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Morningstar | Narrow-Moat Nordstrom Begins to Implement Analyst Day Initiatives; Shares Modestly Overvalued

Narrow-moat Nordstrom posted strong second-quarter results prompting management to raise their full-year profit outlook. Sales are now expected to fall between $15.4 and $15.5 billion (up from $15.2 to $15.4 prior, and near our $16 billion estimate) while the earnings per share forecast was raised to $3.50-$3.65 (up from $3.35-$3.55). After incorporating these results, we expect revenue to grow around 3% (slightly above the updated outlook) and EPS around $3.57. As a result, we do not anticipate to materially alter our $53 fair value given that our long-term thesis is unchanged, incorporating sales growth through the further rollout of Nordstrom Rack stores, e-commerce penetration, and rewards program expansion (sales growth of 2% and operating margins of 6% on average over the next five years).

We are encouraged by Nordstrom's ability to continue to take market share given the year-to-date 0.1% average increase in department store sales versus Nordstrom's 2.4% fiscal year-to-date increase, supporting our thesis that Nordstrom has a brand intangible asset, which underlies our narrow moat rating. We believe the modest increase in merchandise margin, which supported gross margin expansion by 91 basis points (now 35%) is further evidence that the company has modest pricing power from its brand equity, driving the net sales increase of 7% in the period. Furthermore, slightly decreasing inventory levels highlight the success and synergies Nordstrom has cultivated between their full-price and off-price segments. These segments allow the firm to quickly turn inventory while not discounting strategic brands (now 45% of full price sales) which further strengthens their relationships with brand partners.

Finally, we see our long-term thesis playing out particularly in the loyalty program and e-commerce sales. Nordstrom continues to pivot to consumer demands, as indicated by digital sales growth of 23% (40% of anniversary sales were digital), something we expect will continue to be robust given the company's focus on the channel and its recent hire of Chief Technology Officer Ed Mesrobian. In the loyalty department, they currently have 10 million rewards customers (up 30% year over year) who contribute $9 billion in sales (per analyst day in July), a factor which we see continuing to add to their best-in-class service model that underpins our narrow moat rating for the firm.