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Nordstrom, Inc. (JWN): Will This Retailer Outgrow its Competition?

Rising expenses and shrinking margins

Nordstrom seems to be well aware of the weakness of its namesake stores, and is compensating with aggressive expansion of its Rack stores and e-commerce initiatives. However, these initiatives have been costly, with gross profit margin in its retail segment sliding from 37.6% to 37.1%. SG&A (sales, general and administrative) expenses rose 5.3% to $801 million, but decreased as a percentage of its top line.

Yet a comparison of Nordstrom’s climbing expenses, which are rising at a rate faster than both Macy’s and J.C. Penney, is troublesome, especially since its gross margin dropped from 39.7% to 39.1%, while operating margin slid from 10.4% to 10.0%. This indicates that its aggressive expansion could be causing costly operating inefficiencies.

In addition, I believe that Nordstrom’s current strategy of expanding its lower-margin off-price channels will cause margins to contract further throughout the year. Moreover, e-commerce is a higher margin business, but increased investments in expanding its online presence, along with its Fashion Rewards programs, will offset short-term gains until its online system has fully matured.

Learning from Macy’s

Macy’s, on the other hand, has been controlling costs more carefully, using conservative, steady cost-effective initiatives such as its “My Macy’s” localization strategy to grow sales traffic without aggressive store expansions. “My Macy’s,” which was initiated in 2008 by CEO Terry Lundgren, abandoned the department store’s traditional model of carrying similar product lines nationwide. Instead, Lundgren asked local store management to decide what products would best suit their customer base.

Lundgren also successfully launched individually branded boutiques in Macy’s, boosting the brand recognition of its higher profile and in-house brands, which increased its appeal to younger shoppers. J.C. Penney attempted to replicate this strategy but failed, due to Ron Johnson’s abandonment of limited-time sales.

Macy’s approach has kept its gross margin flat at 38.8%, but its operating margin rose from 6.4% to 6.8%, reflecting better operating efficiency and cost controls than Nordstrom. Macy’s has repeatedly emphasized its “three-pronged strategy for growth” – emphasizing localized merchandise, improved staff training, and the use of an “omnichannel” (coordinated effort of the Internet, brick-and-mortar locations and warehouses) to quickly reach the maximum amount of customers.

Compared to Macy’s disciplined focus on these three goals, Nordstrom’s lack of confidence in its own plans shows with its full-year same-store sales guidance of 3% to 5%, which it reduced from its prior estimate of 3.5% to 5.5%. Macy’s, on the other hand, reaffirmed its full-year same-store sales guidance of 3.5%.

The Foolish Bottom Line

In conclusion, Nordstrom is at a crossroads. While its margins are still stronger than Macy’s or J.C. Penney, its same-store sales are slowing and expenses are rising. If sales growth can continue outpacing expenses, then it won’t become a problem, but the weakness of its namesake full-line stores and its dependence on off-price store expansion to grow its top line is a cause for concern.

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