S&P Global Rating lowered its outlook on the debt ratings of Nordstrom due to the retailer’s weaker-than-expected performance.
The rating agency noted that the Seattle-based retailer recently revised its fiscal 2022 earnings guidance downward based on softer sales and a highly promotional environment during its last holiday season. As a result, S&P now expects Nordstrom to show weaker free operating cash flow (FOCF) for 2023 versus 2022 amid ongoing clearance activity, pressured consumer demand and execution missteps.
S&P revised its outlook on Nordstrom to negative from stable and affirmed all its ratings, including its ‘BB+’ issuer credit rating.
The negative outlook reflects the risk that S&P could lower our rating if credit metrics weaken beyond its expectation due to performance deterioration or a less conservative financial policy than anticipated.
S&P said in its analysis, “The negative outlook reflects the weaker-than-expected credit metrics in 2022 amid a challenging operating environment and the ongoing underperformance of the company’s off-price segment. Nordstrom reported a holiday net sales decline of 3.5 percent relative to the comparable period in 2021 and lowered its operating margin guidance for the fiscal year 2022 by almost 30 percent, citing deteriorating macroeconomic conditions and markdowns to clear excess inventory. While we recognize the supply chain and post-pandemic demand right sizing challenges across department stores and other retailers last year, this performance was still materially below our expectations.
“Sales at the company’s Nordstrom Rack off-price business have yet to reach pre-COVID levels as the company announced that net sales decreased almost 8 percent during the last holiday season. The Rack has traditionally focused on serving fashion-forward, brand-oriented customers, and its performance trends have underperformed those of its off-price peers for years, partly due to the brand’s narrower customer segment, resulting in lower overall sales and margins.
“Nordstrom is now working to optimize its Rack assortment. While it has previously positioned its Rack stores in the highly competitive discount space, the company is shifting away from the lower price point items that have not resonated with Rack customers and increasing the penetration of premium brands at Nordstrom Rack. In our view, potential volatility in earnings could stem from the challenging operating environment and execution risks associated with the Rack repositioning initiatives.
“In addition, the company has experienced several management changes over the past 12 months, with some key roles yet to be filled, including the chief financial officer and chief merchandising officer. Amid this and continued weak operational execution, we have an incrementally worse view of the company’s strategic planning process and its management depth and breadth. As a result, we are revising our management and governance score one category to fair from satisfactory.
“We anticipate leverage to be above 3x for fiscal year 2022 before declining over the next 12 months as improved margins and higher cash balances should partly offset the soft topline. The recent soft sales trend, along with the more difficult comparisons from the first half of 2022, which benefited from robust levels of consumer spending, leads to our forecast for revenue declines in 2023. Thanks to its efforts to right-size its inventory positions, which are entering 2023 roughly at 2019 levels, we believe the company’s profitability will start to recover later in 2023 due to less anticipated clearance activity and tighter expense management.
“This leads to our forecast for FOCF in the $325 million-$375 million range over the next 12 months, from the $460 million we were expecting late last year. That said, we do expect more than $500 million of cash on its balance sheet over the next 12 months. While we don’t project leverage to approach the company’s 2.5x target in the next two years, we expect Nordstrom to navigate the continued macroeconomic uncertainty with expense discipline while reducing its share repurchase activity.
“We believe department stores are facing mounting competitive pressures. Apparel purchases are highly discretionary, and we expect performance will remain vulnerable to economic conditions such as the recent macroeconomic slowdown. In addition, our longer-term view is that changing consumer apparel buying habits will be difficult to navigate, which increases the potential for operational missteps. Declining physical store traffic, shifting category preferences and online price transparency are persistent longer-term risks for Nordstrom’s business. While we continue to view the company as having leading omnichannel capabilities in its industry, We think a continued shift to online shopping and competition from off-price players could continue to pressure traffic at brick-and-mortar locations and margins.
“The negative outlook reflects the risk that we could lower our ratings on Nordstrom over the next 12 months if performance deteriorates beyond our expectation or the company pursues a more aggressive financial policy than we anticipate.”
