(Published by Nicholas McCullum on March 19)
The retail sector has been under pressure for some time now.
Consumer tastes are as fickle as ever, and the move toward e-commerce has hurt the more traditional brick-and-mortar business model.
Williams-Sonoma (WSM, Financial) investors have felt this trend. The stock is down from a high of $85 to $48.50.
Source: Yahoo! Finance
Is Williams-Sonoma a better bargain than ever, or should investors be warned by the stock’s significant decline?
Business overview
Williams-Sonoma is a consumer retail company that specializes in kitchenware and home furnishing.
Founded in 1956, Williams-Sonoma has grown to be one of the country’s largest multichannel specialty retailers with more than 600 physical locations and a market capitalization of $4.5 billion.
The company is divided into six segments for reporting purposes:
- Pottery Barn (39.8% of 2016 revenues).
- Williams-Sonoma (19.7% of 2016 revenues).
- West Elm (19.1% of 2016 revenues).
- Pottery Barn Kids (12.5% of 2016 revenues).
- PBteen (4.7% of 2016 revenues).
- Other (4.2% of 2016 revenues).
The company’s brands are visualized below as a proportion of 2015 (not 2016) net revenues.
Source: Williams-Sonoma September 2016 Investor Presentation, slide 7
Each Williams-Sonoma brand specializes in a different area of luxury home furnishing.
Pottery Barn provides casual home accessories; Pottery Barn Kids provides baby furniture; PBteen provides teen bedding and accessories; and West Elm (the company’s fastest-growing brand) provides hip/modern furniture for young families.
Williams-Sonoma is also expanding into international markets.
While the majority of the company’s revenues still come from the U.S., Williams-Sonoma is entering new geographies via a combination of company-owned stores and franchised businesses.
Source: Williams-Sonoma September 2016 Investor Presentation, slide 10
Growth prospects
Unlike many retail companies, the growth prospects for Williams-Sonoma appear bright.
This is partially because of the rapid growth of West Elm. This brand, though only accounting for 20% and 17% of 2016 and 2015 revenues has had 20%-plus annual revenue growth every year since 2010.
Williams-Sonoma is taking advantage by rapidly increasing this brand’s store count.
Source: Williams-Sonoma September 2016 Investor Presentation, slide 9
The company’s management has guided for similar double-digit growth from West Elm moving forward.
William-Sonoma’s future growth will also be driven by the company’s impressive presence in the e-commerce space.
While ~90% of total sales across the broader home furnishings industry occur in physical stores, Williams-Sonoma has a much healthier revenue mix with approximately half of sales coming from e-commerce.
Source: Williams-Sonoma September 2016 Investor Presentation, slide 11
In addition to the cost savings that are generated in the e-commerce segment, Williams-Sonoma has found that multichannel customers (those that shop both online and in-store) spent 4x-5x more than their single-channel equivalents.
The company’s robust e-commerce presence did not happen overnight. Williams-Sonoma introduced its website in 2000 and has grown e-commerce sales at a 27% CAGR ever since.
Source: Williams-Sonoma September 2016 Investor Presentation, slide 12
The company’s strong West Elm brand and its leading e-commerce platform will drive the growth of Williams-Sonoma moving forward.
Competitive advantage and recession performance
Williams-Sonoma’s competitive advantage comes from the strength of its brands and its dominant e-commerce platform. These are the company’s key differentiators from other competitors in the retail space.
Unfortunately, the company has not proven itself to be recession-resistant.
This is partially due to the nature of the Williams-Sonoma business model. Consumers are simply not looking to replace their home furniture during periods of economic recession.
Further, the products offered by Williams-Sonoma tend to be at the high end of the quality scale. Consumers who need to buy new furniture during a recession may lower their expenses by shopping at a more affordable alternative.
Case in point: consider the adjusted earnings per share of Williams-Sonoma during the 2007-2009 financial crisis.
- 2007: $1.76 adjusted earnings per share.
- 2008: 28 cents adjusted earnings per share (84% decrease).
- 2009: 72 cents adjusted earnings per share (157% increase).
- 2010: $1.83 adjusted earnings per share (154% increase).
The adjusted earnings per share of Williams-Sonoma were nearly pushed into negative territory during the depths of the financial crisis, decreasing by 84%. It took the company until 2010 to achieve pre-crisis levels of profitability.
Based on this performance, the company should not be expected to outperform during periods of economic downturn.
Valuation and expected returns
The total expected returns achieved by Williams-Sonoma shareholders will be composed of changes to the company’s valuation multiple, growth in earnings per share and forward dividend yield.
Excluding various one-time charges, the company’s adjusted earnings-per-share for fiscal 2016 was $3.43. This equates to an adjusted price-earnings (P/E) ratio of 14.5 based on a per-share market value of $49.60.
This is an appealing value relative to the rest of the stock market.
The Standard & Poor's 500 P/E ratio sits at ~27, which means an investor can purchase nearly twice as much underlying earnings power by investing in Williams-Sonoma compared to buying an index fund.
Williams-Sonoma's P/E ratio of 14.5 is also appealing relative to the company’s historic levels.
Source: Value Line
Williams-Sonoma also appears undervalued based on dividend yield.
The company currently pays a 39-cent quarterly dividend, which is $1.56 annually for a forward dividend yield of 3.1% based on a market price of $49.60.
Source: Value Line
The last time Williams-Sonoma shareholders generated a dividend yield of 3.1% from this company was in 2009 – the middle of the great recession. Clearly, the company is a bargain today.
Turning to earnings-per-share growth, the company’s management has guided for an earnings-per-share growth target of "low double-digit to mid-teens."
Source: Williams-Sonoma September 2016 Investor Presentation, slide 27
While this is a wide range of possible outcomes, investors can conservatively expect earnings-per-share growth of 5% to 8% for this company. This will be aided in part by Williams-Sonoma’s shareholder-friendly capital allocation strategy.
Source: Williams-Sonoma September 2016 Investor Presentation, slide 26
Over the past six years, Williams-Sonoma has returned more than $1.7 billion to its shareholders via a combination of dividend payments and share repurchases.
Keep in mind this is not a very large company with a market capitalization of $4.5 billion. A substantial amount of capital for a company of this size is $1.7 billion.
For total returns in the range of 8.1% to 11.1% before the effect of valuation changes, Williams-Sonoma investors can expect total returns to be driven by:
- 5% to 8% earnings-per-share growth.
- 3.1% dividend yield.
Final thoughts
Williams-Sonoma is an interesting company: a brick-and-mortar retailer that gains ~50% of its sales from the online channel.
With the current state of the retail industry, it is not surprising that many high-profile investors have recently initiated stakes in this undervalued stocks. Some of the more well-known names include:
- Joel Greenblatt (Trades, Portfolio).
- David Dreman (Trades, Portfolio).
- Ray Dalio (Trades, Portfolio).
- Ken Fisher (Trades, Portfolio) (who owns nearly 10% of the company).
Other than the company’s appealing e-commerce presence, these investments are likely due to the company’s above-average dividend yield, low P/E ratio and strong growth prospects – which all mean that the company would likely rank favorably using The 8 Rules of Dividend Investing.
Disclosure: I am not long any of the stocks mentioned in this article.
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