think is the big takeaway or trend for this sector from this latest wave of results? I think we've heard a little bit about asset sales, better utilization of real estate, we've heard about a few store closures at J.C. Penney. What do you think is the big takeaway for listeners?

Levine-Weinberg:I think making the best use of real estate is really becoming an increasingly important focus for these companies. Store closures are going to be a big theme in 2017. Macy's, right now, is in the midstof closing more than 60 stores, which is part of a broader plan that they announced last August, under which they're going to close roughly 100 stores over the next several years. That's about 15% of their full-line store base, so it's a pretty significant chunk. Then, as I mentioned earlier, J.C. Penneyalso closing close to 15% of their store base, although in that case, it's mostly the smaller and the lower volume stores.

Nordstrom, on the other hand, is actually still growing. If you look last year, it did close one store over the summer, but it opened three full-line stores, two of them in Canada and one in the U.S. Then, it's opening another store in Canada this year, and only closing one store so far, from what it's announced. Aside from that, if you look at the Nordstrom Rack chain, it's expanding at a pretty rapid pace. Not as fast as it has been over the past four years, it'sopen nearly 100 new stores just in the past four years, which has almost doubled theNordstrom Rack store base. For2017, they have 16 Nordstrom Rack openings confirmed. That would be under 10% growth. They may add one to two more to thatin the next few months, but they're sort of running out of time, at this point, to announce morestore openings for this year. But over the next several years,I would expect Nordstrom Rack to continue at a high single-digit expansion pace,which is probably the right amountin terms of letting the store base mature and growin terms of profitability.

Shen: Among these three companies, or even broader for the sector,do you have a favorite,in terms of who has the brightest outlook, or who you're the most bullish for?

Levine-Weinberg:Yeah. Just on a pureretail basis, I think Nordstrom is by farin the best shape of these three companies. It'slargely because it is not as reliant on its full-line stores anymore. In fact, 2016 was in some ways a really big year forNordstrom because as bad as the full-linesales declines were for the company, now full-line sales are just under 50% of their total sales, just looking at the in store. Therest is made up of off-price sales withNordstrom Rack, and then online sales. So, with the online and off-priceparts of the business still growing, and full-lineprobably declining at a modest paceover the next several years, those growingparts of the business are going to become more and more important. So, I thinkNordstrom is going togradually pull out of this slump that'saffected the department store sector,simply because it's becoming less and less like atraditional department store in terms of its full business,when you look at it from a high level.

Now, itsoff-price business still needs some work. It's not nearly as profitable as a company likeTJX, which is the big bear in the sector.TJX got $33 billion in sales, and it's all off-price.Nordstrom Rack is still about $4.5 billion right now. Still a lot of room to run there, and definitely a lot of room to improvethe profitability of the business. But that's a really exciting long-term opportunity for investors.

Adam Levine-Weinberg owns shares of J.C. Penney, Macy's, and Nordstrom. Adam Levine-Weinberg has the following options: long January 2018 $60 calls on The TJX Companies and short January 2018 $90 calls on The TJX Companies. Vincent Shen has no position in any stocks mentioned. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.