Stock Project - Maisy L.

Analyst Report – Maisy Lam | 18 May 2015 | NYSE Ticker: JWN

Nordstrom, Inc. ! ! !!

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Price $75.15 1M Return -1.70%52 Week High $83.16 6M Return 3.10%52 Week Low $64.92 52 Wk Return 8.50%52 Wk Beta 0.79 YTD Return -4.90%

Common Shares Outstanding (M) 190.10Market Capitalization (M) 14310.90Cash and Equivalents (M) 769.00Total Debt (M) 3146.00Enterprise Value (M) 16687.90

Price (as of May 18, 2015 4:00 PM ET)

$75.15 12-Mon. Target Price

(+ 7.59%)

$81.32

Sector: Consumer Discretionary Industry: Retail Sub-industry: Department Store

Recommendation

Hold !

Sell !

Hold !

BUY

Key Stock Statistics (Source: Bloomberg, Company Filings) !

Share Price Performance in USD !

Current Capitalization in USD !

Investment Risk

Low

Medium

High

Valuation Model Summary


Nordstrom, Inc. ! ! !

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Executive Summary Nordstrom, Inc. is a fashion specialty retailer of clothing, shoes, cosmetics and accessories for men, women, and children. Nordstrom is widely recognized as a leader in the industry because of their liberal return policy and best-in-class customer service. Founded in 1901 as a Seattle-based retail shoe company, Nordstrom went public in 1971 with 10 stores and has since expanded into 292 stores across 38 U.S. States and Canada. Nordstrom plans to continue growing by opening 27 new Nordstrom Rack stores and 5 full-line stores in existing and new markets, in addition to expanding their ecommerce platforms. Primary Segments – Operation Overview Retail: The retail segment constitutes $13.11 billion, or 97% of Nordstrom’s sales. Within the broad retail segment, Nordstrom offers brick and mortar storefronts in addition to online shopping platforms. Nordstrom operates 115 full-line Nordstrom stores in the U.S., 167 discount Nordstrom Rack stores, two Canadian full-line stores, five Trunk Club showrooms, two Jeffrey boutiques, and one Last Chance clearance store. Full line stores offer a complete selection of private label and high-quality brand-name merchandise. Nordstrom Rack stores provide a more limited selection of private label and brand name merchandise at discounted prices. Trunk Club showrooms offer men a personalized experience with a stylist. Jeffrey boutiques feature luxury designer brands with a personal shopper. The Last Chance clearance store sells returned and overstocked merchandise from all other Nordstrom retail channels. Nordstrom’s ecommerce platform consists of Nordstrom.com, Nordstromrack.com, HauteLook, and Trunkclub.com. Nordstrom.com offers an extended selection of in-store full-line merchandise. Nordstromrack.com features a larger selection of discounted merchandise in addition to in-store Nordstrom Rack inventory. Hautelook specializes in limited time, daily sale events featuring brand name fashion, beauty, and home goods for up to 75% off retail price. Trunkclub.com provides a mailed, personalized wardrobe selection for men to fit their style, budget, and existing wardrobe. All of Nordstrom’s retail operations both in-store and online, are driven by a single principle: to provide best-in-class customer service and experience to each customer, every time. Nordstrom’s commitment to customer service has generated consistent sales growth over the past five years. Not only can customers return anything purchased through full-line stores, Nordstrom.com, Rack stores, or Nordstromrack.com at any full-line or Rack store, but Nordstrom.com and full-line stores offer free shipping and free returns on all items. Hautelook customers can return items at any Nordstrom Rack location and receive shopping credits for referring friends to shop on the website. Key business activities within the retail segment include the daily operations of physical storefronts, upkeep of ecommerce platforms, maintenance of over 156 trademarks, maintaining a liberal return policy, inventory management, as well as purchasing and receiving merchandise in coordination with seasonal and expected sales trends. Specifically, operations of physical storefronts include: in-store transactions, ordering, returns, and processing of online orders, in addition to alterations and personal stylists. Primary business activities for ecommerce platforms include the processing of orders, returns, and website maintenance.



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Credit: Nordstrom’s credit segment makes up $396 million, or 3% of sales and includes its own federal savings bank (FSB), Nordstrom FSB. Nordstrom FSB provides customers with the option of a Nordstrom retail credit card, two Nordstrom Visa credit cards, and/or a Nordstrom debit card, depending on credit qualification. In line with their tradition for outstanding customer service, each cardholder qualifies for the loyalty program that incentivizes increased customer spending and repeat visits. A key component of the loyalty program is the reward points and Nordstrom Notes. Two points are earned for every $1 dollar spent at any Nordstrom retail channel (with the exception of Jeffrey boutiques and Trunk Club), and Nordstrom Notes are awarded once a customer accumulates at least 2,000 rewards points. Nordstrom notes are credits that usually come in $20.00 increments and are valid towards any future purchases. Additional Nordstrom Rewards benefits include alteration benefits, Personal Triple Points Days and Bonus Points Events, as well as Early Access to special events like the Anniversary Sale. Business activities within the credit segment include opening new accounts, collecting on accounts, billing, and maintaining the rewards program. Industry Overview The retail industry is extremely competitive and mature, as most retailers have been in business for a number of decades and have established a loyal customer following. The retail industry is categorized into seven main types: department store, supermarkets, warehouse retailers, specialty retailers, e-tailer, convenience retailer, and discount retailer. Nordstrom is categorized as a department store because it offers a variety of consumer goods in different product categories. Nordstrom’s closest competitors are Bloomingdale’s (subsidiary of Macy’s), Neiman Marcus, and Saks Fifth Avenue, both of which are privately owned companies. While Bloomingdale’s and Neiman Marcus offer similar high end products in their stores and cater to a similar segment of the market, the cornerstone of Nordstrom’s competitive advantage is the truly unique shopping experience, superior customer service, and generous return policy, which positions well among its peers. There are no true competitors for Nordstrom that are publically traded. The companies that come closest and are publically traded are Macy’s, Dillard’s, Gap, and Target. The customer experience offered at Macy’s pales in comparison to Nordstrom because customers usually approach sales associates at Macy’s whereas customers are approached by sales associates at Nordstrom. Dillard’s typically anchors itself within suburban communities, compared to Nordstrom locations that are centered on the coasts, but also around the country. Gap’s business model is targeted towards different market segments with product offerings that are lower priced. Nordstrom targets a spectrum of high end to lower end market segments through different price points associated with product offerings. Target doesn’t focus on the fashion segment and its designer partnerships sacrifice quality over quantity. Nordstrom on the other hand, focuses solely on fashion and offers exclusive designer partnerships of quality to customers.



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Economic Environment Consumer Movement towards Ecommerce: E-commerce has gained significant momentum within the retail industry over the past decade. The technological age has provided customers with more convenient platforms to purchase goods without entering physical storefronts. Recently, companies such as Barnes & Nobles, JC Penny, Borders, Aeropostale, have announced retail store closures, exemplifying the consumer trend of moving away from brick and mortar stores and into online shopping. Experts indicate that e-commerce will continue to grow and become a larger percentage of overall sales within the retail industry. The growing shift towards e-commerce platforms poses as a potential threat to Nordstrom’s current and future storefronts. As consumers become more and more intertwined with technology, retail sales via e-commerce will become a more appealing option, where convenience does not have to sacrifice quality. Economic Sensitivity: For Nordstrom, high consumer foot traffic is integral to in-store sales, as most locations are located in shopping malls. Nordstrom is an anchor tenant in shopping centers where the company has a large storefront. If there is a substantial decline in mall traffic, it could negatively impact the company’s ability to generate sales in existing and new stores. If fewer consumers are vising physical storefronts, it is possible for the company’s intended growth plans to fail and adversely affect the financial condition of the company. In addition to high foot traffic, Nordstrom depends on its ability to remain competitive in value, quality, price, fashion forwardness, convenience, and consumer shopping experience. If Nordstrom fails to match current and future customer needs, the company will lose market share and relativity with its consumer base. Anticipating consumer preferences requires Nordstrom to maintain adequate inventory. Too much inventory, and the company will have to sell at a lower margin. Too little inventory, the company may lose out on potential sales and damage existing relationships with customers. Competitive Advantages Customer Service: The Nordstrom brand is synonymous with excellent customer service. From employee training to everyday customer interactions, the Nordstrom culture is centered on providing best-in-class service every time to give the customer the best experience possible. Nordstrom does not have a formal protocol for customer situations. Employees are instructed to use their best judgment to address situations with customer satisfaction as the highest priority. The company’s core business practices are extremely effective at promoting the Nordstrom experience, making the company a highly respected brand with a loyal customer following. Return Policy: Nordstrom has a return policy like no other retailer, as it does not have a formal return policy. If a customer is unsatisfied with a product, they can return it for whatever reason, no questions asked. In addition to having an unlimited timeline for returns, customers may receive their refund in whatever tender they please. The only exception to the return policy is purchases made at Nordstrom Rack, Nordstromrack.com, and Hautelook, all of which have a 90-day return policy. To date, there is not another competitor in the market that offers a return



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policy that caters specifically to achieving customer satisfaction even if it means losing the original sale. Nordstrom believes that taking care of the customers through free returns and exchanges in stores or online will perpetuate a good company reputation that in turn with drive repeated business. Investment Summary Growth/Expansion: Historically, Nordstrom has opened up one additional store per year. Recently, however, Nordstrom has been growing their Nordstrom Rack storefronts in the United States, expanding into the Canadian and Puerto Rican market, and diversifying into new e-commerce platforms. The company plans to open two Canadian full-line stores, three U.S. full-line stores, and 27 additional Nordstrom Rack stores in 2015. 2014 marked a groundbreaking year of growth for Nordstrom as the company launched Nordstromrack.com to capitalize on the success of discounted Nordstrom Rack stores. Nordstromrack.com allows Nordstrom to reach customers with lower price points and provides the convenience of purchasing discounted Nordstrom goods in areas that do not currently have physical storefronts. 2014 also brought forth the expansion of Nordstrom Rack stores in the U.S. and the Nordstrom brand into Canada. The new openings of Nordstrom Rack locations are primarily centered along the coasts and in states that do not currently have a full-line store presence. The growth of Nordstrom Rack has strongly increased sales numbers year over year. In terms of Nordstrom Canada, the company has plans to build and develop a total of six locations by 2017. Preliminary reports indicate that Nordstrom Canada is exceeding company expectations. The outlook on the remainder of the expansion into the Canadian market is promising, but will require careful observation in hopes that Nordstrom Canada does not end up in costly failure like Target Canada. Strategic Acquisitions and Partnerships: In 2014, Nordstrom acquired Trunk Club, a personal stylist clothing service catered towards men. The acquisition cost the company $350 million dollars, but added four showrooms, with Nordstrom opening up one additional showroom. The acquisition was anticipated to increase retail selling, general, and administrative expenses, reducing earnings. However, the acquisition is anticipated to contribute substantially to future company sales growth. The acquisition of Trunk Club will add value to shareholders because it specifically targets the male apparel portion of the larger apparel business. Trunk Club customers are assigned a personal stylist and the option of choosing between casual, business, or formal attire within their respective price points. Customers can either visit one of the five physical storefronts for an individualized in-person appointment, or have items selected by a stylist according customer preferences and shipped to the consumer’s home. The home delivery option allows customers to try on the clothes in the comfort of their homes and decide which items to keep or return within 10 days. Nordstrom also holds partnerships with well-known brands that have a strong preexisting consumer base. In 2012, Nordstrom partnered with Topshop, a British fast-fashion chain, and created specialty in-store Topshop boutiques. In 2015, Nordstrom announced a partnership with Madewell, a women’s specialty clothing store known for denim and high quality garments.



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Nordstrom’s partnerships demonstrate the company’s ability to identify trends in the market in order to further increase in store and online traffic. A number of partnerships such as Nike and Dylan’s Candy Bar have resulted in limited-time, specialty pop-in boutiques. These pop-in boutiques offer company exclusive merchandise that strongly contributes to the unique Nordstrom in-store experience. By offering brands that have a loyal customer following, Nordstrom is more likely to attract clientele that may have found previous Nordstrom brand offerings unappealing. Adding additional brands will add value to the company because brand loyal customers will begin to associate the Nordstrom brand with brands they already like, increasing the chances of consumers becoming Nordstrom customers. The partnerships are expanding into more trendy styles and targeting a younger generation of consumers, specifically, millennials into Nordstrom stores and subsequently, the Nordstrom brand. Recommendation The recommendation on Nordstrom’s stock is a Hold with a twelve-month target price of $81.32. The market is pricing in the company’s growth opportunities through the Discounted Cash Flow (DCF) and Market Value Added Models (MVA), but Nordstrom is using costly equity financing in order to finance the growth operations, as shown through the Dividend Discount (DDM) and Residual Income Model (RIM), decreasing value to its shareholders. Nordstrom is currently 82% equity financed and 18% debt financed. Even though sales have increased year over year, Nordstrom is not dispersing the additional retained earnings back to its shareholders. Rather, Nordstrom is maintaining a relatively low growth dividend payment and using the additional free cash flow to reinvest back into the business. The current stock price is taking into consideration the company’s positive growth opportunity in addition to costly equity financing, resulting in a stagnated stock price. The stock price is expected to remain unchanged unless Nordstrom rethinks its capital structure to incorporate a larger percentage of less costly debt financing.

Financial Analysis Revenue: Nordstrom has experienced positive revenue growth over the past five years. Fiscal years 2011, 2012, and 2013 showed a double-digit growth in revenue from the previous years. However, revenue growth has decreased to single digit percentages in fiscal years 2014 and 2015. Notably, Nordstrom’s expansion plans are expected to increase the company growth rate by 7-9% in the next year.

Fiscal Year 2011 2012 2013 2014 2015 2016 (Est.)Sales Revenue (M) $9,700 $10,877 $12,134 $12,540 $13,506 $14,721.54% Change 12.44% 12.13% 11.56% 3.35% 7.70% 9.00%

Recommended Price

$76.89

12-Mo. Target Price

$81.32 !!

Percent Change

+5.76%



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Sales Growth: Although Nordstrom is growing their Nordstrom Rack brand, expanding into the Canadian market, and accelerating their e-commerce platforms, the majority of sales growth is still driven by same store sales, which accounts for about 60% of the sales growth year over year. This metric demonstrates the strength of Nordstrom’s core business operations, as they are not reliant on the opening of new stores to fuel revenue growth. New stores typically take a few years to reach the average sales levels of mature stores, but currently account for about 40% of the company’s overall sales growth.

Dividends per Share: Dividends paid to Nordstrom shareholders have grown by 15.6% on average year over year for the past five years. However in fiscal years 2014 and 2015, the dividend growth decreased significantly to just about 10.5%. The decrease in dividend growth can be attributed to Nordstrom retaining much of their earnings to finance the growth of the business. Earnings per Share: Earnings per share (EPS) have increased for the past five years. In 2013, Nordstrom’s Board of Directors approved a stock repurchase program for up to $800 million in outstanding common stock through March 1, 2015. In September 2014, the Board of Directors issued a second stock repurchase program of $1 billion in outstanding common stock in addition to the previous repurchase program. The second repurchase program is authorized through March 1, 2016. As of fiscal year 2015, the company repurchased 32 million shares for $1.075 billion. EPS is therefore increasing because the number of shares outstanding has decreased by a substantial amount.

Profit Margin: Nordstrom has averaged a profit margin of 5.97 over the past five years. However, there is no significant growth in profit margin year over year. Rather, profit margin has steadily declined over the past 5 years. According to Nordstrom’s accounting principles, their cost of sales includes buying and occupancy costs. Buying costs includes compensation and incurred costs by product development and merchandising groups. Occupancy costs include rent, depreciation, property taxes, and facility operating costs of corporate, distribution, and retail operations. Although Nordstrom is experiencing increased revenue growth, their cost of sales and operating leases are increasing each year as well. The increase in cost of sales and operating leases can be primarily attributed to the increase in occupancy costs associated with the growth

Fiscal Year 2011 2012 2013 2014 2015Sales Growth (in %) 12.44% 12.13% 11.56% 3.35% 7.70%Same Store Sales 8.10% 7.20% 7.30% 2.50% 4.00%Sales Growth from Same Store Sales 65.12% 59.34% 63.17% 74.72% 51.93%Sales Growth from New Store Sales 34.88% 40.66% 36.83% 25.28% 48.07%

Fiscal Year 2011 2012 2013 2014 2015 2016 (Est.)Dividends per Share $0.76 $0.92 $1.08 $1.20 $1.32 $1.41Earnings per Share $2.75 $3.23 $3.56 $3.71 $3.76 $4.22



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plans of the business, ultimately decreasing Nordstrom’s net earnings. As net sales continues to increase with a smaller net income, the ratio results in a lower profit margin.

Return on Common Equity: Nordstrom’s return on equity (ROE) over the past five years has wavered around 35.02. However, since fiscal year 2012, ROE has declined significantly, indicating a cause for concern. As noted in the profit margin section, Nordstrom has incurred an increased amount of occupancy costs to support the growing number of facilities required by the company to carry out operations, decreasing net income. Because Nordstrom is currently using costly equity capital to finance their growth, but generating less return and decreasing shareholder value, it makes sense as to why the company is repurchasing shares. This may indicate a shift in the capital structure of the business where Nordstrom is trying to increase value to its shareholders. Free Cash Flow: Nordstrom has a history of generating positive free cash flows, indicating the strength of Nordstrom’s core business. However, the free cash flow of the firm has decreased in the past fiscal years. The decrease in free cash flow can be attributed to the significant increase in capital expenditures. The increase in capital expenditures indicates that the company is using its available cash to finance expansion plans. As the company continues to grow, its capital expenditures will continue to increase, but their expansion is expected to generate positive free cash flows for the foreseeable future.

Weighted Average Cost of Capital: Nordstrom’s current weighted average cost of capital is 7.2%, with a required return on stock of 8.5%, and a cost of debt of 1.8%. Nordstrom’s cost of capital is much higher than it should be because Nordstrom’s capital structure is primarily equity driven. Since equity is a more expensive financing option, Nordstrom should reallocate their capital structure to encompass more debt financing. Shareholder value is currently depleting because Nordstrom is using the high cost of equity capital to support current and future plans of growth. Valuation Valuation Method: The target price was determined by a simple average across the DDM, DCF, RIM, and MVA models. The 12-month target price accounted for the company’s expansion plans and the high cost of capital.

Fiscal Year 2011 2012 2013 2014 2015Profit Margin 6.32 6.28 6.06 5.85 5.33Cost of Sales (M) $5,897 $6,592 $7,432 $7,737 $8,406Operating Leases (M) $1,031 $1,063 $1,619 $1,995 $2,318

Fiscal Year 2011 2012 2013 2014 2015 2016 (Est.)Free Cash Flow (M) $778.00 $666.00 $597.00 $517.00 $359.00 $518.69Capital Expenditures (M) $399.00 $511.00 $513.00 $803.00 $861.00 $1,200.00



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DDM: The DDM model generated an intrinsic value of $39.88 for the 12-month target price. The value generated from the DDM illustrates the effects of Nordstrom’s decision to retain the majority of their earnings to reinvest back into the business. As a result, the company withholds paying a larger dividend, as shown by the low dividend growth year after year. DCF: After accounting for growth, and using a WACC of 7.224%, the free cash flows of the firm are expected to increase on par with anticipated sales growth. However, in addition to increased free cash flows due to sales growth, capital expenditures of the firm are expected to increase in the near future to support expansion plans. The value of operations was calculated to be $21.7 billion and the value of equity at $18.6 billion, resulting in an intrinsic price of $97.90 for the 12-month target price. RIM: The residual income model generated a low intrinsic value of $53.93 for the 12-month target price. The residual income model exposes the negative impact of Nordstrom choice to finance growth through free cash flows rather than redistributing earnings back to shareholders or taking on leverage as a means of financing. MVA: An intrinsic value of $133.78 for the 12-month target price was generated from the market value added model. The model indicates that Nordstrom’s core operations are able to meet the expected returns on invested capital and exceed the WACC, increasing Nordstrom’s market value. Continued expansion will in return, increase the company’s value. Market Multiples: Among publically traded companies, Nordstrom does not have a true competitor in the market. Market multiples are thus not an appropriate valuation method when assessing the target price for Nordstrom. The closest competitors in the publically traded market are Macy’s, Dillard’s, Target, and Gap. Macy’s was assigned a 45% weight, Dillard’s a 25% weight, Gap a 15% weight, and Target 15% weight. The market multiple valuation generated a market price of $53.82. Market multiples used in the analysis include: P/B, P/Sales, P/EPS, P/FCF, and P/EBIDA. Conclusion: The DDM, DCF, RIM, and MVAM models generated a 12-month target price of $39.88, $97.70, $53.93, and $133.78, respectively. Equal weights were applied to all models, and resulted in a current target price of $76.89 and $81.32 as the 12-month target price. Nordstrom is

P0 P1DDM $38.05 $39.88DCF $92.55 $97.70RIM $51.01 $53.93MVA $125.93 $133.78Simple Average $76.89 $81.32

Market Multiples $53.82



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currently priced at $75.15, supporting the recommendation of holding the stock. The 12-month target price may increase or decrease depending on two specific criteria: changes in the capital structure and meeting anticipated growth. If Nordstrom reevaluates its capital structure to be more debt financed and or meets its expected growth targets, the stock price will increase. However, if the company continues to finance growth with expensive equity capital and or not meet their expected growth targets, the stock price will decrease. Investment Risk

Cost of Capital: Nordstrom operates under a high weighted average cost of capital. If Nordstrom continues to supplement growth aspirations with costly equity financing, negative effects could directly impact and decrease shareholder value. If Nordstrom does not alter its capital structure, the company places itself at risk of not meeting the required returns of shareholders. Canadian Expansion: Nordstrom is entering an untapped market in Canada with hopes of financial success. However, market peers like Target have recently experienced extreme financial and operational failure in the Canadian market. Although the Nordstrom Canada outlook is promising, Nordstrom does not have an established presence and will need to be monitored closely to measure progress. Consumers: The retail market is driven by the purchasing power of its consumers. During times of economic success, consumers have more disposable income and are more willing to spend excess income. However the opposite is also true during times of economic recession. Consumers are slowly starting to spend more in the retail industry, but consumption trends are extremely sensitive to the economic environment. !!!!!!!!!!!!!

Low MEDIUM High



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!Appendix I. Source: Bloomberg, Company Filings

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Appendix II. Source: Bloomberg, Company Filings

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Appendix II (Cont.) !

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Appendix II (Cont.)

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Stock Project - Maisy L.

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