Why J.P. Morgan Upgraded Nordstrom Stock

A rating upgrade by J.P. Morgan drove a 2.5% rise in Nordstrom (JWN) stock at 3:14 PM ET today. J.P. Morgan upgraded its rating to “neutral” from “underweight.” It also raised the price target for Nordstrom stock to $41 from $26. Compared to the closing stock price on January 3, J.P. Morgan’s revised price target reflects an upside of 2.8%.

According to Seeking Alpha, easier comps and lower headwinds related to the top line were among the reasons for the rating upgrade.

Department store chains like Nordstrom and Macy’s (M) struggled in 2019 as online retailers gained traction among shoppers. Competitive pricing, an extensive merchandise assortment, and the convenience of online shopping are helping boost e-commerce sales.

The stock prices of Nordstrom, Macy’s, and Kohl’s (KSS) declined 12.2%, 42.9%, and 23.2%, respectively, in 2019. They lagged the 28.9% increase in the S&P 500. The decline in Nordstrom stock would have been steeper if not for the company’s better-than-expected third-quarter earnings.

Will Nordstrom’s earnings continue to improve?

Nordstrom’s earnings grew in the third quarter after declining in the first two quarters of fiscal 2019. The company’s third-quarter adjusted EPS rose 20.9% YoY (year-over-year) to $0.81 and surpassed analysts’ forecast of $0.64. Improvement in gross and operating margins drove the growth in Nordstrom’s earnings. Lower markdowns drove a rise of 100 basis points in the company’s gross margin to 34.3%.

Moreover, the company’s expense discipline helped drive a year-over-year rise of 252 basis points in the operating margin to 5.4%. Excluding a $72 million one-time charge, Nordstrom’s operating margin improved 50 basis points, backed by efficient inventory management.

Nordstrom’s net sales declined 2.2% YoY to $3.57 billion as full-price sales fell 4.1%, partially offset by a 1.2% rise in its off-price sales. The company’s digital sales increased by 7% YoY in the third quarter. Digital sales accounted for 34% of the company’s total sales in Q3 of fiscal 2019 compared to 31% in Q3 of fiscal 2018.

The company’s credit card revenue grew 6% YoY to $106 million. Overall, Nordstrom’s third-quarter revenue, comprising sales and credit card revenue, fell 2.0% YoY to $3.67 billion. This was in line with analysts’ consensus prediction.

Analysts now expect Nordstrom’s fourth-quarter adjusted EPS to be flat at $0.81. They predict the company’s revenue to rise by 1.8% YoY in the holiday sales quarter.

Better than peers

Nordstrom’s earnings growth was better than its department store peers. In the third quarter, Macy’s adjusted EPS declined 74.1% YoY to $0.07, reflecting the adverse impact of lower sales and weak margins.

Kohl’s third-quarter adjusted EPS fell 24.5% to $0.74 due to lower margins. JCPenney’s adjusted earnings per share reached -$0.30 in the third quarter of fiscal 2019. It was lower than the adjusted EPS of -$0.52 in the third quarter of fiscal 2018.

Nordstrom is improving its profitability through efficient inventory management and expense discipline. The company generated cost savings of $170 million in the first nine months of fiscal 2019.

Nordstrom continues to generate further cost savings by realigning the support structure in its stores, supply chain improvements, enhancing technology, and lower discretionary expenditures. The company expects to exceed its plan to generate cost savings in the range of $150 million–$200 million.

As of January 6, Nordstrom was trading at a 12-month forward PE (price-to-earnings) multiple of 11.4x. Its valuation is higher than the forward valuation multiples of 7.0x and 10.2x of Macy’s and Kohl’s, respectively.

Analysts expect Nordstrom’s adjusted EPS to decline by 5.0% in fiscal 2019 and grow 1.5% in fiscal 2020. They predict a decline of 36.8% and 11.4% in Macy’s fiscal 2019 and fiscal 2020 adjusted EPS, respectively. Meanwhile, analysts forecast Kohl’s adjusted EPS to decline by 13.4% and 0.4% in fiscal 2019 and fiscal 2020, respectively.

Current ratings for Nordstrom stock

Following J.P. Morgan’s upgrade, 16 of 21 analysts have a “hold” rating for Nordstrom stock. Two analysts have a “buy” recommendation, and three have a “sell” rating. On average, analysts have a price target of $36.63 for Nordstrom stock. This indicates a potential downside of 10% over the next 12 months.

Nordstrom stock could rise if it declares better-than-anticipated results for Q4 of fiscal 2019 in February and issues a strong outlook for fiscal 2020. Over the past few years, Nordstrom invested significantly in its off-price Rack business, digital channels, and the flagship store in New York City. These investments, along with the company’s productivity initiatives, are expected to drive future performance.