Williams-Sonoma: A Great Business At A Fair Price

| About: Williams-Sonoma Inc. (WSM)

Summary

Downgraded by the market analysts at the beginning of the year, Williams-Sonoma's market share dropped too harshly.

Williams-Sonoma is a strong and profitable company. ROE and ROIC increase every year since 2009 and were both around 25.6% in 2015.

Williams-Sonoma is a shareholder-friendly company. The annualized paid dividend increases annually by 13% on average for 10 years and is largely covered by the earnings.

With 37% margin of safety based on a discounted cash flow analysis, this is a great business at a fair price.

Corporate Profile: A Multi-channel Specialty Retailer

Williams-Sonoma Inc. (NYSE:WSM) is a multi-channel specialty retailer of high quality products for the home. Williams-Sonoma was founded in 1956 by Chuck Williams who opened a store in Sonoma, California, to sell a French cookware.

With 2015 revenues of €5.0 billion, Williams-Sonoma Inc. is one of the U.S. largest specialty retailer which currently operates directly in the United States, Canada, Puerto Rico, Australia and the United Kingdom and indirectly in a number of countries in the Middle East, the Philippines and Mexico via its franchised network. The U.S. market is Williams-Sonoma's core market as 94% of the earning before income taxes come from the United States.

Williams-Sonoma Inc. groups its operations into two main business segments:

  • The E-commerce segment, which posted $2.5 billion in revenues in FY 2015, comprises Williams-Sonoma's products sold through its e-commerce websites direct-mail catalogs. The products of Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, PBteen, Williams Sonoma Home, Rejuvenation and Mark and Graham are sold via this dematerialized channel distribution.
  • The Retail Segment, which generated $2.5 billion in revenues in FY 2015, sells through traditional retail stores the products of their following brands: Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation.

Either via the Internet or via the traditional retail stores, the products are marketed under the following brands:

  • Pottery Barn, which posted $2.1 billion in 2015, is a premier multi-channel home furnishings retailer acquired by Williams-Sonoma in 1986. Pottery Barn products include furniture, bedding, bathroom and other decorative accessories.
  • Williams-Sonoma, which generated $1.0 billion in 2015, is the original brand of the company and is a specialty retailer products for the kitchen and home.
  • West Elm, with $0.8 billion in 2015, sells local and handcrafted products.
  • Pottery Barn Kids, with 2015 total revenue of $0.6 billion, offers products to decorate nurseries and bedrooms of the children.
  • PBteen, which posted $0.3 billion in 2015, is focused exclusively on the teen market by offering a complete line of furniture, bedding and other accessories for teen bedrooms.
  • Rejuvenation, Mark and Graham and international franchise operations, with $0.2 billion in 2015, remain a small aggregated line of business in spite of a 50% YoY increase.

Competitive Position: Sound Presence In Chosen Markets

We view Williams-Sonoma's competitive position as strong. Revenues grow every year at around 7-8% on average. Even if Williams-Sonoma's business is heavily concentrated in the U.S. (94% of the earnings before income taxes), the abroad business has increased constantly since 2013 (a 31% increase from 2014 to 2015). However, the company remains prudent and is still concentrated on its core market. Furthermore, the company has successfully developed its e-commerce segment which represents now more than 50% of the total revenues and grows faster than the traditional segment does.

Operating Performance: Focus on Operating & Cash Efficiency

Gross margin is stable over time (at 38.0% on average). ROE and ROIC have also increased every year since 2009 and were both around 25.6% in 2015. Furthermore, the free cash flow has increased by 33% per year on the same period. All these metrics are growing thanks to the efforts of the management to increase e-revenues (only 43.9% of the revenues in 2011) and to decrease administrative expenses.

Stock Repurchase Program and Dividend: A growing Dividend over the Years and A Smart and Accretive Stock Repurchase Program

From 2006 to 2015, the annualized paid dividend increased annually by 13% on the average. As the payout ratio is quite conservative over the years (around 41% of the net income), we are confident on the sustainability of the dividend and are expecting a constant but prudent increase of the paid dividend in the future.

Furthermore, the outstanding shares have been reduced by 13.6% to 92 million via a smart and active repurchase program set up by Williams-Sonoma's management. During the last three years, Williams-Sonoma repurchased 10,626,957 shares of its common stock at an average cost of $64.8 per share. In addition, Williams-Sonoma's Board of Directors had authorized a new stock repurchase program to purchase up to $500,000,000 of Williams-Sonoma's common stock over the next three years. Regarding the current share price (almost at the same level as in 2013, when Williams-Sonoma repurchased more than 4 million of its own shares), we consider that the management could purchase at least 3 million of shares during fiscal 2016, reducing accordingly the number of outstanding shares by more than 3%.

Stock Valuation: A Widely Undervalued Company

We based our calculation on the net earnings.

Furthermore we considered the following assumptions:

  • Growth rate for the 10 next years: 10%
  • Growth rate from the 11th to 15th year: 4%
  • Terminal Growth Rate: 4%

We based our assumption on the historical evolution of the net earnings.

By conservatism, we considered that the growth rate for the last 5 years would be equal to the terminal rate.

We set up 12% as discount rate, considered as a market standard.

The intrinsic value per share we have calculated is $66.54 or a 32% safety margin compared to the current share value.

Furthermore, we have also decided to take into account the impact of the repurchase stock program. Indeed, we do not believe that the company will not purchase its own shares regarding the current market value and the number of shares it purchased the last three years. We used the same assumptions and considered that 3 million of shares would be repurchased.

The intrinsic value per share we have calculated is $68.78 or a 37% safety margin compared to the current share value.

We also analyzed the EV/EBITDA metric. Based on EoY 2015 data, EV/EBITDA was 6.85 for Williams-Sonoma. The sector average (Retail - Special lines) was at the same period 8.81.

Regarding the calculations we performed and our analysis and the EV/EBITDA, we cannot believe that Williams-Sonoma values intrinsically $50.25 per share (market value on 17 May 2016). We believe that the share is undervalued at least by 30%.

Conclusion

Undervalued firm, Williams-Sonoma is a well-capitalized and low-debt company which grows every year and rewards its shareholders by increasing year after year the annualized quarterly dividend and repurchasing its own shares. This is absolutely and definitively a great business at a fair price.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WSM over 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.