Trading Williams-Sonoma: Scary Sales Print, But Monster Margins (NYSE:WSM)

Williams-Sonoma, Inc. (NYSE:WSM) is a stock that we traded in 2021 and have been running a long-term house position in for years. There have been positives, including a recent stock split to attract new investors, ongoing strength in the business despite a very questionable housing market, and the loss of the former catalyst of everyone staying and working at home. Through all of this, management has continued to execute.

We think weakness should be bought into the fall, especially if we get another market-wide selloff. A selloff is certainly in the cards seasonally, and we do have mixed economic data, as well as the volatility surrounding the election in the U.S. All of this, of course, is short-term noise. Leverage any weakness and consider going long. A “sample trade” like we do it our service is outlined below as one way to consider going long.

The Play

Target entry 1: $130-$132 (25% of position)

Target entry 2: $120-$121 (30% of position)

Target entry 3: $113-$115 (45% of position)

Stop loss: $85

Target Exit: $175

Options consideration: We think there are a number of options approaches that work here; however, such guidance is reserved for BAD BEAT members.

Discussion

In the past, Williams-Sonoma had always been a bit of a niche retailer. It is not the highest of higher-end merchandise, but also isn’t an affordable low-dollar big box store type name either. It falls in between a bit. That said, it is a great store for both the home and the office. The company just reported Q2 results, and the numbers were a bit mixed. However, the view going forward is still positive thanks to better-than-expected guidance on margins, despite a small revenue decline. Williams-Sonoma saw an income of $1.74 per diluted share. This was a strong beat of $0.13 versus consensus and rose from $1.56 a year ago.

Sales and Comps

The earnings beat actually came despite a very minor sales miss and sales that actually were down from last year (as expected). Sales in Q2 registered $1.79 billion and just missed consensus estimates by $20 million, and were down 3.8% from a year ago.

What about the all-important comps? Well, comparable sales were down 3.3%$ in total, but E-commerce remains strong. In fact, the digital strength of the company is underappreciated in our opinion. Now, looking at the segments, we saw declines in most except Pottery Barn Kids. We saw West Elm comps decline 4.8%, but better than the 20.8% decline a year ago. We saw Pottery Barn comps down 7.1%, but better than down 10.6% a year ago. And Pottery Barn Kids and Teens were strong, seeing 1.5% comp growth versus a decline of 9.0% a year ago. The flagship Williams-Sonoma brands were down marginally, slipping 0.8%. So, while comps are down, we actually think it is clouding the big story here, and that is tremendous margin expansion.

Gross margin came in at a whopping 46.2% which is outstanding in retail. This was up 550 basis points from last year. This solid margin improvement was driven by higher merchandise margins up 380 basis points as well as supply chain efficiencies that added 180 basis points. Further, occupancy costs were $197 million, down -3.0% versus a year ago. This led to a guidance increase, which we will touch on, but the balance sheet is also in great shape.

Balance Sheet in Great Shape

Williams-Sonoma still has a strong balance sheet. Williams-Sonoma had a strong liquidity position of $1.3 billion in cash, including approximately $246 million in operating cash flow resulting from strong performance. What is more, there is no long-term debt here. That is a win. The company is also very shareholder-friendly. In the quarter, the company was able to repurchase an additional $130 million in shares.

The company is also a serial dividend raiser. The dividend has been hiked once again, and now is $0.57 quarterly (or $1.04 before the split), up from the $0.71 it was paying (pre-split) when we first got involved. The yield is a moderate 1.6%, but this is a dividend growth name, and we love owning stocks like that for the long term. This is especially true for a house position that we own with profit for a lifetime.

Valuation and Final Thoughts

From a valuation standpoint, we mentioned enjoying a growing dividend with a 1.6% yield while waiting for shares to move higher. The dividend is secure and likely to see increases as we move year to year. The growth in profit power is impressive, but so is the valuation. Sales this year will be down 1-4%, but management has raised guidance on operating margin for fiscal 2024. Management now expects an operating margin between 18.0% to 18.4%.

Now, over the long term, we think that you can continue to expect mid-to-high single-digit annual net revenue growth from this company, with an operating margin in the mid-to-high teens. As for fiscal 2024 EPS, we see this metric coming in at $8.40 to $9.00 on this margin guide, depending on the degree of sales. This puts the stock at just 15X FWD EPS, which is incredibly attractive in our opinion. If Williams-Sonoma, Inc. shares decline further, consider building a position.