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Nordstrom Rack Just Had Another Terrible Quarter

In the past few years, Nordstrom (NYSE: JWN) has stood out as one of the only companies in the department-store space that was still growing. Most of that growth has come from its Nordstrom Rack off-price division.

The Nordstrom Rack chain holds huge promise and could be worth as much as Nordstrom's entire market cap. However, the Rack hasn't been living up to its potential in recent years -- and its results took a turn for the worse last quarter.

The worst quarter yet for Nordstrom Rack

From 2012-2014, Nordstrom Rack averaged mid-single-digit comparable-store sales growth while also rapidly expanding its store count. That trend abruptly changed in 2015. Comp sales declined 1% at Nordstrom Rack stores during fiscal 2015, rose just 0.2% in fiscal 2016, and then fell 0.9% during the first half of 2017.

Nordstrom Rack has been posting weak comp sales results recently. Image source: Nordstrom.

Last quarter, the sales trend took another step down. Nordstrom reported a 5% decrease in comp sales at its Rack stores -- even worse than the 4.9% comp sales decline it saw in its full-line stores. This drop highlights the extent of Nordstrom Rack's operational miscues. On an industrywide basis, off-price retailers such as TJX (NYSE: TJX) have been outperforming mall-based department store chains by a wide margin.

Nordstrom's management attributed the Rack's weak performance to an inventory glut. The company had an aggressive sales plan to begin the year and ended up buying too much inventory in advance. Doing so reduced its ability to buy fresh, in-demand merchandise later on.

The importance of maintaining the flexibility to buy merchandise at the last minute is something TJX's management discusses repeatedly. Nordstrom Rack is suffering from a failure to follow the basic rules of the off-price retail business model.

Is there a deeper problem?

On Nordstrom's recent earnings call, executives said Nordstrom Rack entered the fourth quarter with a much better inventory position. The company has also significantly reduced its orders. In short, management said all the right things.

However, these inventory issues aren't new. Just a year ago, Nordstrom blamed Rack's weak 2015 and 2016 comp sales results on having too much inventory. Company president Blake Nordstrom said at the time that the Rack's inventory was finally back at an appropriate level. Yet it seems that management hadn't really learned its lesson, as the same inventory problems started to crop up again by early 2017.

In addition, over-ordering merchandise may not have been Nordstrom Rack's only problem this year. Online sales through Nordstromrack.com are on track to increase more than 30% once again in 2017. This barely profitable online off-price business appears to be cannibalizing in-store sales at Nordstrom Rack. Meanwhile, online returns to Rack stores are aggravating the latter's inventory problems.

Perhaps Nordstrom can find a better way to manage these challenges. However, it seems to have ruled out the simplest solution: scaling back its off-price e-commerce efforts. That's unfortunate, as TJX and other best-in-class off-price retailers have shown that it's possible to succeed with little or no e-commerce presence.

No more excuses

Nordstrom Rack's inventory management issues represent Nordstrom's most pressing problem today. Competitors' results indicate that Nordstrom Rack should be able to post much stronger comp sales results, which would in turn lead to a higher profit margin.

Perhaps Nordstrom's management is finally serious about fixing these long-running issues. But if Rack's results don't improve dramatically over the next year, the Nordstrom family should strongly consider hiring an experienced off-price executive from outside the company with full authority to do what it takes to turn Nordstrom Rack around.

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Adam Levine-Weinberg owns shares of Nordstrom and is long January 2018 $60 calls on The TJX Companies and short January 2018 $90 calls on The TJX Companies. The Motley Fool recommends Nordstrom and The TJX Companies. The Motley Fool has a disclosure policy.