Nordstrom Navigated Tough Environment Very Well; Seeking Partner for Credit Card Receivables

Nordstrom beat the high end of guidance by $0.02 (and consensus by $0.04) on a better-than- expected comp and expense leverage (which was encouraging to see given the magnitude of spending this year), offset by weaker gross margin. We are impressed to see sequential improvement across full-line, direct, and Rack, with regional presence (lower-than- average exposure to harsh-weather-prone areas) and execution the key drivers of the upside.

While the company gave up slight gross margin in light of the competitive landscape, we believe the company is evaluating pricing strategies in light of near-term industry headwinds, but with a balanced long-term view of the health of the business. Full-year guidance was maintained despite the beat, which in our view might prove conservative on the top line with some offsetting risk for gross margin pressure depending on the duration of the promotional environment. Lastly, the company announced it is exploring potential partnerships to monetize its $2 billion in credit card receivables and gain greater financial flexibility while maintaining strong control over the customer experience. In sum, the company performed solidly in the first quarter despite strong industry headwinds.

Nordstrom navigated a difficult environment with a 3.9% comp (6.4% at Rack), aided by its minimal exposure to harsh-weather-prone regions (34% of base versus 44% average).

Nordstrom saw a sequential-month improvement with April the best performer and February the worst. • While inventory per square foot is up 10.2%, this relates to strategic investment in pack-and-hold at Rack, an increase in well-performing categories, and the launch of Nordstrom Rack online.

Canadian entry is planned for September with the first store opening in Calgary; this could be a $1 billion sales opportunity over time, but market entry will cost $35 million in EBIT in 2014 ($0.11), compared with $14 million ($0.04) in 2013, and EBIT drag will grow over the next one to two years until Nordstrom is established in the market. The company lost roughly $8.8 million in the first quarter.

The company is exploring a possible partnership related to $2 billion in credit card receivables to gain greater financial flexibility while retaining control of the customer experience; the process could take 12-18 months to complete. If completed, it would not significantly affect headcount or operations. The proceeds would be subject to capital allocation methodology but could be used to pay down debt and accelerate share repurchase.