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Nordstrom: Sales increase only part of the solution

Sunday - 5/13/2012, 2:10pm  ET

While most things retail are still basking in the glow of one of the best consumer confidence reports in years, Nordstrom is taking a relative whooping. “But net income was up in the recently announced first quarter, and direct sales have shot through the roof,” proponents argue. And they’d be right, but boosting sales is only part of the equation – the other is managing expenses. And here is where debt-laden Nordstrom – the specialty retailer has by far the highest debt-to-equity ratio in the industry – dropped the ball. And worse,  according to company management, getting a handle on expenses isn’t expected to happen anytime soon.

Consumer Confidence

The positive impact the recent decline in gas prices has had on reigning in inflation fears – not to mention giving consumers a warm and fuzzy feeling all over – is certainly part of the reason confidence is the highest it’s been in four years. But the gas prices only tell part of the story. This is the ninth straight month consumers have felt better about the economy and the prospects for continued growth – that kind of consistent strength is impressive and goes beyond gas prices. For Nordstrom shareholders all the good tidings make the recent news that much more painful.

The Specs

Though the sell-off since Nordstrom announced earnings after the close on Thursday is easing, it’s not likely value or short-term investors are going to see the declines as an opportunity. The nearly 3% increase in Q1 net income was nice – and the 44% jump in direct sales phenomenal – but the improvements were expensive. The rise in sales in particular was in essence the company buying customers. Promotions aplenty, free shipping and paying through the proverbial nose for the store’s loyalty programs jacked expenses up over 18% -- nearly all of it due to rising costs associated with their online sales. And it’s expected to continue – to the tune of an additional $10 million in expenses over earlier projections through the course of 2012.

Hey, e-tail is supposed to minimize overhead costs – after the initial ramp up period -- and Nordstrom is certainly no neophyte to the online game, so what gives? Cutting prices to boost sales, shipping items across the country for free, and other costly incentives will take their toll. In the long term management hopes these customers will remain loyal without being bought, but that won’t help shareholders in the interim.

With the continued strength in consumer confidence, retail as an industry is certainly going to provide opportunities – Nordstrom just isn't the best alternative right now. Discount retailers such as The TJX Companies – owners of the TJ Maxx and Marshalls shops - and Ross Stores are expensive by most measures -- they are #’s 1 and 2 in return on equity and are great examples of two well-managed retailing machines. There’s also this to consider – for the last several years Americans have been frugal – out of necessity at first, and now because the economic wounds are slowly fading but aren't forgotten. That mindset - consumers demanding bargains as opposed to indiscriminate spending - is likely to continue going forward, and TJX and Ross will benefit and are both sound investment opportunities.

But the best option for investors wanting to cash in on the sector is Macy’s – hands down. At nearly $16 billion Macy’s is a long-time leader in the industry, and more importantly are coming off a string of impressive same-store sales increases, and management fully expects the trend to continue. Macy’s is a ridiculously good value too – the lowest P/E of all the big boys, price to sales right in line with the others and a not-to-be discounted 2.1% dividend. There are investment bargains to be had as consumers return to the stores, but Nordstrom shouldn't be on the list. 

This article was originally published as Nordstrom: Sales Increase Only Part of the Solutionon Fool.com

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