Fitch Ratings has downgraded Nordstrom Inc.'s Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BBB-'.
The Rating Outlook is Stable.
The downgrade reflects Nordstrom's weakening operating trajectory resulting from heightened macroeconomic and competitive pressure and an elongated recovery at Nordstrom's Rack brand, which could suggest longer-term challenges. Adjusted leverage (capitalizing leases at 8x) could trend around 4x in 2022/2023 before settling in the high-3x range, higher than Fitch's prior expectations of leverage sustaining below 3.5x.
Nordstrom's ratings continue to reflect its historically good market position in the apparel, footwear, and accessories space, with its differentiated merchandise and high level of customer service, including omnichannel offering, enabling the company to enjoy strong customer loyalty. The rating also recognizes the company's exposure to stronger shopping centers and good mix of digital and off-price sales alongside its full-price department store presence.
Key Rating Drivers
Ongoing Business Challenges; Elevated Leverage: Nordstrom's operating trajectory has been weaker than most retailers, including its department store peers, since the start of the pandemic in early 2020. Nordstrom's results have since trailed retail peers given its focus on fashion and occasioned-based apparel, exposure to markets with heavy domestic and international tourism, impact of supply chain challenges given above-average digital penetration and elongated turnaround efforts at its off-price Rack division.
In 2022, the company faced a weakening apparel market and the need to clear excess inventory via unplanned promotional activity, with 2022 EBITDA projected around $1.1 billion, around 25% below pre-pandemic 2019 levels of $1.5 billion.
Nordstrom's operating challenges have resulted in adjusted leverage (capitalizing leases at 8x) elevated near 4x in 2021 and 2022, relative to the below 3.5x appropriate for Nordstrom's prior 'BBB-' rating. Fitch expects EBITDA could modestly improve in 2023 to around $1.2 billion, with leverage sustaining in the high-3x over the next two years, assuming reduced inventory purchases allows the company to reign in unplanned promotions. However, ongoing softness in apparel will likely be a headwind in 2023.
Elongated Turnaround at Rack: The company's off-price Rack business has undergone numerous changes in recent years, including management and merchandising. Recent efforts to drive growth have included elevating the product offering (after previously working to bring in lower price point items) and expanding Rack's omnichannel platform. Operating results have been discouraging, with 2022 revenue likely around $4.8 billion, around 8% below 2019 levels.
Weakness has accelerated through 2022, with 3Q revenue approximately 10% below 2019 levels and 4Q forecast down around 15% to 2019. This contrasts with off-price competitors like The TJX Companies, Inc. and Ross Stores, Inc. where revenue through the first nine months of 2022 was up 20% and 16% relative to 2019, respectively.
The company expects its merchandising overhaul to be largely complete by mid-2023. However, recent results limit Fitch's confidence in the company's ability to change Rack's operating momentum. The business could continue to weigh on Nordstrom's results through much of 2023. Given Rack's importance to Nordstrom's business as both a revenue contributor (around 30%) and a source of new customers for the broader Nordstrom ecosystem, the division would need to stabilize operations for Nordstrom to demonstrate positive credit profile momentum.
Diversified Operating Model: Longer term, assuming the company can stabilize Rack, Fitch expects Nordstrom to benefit from its well-developed, diversified operating model across full-line stores, off-price Rack stores and digital presence (44% of 2021 revenue including Rack's digital business). Fitch believes the company's exposure to primarily stronger malls and leading omnichannel model serve as competitive advantages and could allow Nordstrom to grow topline in the low-single digits over time.
Fitch recognizes that the department store industry will continue to face secular headwinds, including reduced time spent in malls, changes to apparel buying behavior (including ongoing trends toward casualization) and encroaching competition from value-oriented and online channels. However, Nordstrom's existing portfolio and efforts to build a strong omnichannel offering should allow it to at least maintain share in a difficult space.
Good Cash Flow: Nordstrom's ability to defend market share is supported by its substantial cash flow, which allows it to make strategic investments such as omnichannel model infrastructure and in-store enhancements. During the three years ending 2019, Nordstrom's cash flow before dividends averaged approximately $540 million, after accounting for around $775 million in annual capex (including $935 million in 2019 to support the opening of the company's Manhattan flagship).
FCF in 2021 was lower but still meaningfully positive in the $200 million range, negatively impacted by lower EBITDA (compared with pre-pandemic levels) and decisions to pull forward inventory receipts given supply chain unpredictability.
FCF, following the company's resumption of quarterly dividends at $0.19/share (around $125 million annually) as of 1Q22, is projected to be around $250 million to $300 million beginning 2022, assuming some working capital benefits in 2022 following an inventory build in 2021. Cash flow could be used for strategic investments or share repurchases. The company could also use cash to repay its $250 million unsecured notes maturity in April 2024.
Nordstrom's capex capacity is a competitive advantage, given consumer behavior shifts and a challenging competitive environment. The company's good cash flow generation also supports its ability to manage through economic cycles or extreme challenges such as the pandemic, with some opportunity to improve competitive positioning particularly if weaker players are forced to retrench.
Derivation Summary
Nordstrom Inc.'s downgrade to 'BB+'/Stable from 'BBB-'/Negative reflects weakening operating trajectory resulting from heightened macroeconomic and competitive pressure and an elongated recovery at Nordstrom's Rack brand, which could suggest longer-term challenges. Adjusted leverage (capitalizing leases at 8x) could trend around 4x in 2022/2023 before settling in the high-3x range; Nordstrom's prior 'BBB-' rating assumed leverage could trend below 3.5x.
Nordstrom's ratings continue to reflect its historically good market position in the apparel, footwear, and accessories space, with its differentiated merchandise and high level of customer service, including omnichannel offering, enabling the company to enjoy strong customer loyalty. The rating also recognizes the company's exposure to stronger shopping centers and good mix of digital and off-price sales alongside its full-price department store presence.
Fitch's rated U.S. department store coverage includes national competitors Macy's Inc. (BBB-/Stable), Kohls Corp (BBB-/Stable), Nordstrom, Inc. (BB+/Stable), and regional player Dillard's Inc. (BBB-/Stable). Each have developed operating and financial strategies to contend with long-term secular challenges inherent in their space. Initiatives include investments in omnichannel models, portfolio reshaping to reduce exposure to weaker indoor malls, and efforts to strengthen merchandise assortments and service levels.
The national players have been best positioned to accelerate investment and transformation efforts given greater relative scale and cash flow generation. Dillard's has less ability to dedicate resources to this transformation albeit is better positioned than many smaller department and specialty stores.
While Macy's portfolio most closely resembles a traditional department store model, Kohl's differentiates itself via its off-mall presence and relatively higher private brand penetration. Nordstrom's business model includes full-line stores, which are focused more on higher-end price points and exposed primarily to A malls; the company also has a substantial off-price business to take advantage of share shifts toward this value channel.
Prior to the pandemic, the three national players operated with adjusted debt/EBITDAR below 3.5x (closer to mid-2x for Kohl's) to support investment grade ratings. Over the medium term, Fitch expects Macy's could operate with leverage in the mid-2x, with Kohl's modestly higher at around 3x and Nordstrom in the high-3x. Reduced leverage at Macy's relative to pre-pandemic is largely due to proactive debt reduction. Dillard's adjusted leverage is projected around 1x, modestly below pre-pandemic levels closer to 1.5x; from a rating perspective the company's low leverage is balanced by the company's relatively smaller scale and regional positioning compared with peers.
Key Assumptions
Fitch's Key Assumptions Within The Rating Case for the Issuer:
Fitch projects Nordstrom's 2022 revenue could expand 5% to $15.5 billion, similar to pre-pandemic levels, assuming a 4% decline in 4Q revenue following 9% through the first three quarters of the year. Revenue could be down low single digits in 2023 assuming a weaker 1H but improvements in 2H, particularly as comparisons ease. Revenue could grow around 2% beginning 2024, assuming some stabilization in the Rack business.
EBITDA, which was $1.1 billion in 2021 (7.5% margin) compared with $1.5 billion in 2019 (9.5% margin) on lower sales and supply chain inflation, could be in the $1.1 billion range in 2022 (7.0% margin) as revenue declines and elevated markdown activity in 2H negate EBITDA growth in 1H. EBITDA could grow toward $1.2 billion by 2024 despite flattish sales as margins improve toward 8% on lower unplanned markdowns.
FCF after dividends is projected around $250 million to $300 million annually, with some working capital benefits in 2022 as the company reverses an inventory build from 2021. In 2022 Nordstrom resumed its quarterly dividends at $0.19 or approximately $125 million annually; this is approximately half the rate of dividends before their suspension in at the onset of the pandemic in 2020. FCF could be used for strategic investments or share repurchases. Debt repayment is another cash deployment option but this is not factored into Fitch's base case forecast.
Adjusted debt/EBITDAR, which was around 3x during the three years ending 2019 and 4x in 2021 on EBITDA challenges, could remain close to 4x in 2022 on flattish EBITDA and trend in the high-3x range in 2023/2024 given Fitch's EBITDA forecast and assuming flat debt levels.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade to 'BBB-' would result from adjusted debt/EBITDAR sustaining below 3.5x, which would occur if EBITDA sustained above $1.3 billion. The company would also need to stabilize revenue trends at its Rack division.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A downgrade would result from EBITDA trending near $1.0 billion, which would yield adjusted debt/EBITDAR (capitalizing leases at 8x) sustaining above 4.0x.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Nordstrom had a cash balance of $293 million as of Oct. 29, 2022 and $700 million of availability on its $800 million secured revolver due May 2027 (reflecting $100 million in borrowings on the revolver). The revolver backstops the company's $800 million commercial paper program; there were no outstanding CP borrowings as of Oct. 29, 2022.
The revolver is secured by substantially all working assets, principally inventory, accounts receivable and intellectual property. The security is released if the company receives an investment grade rating from at least two rating agencies (S&P, Moody's and Fitch) or if the company receives an investment grade rating from one rating agency and company-defined leverage (Adjusted Debt/EBITDAR using balance sheet operating lease liabilities) is less than or equal to 2.5x for two consecutive quarters.
The company's capital structure includes $2.9 billion of unsecured notes. The next maturity is $250 million of notes due April 2024 with the remainder due between 2027 and 2044.
RECOVERY CONSIDERATIONS: Fitch does not employ a waterfall recovery analysis for issuers assigned ratings in the 'BB' category. The further up the speculative grade continuum a rating moves, the more compressed the notching between the specific classes of issuances becomes. Fitch rates Nordstrom's secured revolver 'BBB-'/'RR1', notched up one rating from the IDR given its security package. Nordstrom's unsecured notes are rated 'BB+'/'RR4'.
Issuer Profile
Nordstrom is the one of the largest department store operators in the U.S. with approximately $15.5 billion in revenue across its digital businesses and retail portfolio, with approximately 100 full-line department stores and around 250 off-price Rack locations.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
NORDSTROM, INC. 
