Neiman Marcus Is Running Out of Options

Privately held luxury department store chain Neiman Marcus picked a bad time for a major operational misstep.

Even well-managed competitors in the luxury market like Nordstrom (NYSE: JWN) have faced severe headwinds in the past year. Meanwhile, Neiman Marcus sabotaged its sales and profitability through the botched rollout of a new inventory management system last summer.

To make matters worse, Neiman Marcus has nearly $5 billion in outstanding debt, due to an ill-advised 2013 leveraged buyout. As a result, Neiman Marcus could be forced into filing for bankruptcy in the next year or two. The only way out may be to sell the company. Canadian retailer Hudson's Bay (TSX: HBC) appears to be a potential buyer.

Tough conditions and a big tactical blunder

Few (if any) department stores are posting good results these days. Nordstrom has been one of the best-performing companies in the department sector in recent years, yet it hasn't been able to overcome the impact of weak mall traffic. During the 2016 fiscal year, comp sales declined 0.4% on a companywide basis at Nordstrom.

Sales slumped in Nordstrom's full-line stores last year. Image source: Nordstrom.

This figure lumps Nordstrom's department store business in with its faster-growing off-price operations. Looking just at the full-price segment, Nordstrom saw a 2.7% decrease in comp sales last year, consisting of a 6.4% drop in stores offset by 9.5% growth online.

Thus, even with good execution, Neiman Marcus would probably be suffering from falling sales and earnings. However, Neiman Marcus added to its woes last year by rolling out a new inventory management system with significant glitches.

Since August, Neiman Marcus hasn't been able to accurately track what merchandise it has in its stores, according to a January New York Post report. The inventory management system migration also negatively impacted the website's usability. As a result, management estimates that Neiman Marcus lost at least $55 million to $65 million in sales over the past two quarters.

Another big revenue and earnings decline

On Tuesday, Neiman Marcus reported that revenue and earnings declined sharply again last quarter (the second quarter of its 2017 fiscal year). Sales fell 6.1% year over year on a 6.8% decline in comparable-store sales. Excluding a $154 million impairment charge, operating income plunged more than 60%, from $85 million to just $33 million.

Neiman Marcus posted a big loss last quarter. Image source: Neiman Marcus.

This was a dreadful result for the holiday quarter, which is usually the most profitable time of the year for retailers like Neiman Marcus. For the first half of fiscal 2017, adjusted operating income was just $59 million, compared to $140 million a year earlier.

Neiman Marcus is incurring more than $70 million of interest expense each quarter. Clearly, it is not making nearly enough money to sustain its massive debt load. Thus, it's no wonder that the company is looking to restructure its debt while also considering "strategic alternatives" such as selling the company.

Hudson's Bay is interested. Is it serious?

With its far-fetched push to acquire Macy's running into too much resistance, Hudson's Bay is now looking at Neiman Marcus as another option for growing its retail empire. Hudson's Bay already owns the high-end Saks Fifth Avenue and Lord & Taylor chains. Thus, acquiring Neiman Marcus would make it a real powerhouse in the U.S. luxury retail market.

As always, the real question is whether Hudson's Bay -- with its market cap of less than $2 billion -- can afford to make a deal happen. The company wants to buy Neiman Marcus without assuming its nearly $5 billion of debt, according to The Wall Street Journal.

It might be hard to pull off this kind of deal without protracted litigation from angry Neiman Marcus bondholders who would be forced to write down the value of their holdings. Filing for bankruptcy would be one way to overcome these objections, but it's obviously not an attractive prospect.

Time for consolidation

Consolidation would be good for the luxury department store sector, including both Hudson's Bay and Nordstrom. As I noted last month, there are too many luxury chains today relative to the amount of luxury demand in the United States.

Neiman Marcus has a strong brand, so it's likely to survive in some form going forward. The current stand-alone company doesn't seem sustainable, though. Joining a larger department store company like Hudson's Bay and closing some lower-performing stores could be the best option left for Neiman Marcus.

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Adam Levine-Weinberg owns shares of Macy's and Nordstrom. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.