Nordstrom Shares Overshoot Their Price Target
Retailers often share a similar story. Department stores, for example, are often started as family businesses. The remaining stores often bear the name of the founding family such as J. C. Penney, Dillard’s or Nordstrom’s to cite just a few of the many examples.
The Nordstrom family still owns a significant stake in Nordstrom, Inc. (NYSE: JWN). In fact, the family tried to buy the entire company to take it private. The family currently owns a little more than 30% of the company.
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In late 2017, CNBC reported that “the family group linked up with private equity firm Leonard Green & Partners to help fund their efforts to take it private. Those effort stalled over financing skittishness, amid a bubbling number of bankrupt leveraged buyouts and general uncertainty over the future of retail.”
That deal never happened and the company recently reported robust earnings.
Earnings Report Makes the Company Even More Valuable
TheStreet.com reported, Deutsche Bank AG (DB) analyst Paul Trussell wrote that Nordstrom’s “superior business model drives superior results” in his note raising the price target for his firm to $61 from $56 and issuing a buy rating.
“JWN’s second quarter same-store performance clearly separates it from the mid-tier department store group which posted only slightly positive comps this quarter despite the calendar shift benefit that JWN does not enjoy,” he explained in a note on September 21.
Jim Cramer’s Action Alerts Plus research team, which holds Nordstrom in its portfolio, called results “the quarter we have been waiting for.”
Cramer’s AAP team highlighted the e-commerce sector as an opportunity as well, as the company’s digital sales grew 23% in the second quarter and now account for 34% of its sales.
Keybanc Capital Markets analyst Edward Yruma drew parallels to Walmart’s prominent earnings growth based on digital business.
“Similar to Walmart, heavy digital investments position the company well for long-term growth,” he wrote.
Walmart saw its share price surge to nearly $100 per share yesterday largely driven by its surprising e-commerce performance.
A few years ago, many thought Walmart would be the death of stores like Nordstrom’s. The turnaround pushed the share price of JWN up.
But, Skepticism remains High
TheStreet.com also highlighted industry concerns:
Not all analysts were so bullish, citing significant downside risk associated with the retail industry.
Erinn E. Murphy, senior research analyst at Piper Jaffray & Co. called the second quarter report for the company “befuddling” and set a price target at $49, below the previously proposed buyout price.
“We continue to have longer-term concerns regarding structural headwinds facing the industry,” she wrote in a note published on September 21.
“We’d expect shares (while they were up 14% initially at the close) to fade throughout the day as third quarter estimates move down,” she predicted.
Morgan Stanley equity analyst Kimberley Greenberger concurred, citing e-commerce as a potential pitfall rather than a growth engine in her own note this morning.
“E-commerce is lower margin than full-line stores and as greater percentage of sales shift online, we expect margins to continue to suffer,” she commented. “Moreover, the digital investment cycle may prove unending as eCommerce leaders (i.e Amazon) continue to raise consumer expectations for speed, accessibility, and price.”
As a result, she set her price target at $47, about $10 below the share price this morning.
This latest surge pushed the price back to highs last seen when the family was negotiating financing for its deal.
A Trade for Short Term Bulls
As with the ownership of any stock, buying JWN could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for JWN
For JWN, the September 21 options allow a trader to gain exposure to the stock.
A September 21 $40 call option can be bought for about $1.60 and the September 21 $45 call could be sold for about $0.40. This trade would cost $1.20 to open, or $120 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $120.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in JWN the maximum gain is $3.80 ($45 – $40 = $5.00; $5.00 – $1.20 = $3.80). This represents $380 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $120 to open this trade.
That is a potential gain of about 216% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.