Nordstrom Manages to Stay in Fashion

The stock's been a star for three years and could keep soaring.
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With the onset of August, the summer shopping spurt at retail chains is giving way to clearance sales, while Wall Street shifts its sights to the back-to-school rush.

One of the most prolific of such sales takes place at

Nordstrom

(JWN) - Get Report

, a Seattle-based department-store chain at the height of its powers that analysts expect will keep cashing in on strength in high-end consumer spending -- a trend in the economy that refuses to abate.

The company is in the midst of its Anniversary Sale, a promotional event that discounts its designer product line every year from July 15 through Aug. 31. Some analysts are expecting the sale to lend further momentum to a stock that is already on its way to being a star in 2005.

Credit Suisse First Boston analyst Michael Exstein noted that Nordstrom's annual summer sales normally start strong, since customers can earn double the rewards points on their credit cards in its first few days. Still, his research indicates the sale got off to an unusually good start this year, posting double-digit sales gains from 2004. That observation inspired Exstein to bump up his second-quarter earnings estimate for Nordstrom by 3 cents to 48 cents a share.

Exstein's firm has an investment banking relationship with Nordstrom.

When it reports its second quarter on Aug. 16, the retailer is expected to post earnings of 47 cents a share, according to consensus estimates by Thomson First Call, up from 38 cents a share a year ago. Nordstrom has beaten Wall Street's consensus estimates for earnings in six out of the last seven quarters, and many analysts predict it will continue to outperform.

"Among the companies in our coverage,

Nordstrom is the most likely candidate for positive earnings revisions," said Bernstein & Co. analyst Emme Kozloff in a recent research note. "Macroeconomic indicators continue to suggest that companies exposed to the higher-income consumer will continue to fare better."

Kozloff's firm has a position in shares of Nordstrom, but it does not have an investment banking relationship with the company.

So far this year, shares of Nordstrom have run up about 59%, trading Tuesday around $37. That follows a 38% gain in 2004 and an 84% jump in 2003. Meanwhile, the stock sports a dividend yield of about 0.4%.

This streak of success follows years of lackluster earnings and problems in the retailer's product mix. After the company hit a sharp downturn in the late 1990s, the Nordstrom family ousted management and took over in 2000, focusing on enhancing merchandise, controlling inventory and reducing expenses. In 2002, the company rolled out a state-of-the-art merchandising system, ending an ancient process in which sales were tallied by hand.

"Nordstrom differentiates itself from other department-store chains with its high-quality, often fashionable, brand-name merchandise and superb customer service," said Morningstar analyst Kim Picciola in a research note. "Its efforts are paying off. With same-store sales in the mid-single digits for the first half of 2005, shoppers continue to buy the latest in apparel, shoes and accessories from this high-end retailer."

With its own house in order, Nordstrom offers investors one of the clearest plays on the booming market for luxury retail. For close to two years now, sales trends have shown strong, consistent growth at the high end of the consumer spending spectrum as wage growth and employment opportunities continue to lag for lower-income spenders while soaring gas prices eat into their budgets. Meanwhile, retailers catering to wealthy consumers offer obvious hedges against the various shocks that could befall the economy.

Other high-end retail stocks have complications of their own.

Neiman Marcus

(NMG.A)

is in the middle of a private equity takeover.

Saks

(SKS)

is surrounded by speculation that it will be sold.

Coach

(COH)

, the designer handbag maker, is performing well, but its towering valuation at close to 30 times its 2005 earnings estimates makes it risky. Also, shares of

Tiffany

(TIF) - Get Report

, the iconic jeweler, have lagged in recent years due to concerns that its brand has lost some cachet.

With a price around 18 times its earnings estimates through 2007, Nordstrom's stock trades roughly in line with the

S&P 500

(SPX)

, and it's expected to grow its earnings by about 15% annually for the next several years. That would mark nearly double the growth predicted on average for companies making up the S&P.

Its balance sheet shows $928 million in long-term debt, but last year's free cash flow of $315 million suggests it's manageable, even with a higher dividend.

Piper Jaffray analyst Neely Tamminga said the recent announcement from

Federated Department Stores

(FD)

about its intention to sell off 68 stores in 66 mall locations that it will own after its merger with

May Department Stores

(MAY)

could offer new growth opportunities to Nordstrom.

Tamminga recently noted that 12 of the 66 locations earmarked by Federated are located in the vicinity of a Nordstrom store, suggesting that Nordstrom will be losing a competitor, at least in the short term, at 13% of its store base. Meanwhile, 54 out of the 66 locations are in markets where Nordstrom has yet to establish a presence. While Federated will probably do everything it can to avoid selling to Nordstrom, Tamminga said that in some instances, Nordstrom could be a well-positioned buyer.

"While we do not believe Nordstrom would be interested in all 54 locations, we do believe there is an opportunity for Nordstrom to take over some of the locations and increase their rate of store growth," Tamminga said. (Her firm makes a market in shares of Nordstrom, but it does not have an investment banking relationship with the company.)

Nordstrom did not return a phone call asking for comment on this story.

Tamminga said the situation could add some upside to her estimate for 2% to 3% annual store growth for Nordstrom over the next few years, which would in turn lead her to raise her already optimistic earnings estimates for the retailer.

She has an outperform rating on Nordstrom with a price target of $41 based on her expectations that it will "continue to be a top-of-mind destination for apparel and accessories while at the same time reaccelerate store growth plans with real estate opportunities becoming available from industry consolidation."