In the past 15 years, the obituary for the traditional “brick-and-mortar” retailer seems to have been written many times over. However, a decade-and-a-half later, online shopping only accounts for just 6%-7% of all retail sales.

 

#-ad_banner-#To be sure, e-commerce has clearly altered the face of retail, just not as expected. Rather than making physical store locations obsolete, an online presence has become a complementary part of the retail landscape. These days, the successful brick-and-mortar retailer is one that can deftly merge physical store and online operations to best serve customers and move inventory.

 

Few do this as well as Nordstrom, Inc. (NYSE: JWN), a century-old high-end department store chain that is known for its top-notch customer service.

 

Though the company’s upscale image remains intact, it has evolved with the times. Today, Nordstrom Rack discount locations actually outnumber traditional Nordstrom department stores (167 to 119), while e-commerce paves the way for future growth.

 

Investors are clearly pleased: During the past three years, shares returned more than 57%, compared with a roughly 52% gain for the S&P 500.

The outperformance of Nordstrom’s stock makes sense. During the past five fiscal years (ended January 2015), revenue jumped 57% to $13.5 billion and earnings soared 85% to $3.72 per share, thanks to a burgeoning e-commerce business.

 

Indeed, online sales have doubled in just the past two fiscal years to a current $2.5 billion. E-commerce now represents 19% of Nordstrom’s total revenue, compared with 11% in 2012.

 

Such gains would be impossible without the large investments Nordstrom has been making to spur e-commerce, like website upgrades and mobile application development. Such initiatives are part of an overall growth plan involving capital spending in excess of $2 billion over the past several fiscal years, with another $4 billion in outlays anticipated.

 

The flagship Nordstrom.com website roughly tripled the number of products offered during the past few years. Future investments are also likely to include a further expansion of online product offerings.

 

Nordstrom may augment e-commerce operations through acquisitions, too. So far, the company has seen excellent results from HauteLook, an online retailer of designer products purchased in 2011 for $270 million. HauteLook has about 20 million members, roughly a fourfold increase since the acquisition. The segment’s sales grew 27%, and 22%, respectively, in fiscal years 2013 and 2014.

 

There should also be a payoff from strategic partnerships with e-commerce specialists as well. In August 2014, the retailer began to work with Curalate, an online marketing firm. Through Curalate, Nordstrom has access to Like2Buy, a platform that allows customers to buy directly from Nordstrom’s Instagram page. In October, the company partnered with Twilio, a communications firm whose cloud-based platform enables Nordstrom employees to text customers with product ideas.

 

Yet another key investment: A massive new Pennsylvania distribution center slated for a summer 2015 opening will enable two-day ground delivery to nearly half of Nordstrom’s customers. This should facilitate speedier online order fulfillment and allow more customers to receive free shipping, enhancing loyalty. The next goal, says management, is to get 90% of customers within a two-day shipping radius.

 

Nordstrom’s strategy of handling online returns at stores — the “return-to-store” program — is savvy because it boosts store traffic. Indeed, more than 70% of HauteLook and NordstromRack.com returns are brought to Rack locations. This resulted in a million additional visits to Rack stores last year, management estimates. Since more than 60% of Nordstrom.com returns are brought to traditional Nordstrom stores, it’s likely the return-to-store program increases traffic at these locations, too.

 

Robust online and store traffic is apparent in Nordstrom’s inventory turnover, a closely-followed industry metric that gives investors a sense of how well a retailer’s merchandise is selling. Nordstrom turns its inventory over more than five times per year, compared with only about three times annually for the typical competitor, according to Morningstar. This suggests that Nordstrom is a lot less reliant  on profit-sapping markdowns. The company saves most of its inventory clearing for the Rack outlet stores.

 

This advantage is especially crucial now, as it should cushion the impact of this year’s high expansion costs. Despite guidance for 7%-to-9% net sales gains, management sees costs holding fiscal 2015 earnings to around last year’s levels. Nordstrom would have been looking at a substantial pullback in profits this year were it not for its superior ability to move inventory.

 

Looking ahead, Nordstrom appears set for 8% annualized profit growth, and assuming the current forward multiple of 22 remains constant, that suggests roughly 50% upside for this stock in the next five years. A strong balance sheet should enable the company to maintain at least a 2% dividend yield during that time as well.

 

Risks To Consider: Although its primarily-affluent customers tend to keep spending during economic downturns, Nordstrom is by no means recession-proof. For example, the company’s earnings dropped 36% in fiscal 2009, the worst year of the latest recession. Also, analysts say there probably isn’t much room left for expansion in the number of Nordstrom’s traditional high-end stores.

 

Action To Take –> Ignore predictions about the death of brick-and-mortar retail. The industry is still going strong, and Nordstrom is an excellent long-term play on that strength.

 

While its traditional department store business may be maturing, the company is adapting not only by expanding in e-commerce, but also through timely emphasis on its fast-growing Rack chain, where sales rose 17% last year. The goal for Rack is to add 63 more locations by 2016.

 

With most of its revenue coming from the United States, Nordstrom offers excellent insulation from the strong dollar, as well as prospects for attractive total returns.

 

 

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