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Nordstrom Stock Soars 16% Despite Mixed Earnings Report

Adam Levine-Weinberg, The Motley Fool

On Wednesday afternoon, Nordstrom (NYSE: JWN) reported a third consecutive quarter of slowing sales trends. This marked an abrupt turnaround from the solid growth it posted in the second and third quarters of fiscal 2018.

However, this sales slowdown was offset by significant progress on Nordstrom's cost-cutting initiatives. Furthermore, the upscale retailer continued to reduce its inventory, boosting cash flow and limiting the need for markdowns. With Nordstrom stock having already lost more than half of its value over the past year, investors viewed the quarterly results with relief, causing Nordstrom shares to rally 16% on Thursday.

JWN Chart

Nordstrom Stock Performance, data by YCharts.

The sales slump continues, but margin pressure eases

In the first quarter of fiscal 2019, Nordstrom's net sales declined 3.5%, with full-price sales down 5.1% and off-price sales down 0.6% year over year. Management blamed the weak sales results on unexpected headwinds from moving to an all-digital loyalty program, a reduction in digital marketing spending, and some merchandise assortment mistakes (particularly in the key women's apparel category).

This sharp sales decline caused significant margin erosion at Nordstrom in the first quarter. The company's operating margin fell to 2.3% from 4.4% a year earlier, causing earnings per share to plunge more than 50% year over year to $0.23.

Nordstrom fixed the issues with its loyalty program last quarter, resuming its former practice of mailing paper rewards certificates to members. It also began to ramp up its investments in digital marketing, again. However, these moves didn't stop the bleeding. Net sales tumbled 5.1% to $3.78 billion in the second quarter, with the rate of decline accelerating for both sides of Nordstrom's business. Full-price sales plummeted 6.5% and off-price sales fell 1.9%.

Nordstrom stock was able to shrug off this weak sales performance because the company's profit trajectory started to improve. The company reduced operating expenses 4% year over year due to various efficiency initiatives and lower performance-based pay. Meanwhile, good inventory management enabled Nordstrom to limit the gross margin impact of lower sales volume.

The entrance to a Nordstrom Rack store, with a full-line Nordstrom store in the background

Weak sales didn't dent Nordstrom's profit as much as expected last quarter. Image source: Nordstrom.

As a result, Nordstrom's operating margin slipped just 0.5 percentage points year over year to 5.7%. Earnings per share (EPS) declined to $0.90 from $0.95 a year earlier, beating the average analyst estimate of $0.75 by 20%.

Year-to-date cash flow results look even better

Cash flow got less attention in Nordstrom's earnings results, but better inventory management has allowed the company to increase operating cash flow this year, despite its lower reported earnings. Cash from operations rose to $692 million for the first half of fiscal 2019 from $594 million in the prior-year period. All of that increase came last quarter.

Free cash flow still declined to $304 million from $388 million in the first half of fiscal 2018, but that can be traced to a temporary surge in capital expenditures (capex) related to the two new full-line stores Nordstrom is opening this fall (and primarily its new Manhattan flagship location). Nordstrom plans to reduce capex significantly after this year.

The company also reported $26 million in "other" cash received from investing activities for the first half of the year. At least part of this cash inflow likely reflects asset sales related to some of Nordstrom's store closures.

Can Nordstrom turn its sales trajectory around?

A little over a year ago, Nordstrom laid out an ambitious plan to grow sales to $18 billion by fiscal 2022 while expanding its profit margin. In fiscal 2018, net sales reached $15.5 billion -- up 3.8% year over year, excluding the impact of an extra week in fiscal 2017. This seemed to put the company on track to achieve its five-year target -- and the solid growth powered strong gains for Nordstrom stock for most of 2018.

However, sales have plunged 4.3% so far in 2019. Nordstrom's $18 billion sales target already looks unrealistic -- but the company will need to achieve at least modest sales growth going forward in order to return to sustainable profit growth.

Nordstrom expects to report another sales decline for the third quarter. However, based on its guidance for a 2% full-year sales decline, Nordstrom is counting on a return to robust growth in the fourth quarter, powered by the late-October opening of its Manhattan flagship store. Given the size of the New York City market, that forecast may be realistic.

Keeping that growth going beyond the new store's first year will be more challenging, though. On the plus side, Nordstrom has a big off-price business, and that part of the retail industry has been growing quickly. It also has a vibrant e-commerce business that accounts for nearly a third of its sales, and its full-line stores tend to be well-located and well-maintained.

On the other hand, Nordstrom has been plagued by repeated execution mistakes in recent years. That's simply unacceptable in today's hyper-competitive retail environment. For the storied fashion giant to achieve its goals -- and for Nordstrom stock to keep rising -- the company must avoid self-inflicted setbacks in the coming years.

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

This article was originally published on Fool.com