Notes for readers
Most of the figures are based on the latest quarterly results of Williams-Sonoma (NYSE:WSM) or on the financial documents of the other mentioned companies
The Swan Song Of The Brick & Mortar Stores?
The comparable revenue in Q3 2016 decreased 0.4% compared to 4.5% growth in Q3 2015.
Source: Q3 2016 Williams-Sonoma's Press Release
As shown in the table above, Pottery Barn, PB teen were the most impacted brands as the revenues coming from these both branches dropped respectively by 4.6% and 10.9% compared to last year. West Elm is the only branch which continues to growth, the revenues from Williams-Sonoma band being stable (only a 0.1% increase compared to Q3 2015). Furthermore the e-commerce net revenues represent now 52.1% of the total revenues of the company while it represented only 51.1% last year, following the same trend than the one observed during the last three years (an increase of the revenues coming from the e-commerce segment). This trend is even more significant if we compare only Q3 evolutions. From Q3 2015 to Q3 2016, the retail revenues decreased by 1.2%, offset by the 3.3% increase of the e-commerce revenues. On year-to-date basis, the total revenues increased by 3.3% mainly driven by the positive trend on the e-commerce segment (+5.4%) while the retail segment revenues increased slightly (+1.1%).
Regarding the number of the number of stores, Williams-Sonoma seems to focus its development on the West Elm brand (13 new stores and only two closed stores), Rejuvenation (1 new store), while for the other brands, the number of planned closed stores represent half or more of the planned store opening. The store closing program mainly for Williams-Sonoma brand may not a bad move if the company increases slightly its margin by closing the less profitable stores. Furthermore, the company introduced The Key, our first cross brand loyalty program. The management is confident on this program to improve the ability of the company to deliver a more relevant experience across all its brands. In our view, improving the customer experience remains the best solution to increase the revenues of the retail segment which is not yet dead. However the company should not sacrifice its margins by providing more discount to its customers. The impact of The Key should be analyzed to assess if it was a good strategic decision or not.
Goodbye Underperforming Brick & Mortar Shop Segment?
Gross margin was 36.8% in Q3 2016 versus 36.6% in Q3 2015. Compared to Q2 2016, the gross margin increased by 1.4 percentage point. On year-to-date basis, the gross margin is lower than last year and reaches to 36.0% (36.5% in 2015 YTD), still impacted by the Q2 2016 operating performance.
The GAAP operating margin and Non-GAAP operating decreased respectively by 0.2 percentage point and 0.1 percentage point to 8.8% and 8.9%. The decline of the operating margin is driven by the decline of operating margin of retail segment (from 8.1% to 7.9%) and the negative impact of unusual business events due to severance-related reorganization charge. These two negative impacts were partially offset by the increase of the operating margin of the e-commerce segment (1.2 percentage point increase to 23.1%).
By channel, the evolution of the operating margin in the e-commerce segment and in the retail segment could be explained as follows:
- In the e-commerce channel, the 1.2 percentage point improvement is primarily associated with higher gross margins resulting from improved year-over-year shipping and fulfillment related costs as a result of Williams Sonoma's focus on all of its supply chain and inventory initiatives.
- In the retail channel, the 20 basis point deterioration is mainly driven by the lower gross margins from occupancy deleverage, partially offset by SG&A leverage. However, it is important to note that the Q3 2016 operating margin improved compared to Q2 2016, as last quarter the retail margins were impacted by the decisions of the company to more aggressively liquidate the less profitable products.
In our view, if the company is continuing to put some efforts on the cost reduction side, Williams-Sonoma could restore its operating on the retail segment. On e-commerce segment level, the operating margin could not be indefinitely improved but we could expect Williams-Sonoma to maintain a 23% operating margin. However it is also important to remain prudent regarding the year-to-date figures. With a 5% decrease of the net earnings, the profitability of the company remains dependent from margin level and could not indefinitely offset by the stock repurchasing program.
A Smart & Accretive No-Brainer Approach Regarding Stock Repurchasing Program and Dividend Policy
As every quarter, Williams-Sonoma repurchased a part of its own shares and paid a quarterly dividend. During the third quarter, the company returned to its shareholders $72 million consisting of $39 million in stock repurchases and $33 million in dividends. Williams- Sonoma repurchased 771,327 shares of common stock at an average cost of $50.56 per share. As of October 30, 2016, there was approximately $447 million remaining under Williams-Sonoma's current stock repurchase program. Regarding the paid dividend, Williams decided to keep it stable at $0.37 per share.
In our view, we expect Williams-Sonoma to maintain its dividend policy and will pay in Q4 a $0.37 per share dividend and continue repurchasing around 700,000 shares to reach 88 million of outstanding shares. Depending on the final year results, the both evolution of the margins of the different segments and the evolution of the free cash flow level and constant decrease of the outstanding shares, we could also expect Williams-Sonoma to increase its annualized dividend by 3%-5%.
Undervalued? Overvalued? Let's Talk about Money!
Seven months ago, the estimated intrinsic value in that article was $66.54 per share. We could draw some conclusions:
- As spotted by Terd Ferguson, the taken assumptions were definitely too optimistic
- Considering only DCF as a valuable method was also imprudent
- Not considering a worst-case scenario with DCF method was not enough prudent
Regarding the above comments it is important to say mea culpa. The safety margin might be lower than expected. So what is the intrinsic value of the company? Let's start by learning from our mistakes and let's consider three DCF scenarios:
- Best case: a 4% increase of the earnings for the next 15 years and a 0% termination growth rate
- Base case: a 2% increase of the earnings for the next 15 years and a 0% termination growth rate
- Worst case: a 2% decrease of the earnings for the next 15 years and a 0% termination growth rate
- Historical Ratios: P/E, Price/Sales and Price/Book
- Valuation Multiple: EV/EBITDA, FCF yield and EV/Revenue. As a peer review, we have chosen the following companies: Bed Bath & Beyond Inc., The Michaels Companies Inc. (NASDAQ:MIK), Pier 1 Imports Inc. (NYSE:PIR) and Macy's (NYSE:M). Even if Macy's is a bigger and more diversified retailer, we have decided to keep it in our peer review.
Regarding the implicit value calculated through a weighted average of the three valuation approaches, Williams-Sonoma seems to not be undervalued at all! If Williams-Sonoma is a profitable company, there is no safety margin. Maybe the implicit value calculated above is as incorrect as the one calculated last time. That's why, for the sake of prudence, an investor should wait for a punishment from Mr. Market or for the release of the Q4 results. And Mr. Ferguson, thanks a lot for your quite rough but meaningful comment ! Only fools never change their minds.
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.