For Nordstrom, best in class won't cut it: Analyst

It hasn't saturated the U.S. market with too many stores. It kept inventories lean heading into the fourth quarter, when an abundance of product weighed on many of its competitors. It's also avoided much of the discounting that's plagued the broader retail industry.

Yet on Tuesday, Nordstrom saw Citi downgrade its shares from "buy" to "neutral," saying its best-in-class positioning is no longer enough to withstand the challenges department stores are facing.

Customers exit a Nordstrom department store in Christiana, Delaware.
William Thomas Cain | Bloomberg | Getty Images
Customers exit a Nordstrom department store in Christiana, Delaware.

"Even with the stock near 12-month lows, we have a hard time telling investors to buy at this time," Citi analyst Paul Lejuez said in a research note.

Nordstrom's shares have fallen nearly 32 percent over the past year, toward $49. Citi cut its target price to $52, from $65.

In addition to worries about the broader department store set, Lejuez questioned two Nordstrom-specific issues. First, although the company has been pouring billions of dollars into future investments — among them, expansion into Canada and New York City, and staying ahead of the curve online — these investments have yet to pay off.

"These don't seem like bad investments, but it is unclear what the company is getting for it now that sales have slowed," he said.

To his point, Lejuez said he expects Nordstrom's 2016 net income, excluding the sale of its credit card portfolio, to be below where it was in 2012.

He also cautioned that Nordstrom's lower-price Rack division, which has been fueling the company's revenue growth, is at a disadvantage to its off-price peers. At a time when apparel sales are weak, Rack's product is skewed toward that category, and has relatively limited exposure to the more popular home goods items.

Citi's downgrade comes one day after Cowen & Co. lowered its price targets across the department store sector, citing above-average temperatures, weak traffic and shifting consumer preferences as headwinds. And last month, Morgan Stanley downgraded these stores to "cautious" from "in-line."

Still, Cowen analyst Oliver Chen maintained his "outperform" rating on the retailer, saying its growth and online investments should pay off in the long term.

Also Tuesday, Citi upgraded shares of low-price department store J.C. Penney to "neutral" from "sell," saying its shares have fallen about 30 percent over the past three months. That means it is more fairly valued, Lejuez said.

"We believe [the] market appreciates the challenges J.C. Penney faces in its turnaround," he said.

Penney shares were slightly higher, near $7, in late morning trade on Tuesday.