Investment Decisions - October 2017 - Part 3

Bought shares in Nordstrom (Ticker: JWN)

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I'm always keeping my eye on the luxury retail space looking for opportunities to jump in when a company is facing a lull. Even when they are on a down cycle, luxury retailers still manage to create tangible wealth, which to me shows how strong they are. So in the past month, Nordstrom entered my radar screen as there were some significant events that had taken place. I've owned Nordstrom previously and was able to make a bit of profit. 

So let's get to the 8 questions that I always ask when I'm evaluating a stock.

Question 1: What do they sell?

Here's the bio from Reuters:

"Nordstrom, Inc. is a fashion specialty retailer in the United States. The Company's segments include Retail and Credit. As of March 20, 2017, the Company operated 344 the United States stores located in 40 states as well as an e-commerce business. The Company also offers its customers a variety of payment products and services, including credit and debit cards. As of March 20, 2017, the Retail segment included its 117 Nordstrom-branded full-line stores in the United States and Nordstrom.com, 216 off-price Nordstrom Rack stores, five Canada full-line stores, Nordstromrack.com/HauteLook, seven Trunk Club clubhouses and TrunkClub.com, two Jeffrey boutiques and two clearance stores that operate under the name Last Chance. The Company, through Credit segment, allows its customers to access a range of payment products and services, including a Nordstrom-branded private label card, approximately two Nordstrom-branded Visa credit cards and a debit card for Nordstrom purchases."

Nordstrom's is a traditional department store that sells premium, exclusive apparel goods. They have developed a reputation for providing exceptional customer service.

 

Question 2: Who do they compete with?

Nordstrom competes with other luxury retailers such as Saks, Barney's in the US as well as Harry Rosen, Holt Renfrew, and Simons in Canada. The luxury retail space has become a very crowded segment. The company is very much a North American centric business. 

Question 3: Who buys their products and services?

The luxury retail segment has benefitted greatly from the global redistribution of wealth. The number of affluent people has grown dramatically over the last 20 years. The upper income demographic is looking for the nicer things in life.

Question 4: Will these people buy the company's product over and over again?

Nordstrom has 

Question 5: Do they make money?

Source: Valuentum Securities

Source: Valuentum Securities

The company has been generating very high levels of Economic Profit. The company's Return on Invested Capital has ranged in between 17 and 25 percent over the past 3 years compared to a cost of capital of 9 percent. The company's revenues have grown modestly in low single digits.

Question 6: What do they own and who do they owe other?

A quick look at the balance sheet shows Nordstrom's has sufficient cashflow and liquidity to meet its day-to-day operational requirements. The company has a relatively high debt level to its common equity which is a bit concerning however it is generating enough cashflow to handily cover its interest payments which is to see. The company has trace amounts of intangible assets so the quality of the company's capital is pretty strong. It's interesting to note that Nordstrom family are majority owners of the business. 

Question 7: What are the risks the business is facing?

Like other retailers, Nordstrom's stock price has been under pressure thanks to Amazon. Although there has been no signal by Amazon that the want to enter the luxury retail space, many analysts think it’s about time.

From my perspective I think luxury sector is somewhat shielded from Amazon. I think the bigger threat for Nordstrom is competition from its rivals like Saks, Harry Rosen, and Holt Renfrew as the space is quite saturated now.  Luxury brands have resisted selling through Amazon because of the fear of the loss of the exclusivity factor. Having said that, there has been some chatter that maybe Amazon could make a bid for Nordstrom to have that instant access to the luxury space. The fact the family is looking to sell is what I think is driving this thinking.

The recent purchase of Whole Foods was received as possibly Amazon signalling they want to enter the space as Whole Foods is considered a brand that appeals to upper income people. The big watch for me was to see if they keep the Whole Foods value proposition intact or are their intentions simply to leverage the stores, location, and distribution network for their overall market.

Well it seems we’ve got our first signal

What this tells me is that the Whole Foods as a luxury brand concept is done. They bought Whole Foods as a foray into grocery but not the high-end. If that is the case then they don’t’ seem to be in a hurry to enter the luxury space. That’s good news for luxury brands and retailers like Nordstrom so maybe the concept of Amazon buying Nordstrom may not have legs.

I think another risk is their Rack stores canibalizing their main stores by selling discounted goods. I was surprised to know they have over 200 Rack stores. We've seen this similar situation with Coach which went heavy into factory outlet stores and created a situation where they diluted their brand. It took a long time for the stock to recover. The common theme with luxury retail is when they try to down market and appeal to a broader demographic their brand gets diluted and when that happens it takes a long long time to get it back. Coach realized this and is only know getting its legs back. 

 

Question 8: Is the stock cheap?

Source: Valuentum Securities

Source: Valuentum Securities

Luxury stocks have had a pretty good run in the last few months. Nordstrom was in a similar space after the company announced it was looking to take the company private. however the stock dropped down to $40 when lenders wanted a 13 percent return on debt which was too high. I wouldn’t be surprised to see family try again and even entertain an offer to sell out.

On a discounted cashflow basis the intrinsic value comes in a range of $49 to $59 so the stock is trading at a discount right now. 

It’s a definite contrarian play to invest in retailers not named Amazon right now. The pounding of the table that Amazon will sell everything is quite deafening right now. However I came across an interesting line of thinking that says 

Just because Amazon disrupts a space doesn’t garrantee them the privilege of taking control of all the cashflows and profits that come with it. They still have to compete. They’ve tried in grocery, and mobile hardware and really have’t hit it out of the park.

When the stock went to $40 I thought there has to be a at least 20-30 percent upside surprise if it does what it keeps doing. So I decided to take the other side of the trade and open a small position and build up slowly.