Williams Sonoma's Delicate, Albeit Successful, Juggling Act

By Stephen D. Simpson, CFA | May 21, 2012 AAA

Doing one thing well in retail is hard enough, but simultaneously executing on multiple strategies with a high degree of skill is beyond most management teams. To that end, Williams-Sonoma (NYSE:WSM) at least merits a great deal of investor respect. Although the upside in the stock doesn't look so impressive today, the potential to improve sales growth and/or profitability could lead to more surprises down the line.
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A Good Start to 2012, with One Area of Concern
Williams-Sonoma has a reputation for relatively conservative guidance, and the company posted another slight beat this quarter. While overall trends look relatively healthy, the ongoing malaise in the flagship Williams-Sonoma stores has to be addressed.

Revenue rose a little bit more than 6%, with retailing revenue up about 4% and direct-to-consumer revenue up almost 9% (with e-commerce growing nearly 12%). Same-store sales rose 4.6% against a very strong year-ago comps (up 6.7%), while core comps brand revenue rose 5.4% (against a 9% comps). Once again West Elm and Pottery Barn were stand-outs (up 225 and 9%, respectively), while Williams-Sonoma remains a laggard (down 4.3%).

Williams-Sonoma also did OK on profitability. Gross margin fell about half a point, but good SG&A expense control allowed the company to grow operating income more than 6% and post a slight improvement in operating margin.

SEE: Understanding The Income Statement

Balancing Online and In-Store
While sell side analysts still listen attentively to various retail management presentations on online/e-commerce strategies, the reality is that very few retailers ever manage to do both successfully and simultaneously.

SEE: Buy Side Vs. Sell Side Analysts

What makes Williams-Sonoma different, though, is that they seem to not only out-do store-based rivals like Bed, Bath & Beyond (Nasdaq:BBBY) online, but also online-only merchants like Wayfair and Hanover Direct. To that end, while no retailer of anything small enough to be shipped can ever be completely safe from Amazon (Nasdaq:AMZN), Williams-Sonoma seems to have fared much much better than most.

All the while that Williams-Sonoma has driven direct sales to more than 50% of the total, the company has continued developing new store-based retailing concepts. Of these, West Elm could well prove to have the most potential. Cheaper than Ethan Allen (NYSE:ETH), but arguably more stylish and higher-quality than IKEA or traditional furniture stores like Hooker (Nasdaq:HOFT), West Elm has held up through a miserable housing market and could ride that recovery to becoming a break-out success.

The Need to Fix What It Has
It's not all sweetness and light at Williams-Sonoma. The flagship store has had some definite ups and downs in recent years, with more downs than ups. I'm not sure how much momentum the company has lost to cheaper options like Bed, Bath & Beyond or Target (NYSE:TGT), nor whether the apparent decline in interest in cooking has hurt sales.

What I do know is that the company is hoping that a stronger focus on exclusive products and store-brand products will help turn things around. Both seem like logical moves, particularly if the company can support them with high-visibility TV usage or advertising. That said, I still can't shake the concern that Williams-Sonoma may have priced itself out of its core market and may need to consider walking back its prices as part of an overall attempt to drive better sales.

SEE: Earning Forecasts: A Primer

The Bottom Line
Williams-Sonoma is well-liked and well-known, so it's no great surprise that the shares aren't cheap now that investors have warmed up to retail in general. If there is upside to the stock's fair value (which would be about $40 on the basis of mid-to-high single digit free cash flow growth), it would most likely be from a stronger recovery in the core Williams-Sonoma brand and even better-than-expected expansion and growth at West Elm, coupled with tight expense control. The company's history makes this a plausible scenario, so current investors don't need to be in a hurry to cash out of this equity.

SEE: 5 Must-Have Metrics For Value Investors

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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