Williams-Sonoma: Time To Double Down?

| About: Williams-Sonoma Inc. (WSM)

Summary

Williams-Sonoma has successfully integrated a world-class e-commerce website into its sales mix, currently providing 50% of company revenues.

Analyst expectations have been missed, and guidance has been set lower than expected, leading to a 40% drop in WSM since August of 2015.

Competitive pressures and macroeconomic risks plague WSM and pose long-term risks to the company's profitability moving forward.

Williams-Sonoma Inc. (NYSE:WSM) is a high-end home furnishings company which has dominated the fragmented home furnishings category on a quest to take over the vast majority of market share in this market segment. WSM has recently fallen out of grace with investors, and has fallen approximately 40% from its peak in August 2015. We will take a deeper look into the reasons why WSM has fallen so sharply over the past six months, and assess what sort of value may be had from picking up this stock at its current levels.

Getting the Internet Right

WSM has successfully integrated its e-commerce platform into its business model, with approximately 50% of total sales coming from its online platform. Additionally, the huge database of high-income consumers compiled by WSM, along with a world-class web marketing and analytics platform, position WSM to continue to incrementally grow its e-commerce market share and continue to be the dominant player in the online high-end home furnishings market.

Other physical retailers have been struggling to find the right mix of online e-commerce sales, and physical retail sales growth to grow the top line responsibly into the future. Giants such as Wal-Mart (NYSE:WMT) have been aggressively ramping up the development of their online platform, but nearly all traditional bricks and mortar retailers are feeling the sting of losing an increased amount of American retail market share to online platforms and companies like Amazon (NASDAQ:AMZN). The need to continue to integrate such e-commerce platforms to survive and be profitable in the long-run is a long-term issue taken very seriously by WSM. We like WSM's proven commitment to its online e-commerce platform and view WSM's strong e-commerce sales numbers as a short-term indicator of stability and a long-term understanding of what WSM will need to do to survive and be profitable in the long-run.

Incubating Great Brands

Another thing WSM has done better than many other companies in its space is incubating and integrating brands within its portfolio successfully. The West Elm integration is a great example of Williams-Sonoma broadening its product range and brand portfolio while maintaining relatively high gross margins. Many brand acquisitions and subsequent integrations into parent company portfolios result in diminished margins and a lack of focus, but WSM has done well to strategically integrate this brand into its existing infrastructure, increasing sales per square foot in its retail stores, and bolstering its online offering, further driving top line growth.

Growing Presence Overseas

We like WSM's commitment to expanding global market share. WSM has done a fantastic job of continuing to maintain its primary focus on the U.S. market, but has branched out successfully in the U.K. and Australia, growing overseas sales YOY at a considerable rate. We will continue to monitor WSM's global growth strategies moving forward, but generally view this direction as a positive for the company in the long-term.

Why Has Williams-Sonoma Stock Price Crashed So Significantly?

Williams-Sonoma is an example of a great growth company that has grown revenues and earnings at a remarkable above-market rate for an extended period of time. The company's impressive growth rate until this time last year led some analysts to believe that WSM could double in size YOY. Analyst expectations of above-market growth in top and bottom line financials have led to an ever-increasing bar WSM has been forced to meet, and has done so successfully until August of 2015.

Analyst Expectations

On August 26, management guidance for the rest of 2015 was much lower than analyst expectations, leading the stock price significantly lower for the first time in almost five years. In mid-November, the company matched its guidance for Q3, however the market, expecting out-performance, further viewed this "meet expectations" earnings hit as a negative surprise, and the stock price continued to move lower. Only matching company guidance was a shock to many analysts hoping for a return to form, and the 80 bps gross margin miss in Q3 was taken rather seriously by many analysts, providing further downward pressure to the WSM stock price. Goldman Sachs lowered its outlook for Q4 2015, and other analysts followed suit.

Inventory Issues

One of the prevailing threats in retail, and even more so in the high-end retail segment, is the seasonality of inventory and the need to create room for next season's products. Williams-Sonoma's gross margins miss can be attributed to a number of key factors, primarily inventory mismanagement and an increased percentage of discounted inventory due to over-purchasing from suppliers in Q2 and Q3 2015. Over the course of the winter, a number of boutique firms further downgraded WSM stock, stating one of the primary threats to WSM being a glut of inventory and further discounting and losses in gross margin hampering earnings growth moving forward.

Competition

WSM is undoubtedly competing in a very competitive space. Wayfair.com is an example of a company with very similar products, offering a range of lower-quality substitutes at a 50% discount to WSM. HomeGoods from TJX (NYSE:TJX) is another competitor which has been taking market share away from WSM, and a number of other high-profile retailers are expanding their product lines to compete in this space due to the relatively high margins offered in this sector. WSM has a very unique and broad product offering, and while we like WSM's product lines relative to its competitors, we do view increased competition and especially competition from lower-cost competitors, as a significant risk for WSM in the long-run.

Macro-Economic Outlook & Risks

Looking forward to the short and medium-term expectations of the market, we look at the Fed continuing to raise interest rates as one of the key indicators of how robust consumer spending on high-end home furnishings will be. If the Fed continues to raise interest rates on schedule (two to four increases in 2016), variable mortgage rates will spike, hurting American disposable income, leading to an increased search for lower-price or lower-quality substitutes for WSM products. We see such a threat to WSM as being both realistic and potentially long-term, and WSM will need to focus on differentiation strategies to combat this threat accordingly.

Additionally, many of the physical retail stores operated by WSM are mall-based, and we view the macroeconomic trend of further reductions in mall revenues coinciding with increased online retail sales growth as both a risk and an opportunity for WSM. If WSM is able to continue to effectively and successfully grow its e-commerce platform, we believe WSM may be able to mitigate this risk in the long-term and find the equilibrium level of online vs. bricks and mortar sales to continue to grow rapidly in the long-run.

Conclusion

Williams-Sonoma's current price/earnings ratio of 16 is much lower than its historical average, and on par with other high-end home furnishings companies. We like the long-term appeal of WSM as a dominant market player in the high-end, high-margin home furnishings sector, and will maintain a "wait and see" strategy with respect to this stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.