DBRS Morningstar Changes the Trend on Nordstrom Inc. to Positive from Stable, Confirms Issuer Rating at BB

DBRS Limited (DBRS Morningstar) changed the trend on Nordstrom, Inc.’s (Nordstrom or the Company) Issuer Rating to Positive from Stable and confirmed the Issuer Rating at BB. The trend change reflects the ongoing recovery in Nordstrom’s earnings as a result of the uptrend in consumer demand amid economic re-openings. It is further supported by DBRS Morningstar’s expectation that Nordstrom’s EBITDA levels will be sustained above $1 billion annually and that the leverage ratio will remain within the range of 3.0 to 3.5 times (x) on a normalized and sustained basis. Nordstrom’s ratings continue to be supported by its well-established reputation for customer service, size, market position, and leading digital capabilities as well as its increasingly diverse customer base and retail channels. The ratings also consider Nordstrom’s exposure to intensifying competition, economic cycles, and structural changes to consumer trends that accelerated through 2020 and 2021.

On April 21, 2021, DBRS Morningstar confirmed the Company’s rating at BB and changed the trend to Stable from Negative. The confirmation and trend change reflected DBRS Morningstar’s expectation that Nordstrom’s earnings would benefit from the gradual reopening of the economy through 2021 and, while there was still considerable uncertainty about the pace and magnitude of recovery, Nordstrom’s credit metrics were expected to remain in a range acceptable for that rating over the near to medium term. DBRS Morningstar expected operating cash flows to be sufficient to support historic capital intensity of 3% to 4% and modest debt reduction. DBRS Morningstar also noted that further positive rating action was possible if operating results recovery was stronger than expected and was combined with strong operational execution and prudent financial management.

For the fiscal year ended January 29, 2022 (F2021), Nordstrom reported strong topline recovery as net sales increased 38% year over year (YOY) to $14.8 billion but still trailed 4.8% below the pre-pandemic F2019 sales. Digital sales increased 7% YOY and by 24% when compared with F2019, while sales from the full-price stores and off-price stores (Nordstrom Rack) decreased 3% and 8.2%, respectively, compared with F2019, as e-commerce channels were preferred over in-store purchases, especially during H1 2021. Additionally, sales were negatively affected during Q2 2021 and Q3 2021 because of supply chain disruptions, particularly for the off-price stores, and recovery at Nordstrom Rack lagged that of its peers. However, Nordstrom Rack reported strong recovery in the holiday season (Q4 2021) as the Company was able to refresh the inventory with more sought-after brands. EBITDA margins also improved materially to 9.3% in Q4 2021 because of operating leverage and lower markdowns, partially offset by rising labour costs and fulfilment cost pressures. On a full-year basis, EBITDA margins at 7.0% in F2021 were still considerably below the 9.4% margins in F2019, taking into account lower profitability during H1 2021. As such, EBITDA at approximately $1.03 billion in F2021 was approximately 29% lower than EBITDA at $1.45 billion in F2019. Through curtailed capital expenditures (capex) and suspension of dividends, Nordstrom managed to generate a meaningful level of free cash flow (before working capital changes) of $0.33 billion, which the Company used, in combination with cash on hand, to repay approximately $0.46 billion in gross debt. As such, debt-to-EBITDA ratio stood at 3.47x in F2021 compared with 2.77x in F2019.

Looking ahead, DBRS Morningstar believes that Nordstrom’s earnings will continue to benefit from steady consumer demand because of the positive trends in travel and the return to office, notwithstanding ongoing near-term headwinds related to inflationary pressures and supply chain disruptions. DBRS Morningstar expects overall revenue to increase in the mid-single digits to around $15.4 billion in F2022 and the low- to mid-single digits in F2023, benefitting from an increase in volumes with economic re-openings and price increases in full-price stores, which are partially offset by higher markdowns in the off-price stores, relative to 2021. While demand tailwinds support growth in revenue, margin recovery is likely to take time and margins are expected to remain considerably below the historic levels of 9% to 10%, at least in the near term, because of the inflationary pressures from increased labour and freight costs as well as the higher fulfilment costs to support omnichannel capabilities, partially offset by operating leverage and cost structure resets. EBITDA margins are likely to improve sequentially in F2023 and, as such, DBRS Morningstar forecasts EBITDA to be around $1.1 billion in F2022 and to increase above $1.2 billion in F2023.

In terms of the Company’s financial profile, DBRS Morningstar expects cash flow from operations to track improvement in operating income and increase to a range of $0.85 to $0.90 billion in F2022 and F2023, and to be sufficient to support capex of approximately $0.6 billion annually, primarily for technology and supply chain investments, and reinstated annualized dividend payments of approximately $0.15 billion in F2022 and above $0.20 billion in F2023, resulting in limited free cash flow generation for debt reduction. As such, with the improvement in EBITDA and relatively stable debt levels, DBRS Morningstar forecasts debt-to-EBITDA to continue to remain below 3.5x in F2022 and move toward 3.0x in F2023.

Should Nordstrom continue to deliver an operating performance in line with DBRS Morningstar’s expectations such that the Company’s financial leverage is sustained between 3.0x and 3.5x, the Issuer Rating is likely to be upgraded to BB (high) over the next two to three quarters. Conversely, should credit metrics deteriorate (i.e., debt-to-EBITDA rise meaningfully above 3.5x on a sustained basis) as a result of either weaker-than-expected operating performance, because of reinstated regulatory restrictions or substantial cost inflation, and/or more aggressive financial management, the trend could be reversed to Stable.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is Rating Companies in the Merchandising Industry (July 26, 2021; https://www.dbrsmorningstar.com/research/382073), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577