Nordstrom fires on all cylinders

By Robert Walberg

Cutting prices isn't the only way to win in the retail business.

Consider Nordstrom (JWN, news, msgs), which announced robust earnings Monday thanks to its firm pricing strategy. Quarterly sales rose 12% and earnings climbed 33%. Equally important, the company boosted its forecasts for the fourth quarter and for the full year.

The performance contrasts with Wal-Mart Stores (WMT, news, msgs), which has disappointed investors recently and heads into the holiday shopping season trying to win sales by aggressively discounting prices.

Nordstrom stock -- up nearly 50% from its July low -- could experience a brief and limited sell-on-the-news response. Yet investors still have plenty of reasons to ring the register.

Inventories under control

One reason Nordstrom hasn't had to cut prices to move merchandise is that investments in technology have helped it better manage inventory. Inventories in the third quarter were up 5.3%, or less than half the rate of sales growth. By contrast, specialty retailer Urban Outfitters (URBN, news, msgs) loaded up on products that it couldn't sell and was then forced to slash prices. By updating its technology and making careful decisions, Nordstrom has been able to hold firm, translating into higher margins and strong bottom-line growth.

Nordstrom also deserves credit for improving its merchandising mix. A couple of years ago, the company was struggling, especially in the women's department. Younger women in the 25-to-40 range were increasingly turning to specialty retailers such as bebe stores (BEBE, news, msgs) and Guess? (GES, news, msgs) for more fashion-forward offerings, while older customers were enticed by the casual yet stylish apparel at stores like Chico's (CHS, news, msgs) and Coldwater Creek (CWTR, news, msgs). Nordstrom added offerings such as high-end denim, and it's been smooth sailing ever since.

Another clear factor in Nordstrom's favor is that it targets higher-end customers. Such consumers are less likely to alter their spending habits due to concerns such as modestly higher gas prices. In fact, with incomes on the rise and the economy benefiting from near-full employment, Nordstrom is operating in the sweet spot of the retail sector. Of the other department stores, the only stock that has come close to matching Nordstrom since July is fellow high-ender Saks (SKS, news, msgs), with a gain of 43.8%.

Both Nordstrom and Saks are leading the group in terms of same-store sales growth. Last month, Nordstrom delivered same-store sales growth of 10.7% -- more than four points better than expected. Saks came in with growth of 9.2%. By comparison, J.C. Penney (JCP, news, msgs), Federated Department Stores (FD, news, msgs) and Dillard's (DDS, news, msgs) posted same-store sales growth in October of 8.1%, 7.7% and -0.5%, respectively. Though Nordstrom expects the pace of sales growth to moderate in the current quarter to the low single digits, the company continues to hit on all cylinders.

Therein lies management's biggest challenge: continuing to grow same-store sales at a rate at or above estimates despite increasingly difficult comparison periods. Failure to meet those rising targets will almost certainly lead to a reversal in the stock's recent advance, especially with Nordstrom trading at 19 times its most optimistic estimate for fiscal 2007.

But until there is evidence of a problem, there's no reason to shy away from Nordstrom stock. The company has performed at a very high level for nearly two straight years, and there's nothing to suggest that it will falter any time soon. Barring any missteps, the stock has upside to the $55 to $57 area over the next three to six months.

At the time of publication, Robert Walberg did not own or control shares of any companies mentioned in this article.