Improving Consumer Spending Offers Upside For Williams-Sonoma

Jan.11.12 | About: Williams-Sonoma Inc. (WSM)

Early last decade, you couldn't change the channel on TV without coming across a design show. Credit was easy, unemployment was low and everyone was eager to update the look and feel of their homes. But recession changed our attitudes, and millions of Americans hunkered down, deciding to make do with their furniture and linens.

The trend toward domestic austerity hasn't faded. But, there are signs spending on the home is on the rise. In November, furniture imports increased 5%, driving containerized imports to their highest year over year gain since May. In the same month, consumer credit ramped by $20 billion from October, marking the single largest monthly gain since the end of 2001. In all, holiday spending increased by 3.5% from 2010.

In short, people started spending again, albeit timidly. This is good news for home decor stocks including Ethan Allen (NYSE:ETH), Pier One (NYSE:PIR) and Williams-Sonoma (NYSE:WSM), which make their money selling to design-conscious shoppers.

At Williams-Sonoma, spending growth on home items offers opportunity, particularly if it kick-starts its namesake kitchenware brand, which grew an unimpressive 0.1% in Q3 year-over-year. This segment has been weighing down growth at its West Elm and Pottery Barn Teen brands. Results for the brands were nothing less than impressive in the third quarter, when West Elm comparable sales rose 27%, and PBteen's comparable sales increased 18.1%. If Williams-Sonoma can remove the overhang from its kitchenware segment, earnings will grow handsomely.

Williams-Sonoma successfully navigated the downturn by aggressively shifting sales to higher-margin e-commerce and away from costly retail storefronts. The move paid off with 9-month direct-to-consumer segment sales hitting $1.01 billion in 2011, up from $986 million in 2010. It's e-commerce sales were particularly strong, increasing 14.6% in Q3. For comparison, U.S. non store retail sales increased 12.5% in the three months ending November.

This online growth increased e-commerce to 87% of Williams-Sonoma's direct sales. This shift allowed the company to cut costly catalog circulation, adding additional margin support. In Q3, Williams-Sonoma shipped 7.7% fewer catalogs and 3.3% less catalogs year to date. The company also shrank the size of its catalogs, with pages circulated dropping 8.8% and 3.5% for those same periods, respectively. This helped cost of goods drop to 61.8% from 62.4% year-to-date and SG&A fall to 30.7% from 31.6%.

Exiting the recession, the company took the painful and necessary step of shuttering non-performing stores. As a result, its leased square footage fell 4% from 2010. While a drop in square footage typically acts as a growth headwind, the company's retail comparable brand sales still climbed 6.3% and retail revenue rose 3.6% year-over-year in Q3. This suggests the company closed the right stores and succeeded in shifting affected customers to its direct channel.

If housing starts continue to improve and unemployment continues to drop, look for consumers to unlock some of their pent-up demand for updating homes. Given a leaner cost structure thanks to its online stores, a solid balance sheet and improving spending trends, the company offers shareholders an opportunity for upside.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ETH, PIR, WSM over the next 72 hours.