Nordstrom vs. Macy's: Class Struggle

Customers of the Seattle-based high-end chain kept spending in June while shoppers at the mass-market department store cut back

Comparable-store sales results for U.S. retailers in June showed that upscale shoppers seem undeterred by higher gasoline and food prices, while lower-income consumers have cut back on retail purchases.

And that's quite apparent in the sales figures for two big department-store outfits released July 12. High-end retailer Nordstrom Inc. (JWN) posted a 2.0% increase in same-store sales for the five weeks ended July 7 vs. a year ago, with accessories, women's designer and intimate apparel and men's wear driving improved sales during the clearance period. Total sales were $851.1 million, up 2.9% from $827.0 million in June 2006.

By contrast, Macy's Inc. (M), still struggling to integrate the stores it acquired from May Company nearly two years ago, reported a 2.7% drop in same-store sales from a year ago, a bigger decline than the flat to 2% lower results it had expected. Total sales fell 1.9% to $2.32 billion from $2.37 billion a year ago.

The Cincinnati department store chain, which was known as Federated before changing its name and stock symbol on June 1, cut its earnings outlook for the second quarter to 20 to 30 cents a share, excluding merger expenses, from previous guidance of 35 to 40 cents a share. The company also projected that same-store sales in July would be flat to 3% lower than July 2006.

Macy's shares were trading 3.5% lower at $38.99 on July 12, while Nordstrom was up 1.5% to $48.96.

"Nordstrom came in with superb results, which beat their own plan as well as surpassing [Wall Street] expectations," said Bill Dreher, an analyst at Deutsche Bank Securities.

The Seattle retailer's results were the best of any department store company he covers, which "reflects the strength of the high-end consumer, as well as Nordstrom's expertise in catering to them," he said.

Macy's poor results came on the heels of a 3.3% drop in comparable-store sales for May. The weakness came from Macy's legacy stores as well as from the former May stores, whose customer base the company seems to have lost in the shift to trying to attract a new, lower-end consumer, Dreher said.

Customers at the former Marshall Fields segment, which has been renamed Macy's North, were accustomed to waiting for promotional sales on the upscale merchandise, very little of which ever sold at full price. Macy's is "now trying to focus on merchandise that can successfully sell at full-margin, and, in the process, are transitioning their customer base," Dreher said.

There's no question that Nordstrom's June results improved at least in part due to the lower sensitivity of its wealthier clientele to higher food and energy prices, compared with people who shop at Macy's.

But Nordstrom is also benefiting from being a more efficient operator, with an expense-to-sales ratio of 27%, versus Macy's 32% ratio, says Robert Buchanan, an analyst at A. G. Edwards & Sons. Nordstrom's prices demonstrate its efficiency.

"Nordstrom can price sharply and still generate high returns on sales and invested capital," Buchanan says. "As you know, we're in a soft economy right now, so if you're a retailer and you expect to retain market share, you really have to be sharp on price."

Macy's isn't doing as well in attracting cost-conscious customers as Kohl's Corp. (KSS) and Target Corp. (TGT), whose greater efficiency translates to savings for shoppers, he says.

While the pace of its integration of the May stores has been disappointing, Buchanan said the bigger problem is that Macy's cost structure is bloated and as a result its prices are too high.

One factor contributing to their efficiency is that Kohl's and Target each have one buying office in the U.S., vs. the seven offices Macy's maintains to deal with merchants. All the people working at those additional offices add to Macy's expenses, he notes.

Buchanan says he's estimating a 6% increase for comparable-store sales for Nordstrom for the full year, and a 1.0% decline in comps for Macy's, mostly due to prices.

At Macy's, like other retail stores, merchandise for teens sold better in June than specialty and women's apparel, says Lizabeth Dunn, an analyst at Thomas Weisel Partners.

"Their more mature customer has stopped shopping," while younger customers, unburdened by mortgage payments and gasoline costs, and buoyed by a recent minimum wage hike, continue to spend some of their own money at the mall, she said.

Macy's "pretty significant reduction" in earnings guidance for the second quarter stems from slow sales and its need to mark down prices on its merchandise, she said. The weaker view of the latest quarter's results is specific to Macy's, as other department stores sales came in closer to plan, enabling them to reaffirm previous earnings estimates, she added.

One reason that Macy's markdowns have been so disciplined is that the company wants to make sure it contains the inventory bulge caused by sluggish sales and that it doesn't carry that inventory into the third quarter, Dreher said.

Dreher has a buy rating on Macy's and a hold rating on Nordstrom,

"As soon as [Macy's] can start driving better sales at the acquired May stores, I think the stock will work very well," he said. "I also think the risk/reward is very favorable here," with the likelihood of a $2 to $3 move lower versus a $6 to $8 move higher.

There's also realistic potential for a leveraged buyout of Macy's at around $54 a share, which is supporting the stock price at the moment, he added.

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