EUR 850.00 For Business Accounts Only

Morningstar | Williams-Sonoma Attracts Discretionary Spend Via Compelling Product; Shares Fairly Valued

Bolting on its fourth consecutive quarter of positive brand comp gains despite operating in the fragmented and competitive home furnishing industry, narrow-moat Williams-Sonoma's financial results evidence that its brand intangible asset continues to carry weight with its customers. We'd contend that the firm is gaining market share, growing its top line 6% over the quarter, with the furniture and home furnishing industry clocking an average 4% gain. Furthermore, over the last six months, the industry averaged 4.8% sales growth (Census) while Williams-Sonoma posted an impressive 7% hike. In our opinion, this is a function of efficient marketing, tactical promotions and smart partnerships, which motivate consumers to participate in the firm's umbrella of brands.

We don't believe Williams-Sonoma will take its foot off the innovation pedal, offering products that pivot with evolving consumer demands. However, this implies that spending in SG&A could remain inflated from recent levels (27.7% in 2017) as Williams-Sonoma invests to protect its brand. This also underlies our long-term outlook, which calls for top line growth that averages around 3.5% and operating margin that remains constrained to around 10% over the next decade, supporting high-single-digit earnings per share growth throughout our forecast. We don't plan any material change to our $68 fair value estimate and view shares as fairly valued, trading around 16 times our 2018 earnings per share estimate.

The second quarter was impressive on nearly all fronts, with sales increasing 6% supported by brand comp increases of 2% at Pottery Barn (the third consecutive quarter of positive comps), 1.6% at Williams-Sonoma (eighth straight quarter), 5.7% at PBkids/teen (fourth quarter), and a strong 9.5% at West Elm (marking 34 quarters of positive comp growth). While both sales of $1.27 billion and brand comps of 4.6% were at the high end of the company's prior guidance (for $1.25 billion-$1.27 billion and 3%-5%, respectively), the successful execution down the income statement led to better than expected EPS of $0.77 (versus our estimate of $0.71 and guidance of $0.65-$.70).

Strong sales growth offered operating leverage that was better than we forecast, at 6.8% (flat year over year and 40 basis points higher than we modeled), with gross margin rising 130 basis points to 36.5%. The largest contributor to this expansion was from selling margin benefit along with improved occupancy costs, along with new accounting surrounding revenue recognition changes. These accounting gains were offset in SG&A, which was slightly weaker than we anticipated, at 29.7%, deleveraging 130 basis points year over year, which was also hindered by higher digital advertising and higher wages.

Over time, we think three efforts the company is making today will help support operating margin expansion despite Williams-Sonoma’s exposure to a fragmented industry and a peer set that is willing to spend aggressively on customer acquisition. First, an improved loyalty program should help connect with the consumers that are repeat brand visitors. Since the Key (the cross-brand loyalty program) has been replatformed, enrollments have been growing at four times the pace of last year and spending has been five times the value of the Key rewards. Repeat customers could provide better advertising efficiency, lowering costs over time. Second, the ongoing retail transformation, through closing underperforming stores and remodeling and relocating others has allowed for new locations to outperform the company average in terms of profitability. The company noted that when the entire list of underperforming stores are closed, it should have the ability to generate 20 basis points in operating margin expansion annually. And finally, the potential for mix shift remains, with e-commerce representing 54% of total sales in the quarter. For reference, e-commerce operating margin clocked in at 20.6% in the second quarter versus retail operating margin of 6.6%. These significant opportunities help support our long term forecast for operating margin that reaches nearly 10% at Williams-Sonoma, about 100 basis points higher than 2017 levels.