WSM - Williams Sonoma

[LC]

Just putting this thread up here, I plan on taking a deeper look in the next few days.

 

Company has been listed since the mid 80s.

 

Revenue has grown annually coming out of the financial crisis, although it took them a bit longer to stabilize (into 2010). Probably due to consumer spending habits more than anything.

 

Gross margins around 37%

 

Operating cash flows around 450-550MM range, about 200MM of annual capex.

 

Have been paying an uninterrupted increasing dividend since 2006.

Have been net buyers of their own stock since 2011.

 

Currently trading around 13x earnings, or maybe 14-15x adjusted earnings.

 

Anyone have followed or has some thoughts? This is just a cursory glance.

[thepupil]

the short thesis is that they make/made great margins online and not so much in stores and that they'll face competition going forward...and it's a retailer that's ticker is not AMZN..ergo it's a short

 

https://www.valueinvestorsclub.com/idea/WILLIAMS-SONOMA_INC/138362

 

Nothing else to add, but that's why 20% of the float is short and the company has re-rated. I don't really invest in operating businesses or take views on them too much so I have no insight to offer. Just stating the (perhaps obvious) key issue.

 

My wedding guests probably spent $5K there on our registry so I'm doing my part to help out!

[LC]

Thx for posting! A good read as I am just starting to look at the company and have not gotten comfortable one way or another.

[KJP]

I looked at Williams Sonoma briefly last year.  I thought that there was a significant risk that the economics of the business would continue to decline, particularly because of Wayfair. 

 

Here's a high level summary of the company's income statements for 2012 and 2016:

 

Category: 2012/2016

Revenue: $4,042 billion/$5,083 billion

Gross Profit: $1,592 billion/$1,883 billion

Gross Margin: 39.4%/37%

Operating Income: $409 million/$472 million

Operating Margin: 10.1%/9.3%

 

So, over those five years, the company lost 240 bps of gross margin, but only 80 bps of operating margin, meaning they managed to cut SG&A by 160 bps.  The bulk of that savings came from cutting advertising, which fell more than 100 bps (the raw numbers are $318 million in 2012 and $347 million in 2016). 

 

Meanwhile, during that same timeframe, Wayfair (perhaps the company's most dangerous competitor) ramped it's advertising spend from $65.5 million in 2012 to $409 million in 2016.  That spending helped Wayfair's revenue explode from $600 million to $3.8 billion.  In other words, Wayfair grew from a pimple to a company nearly as large as Williams Sonoma in just five years, and it's continuing to grow rapidly.

 

But it wasn't just advertising spend that allowed Wayfair to grow so rapidly.  It's also it's negative working capital business model.  For example, Wayfair generated $3.8 billion in sales on essentially no inventory, while Williams Sonoma had to carry about $1 billion in inventory to generate $5 billion in sales. 

 

Finally, Wayfair's business model is to sell at about 25% gross margins.  I don't know whether Wayfair will ultimately be successful with that approach, but because of the negative working capital nature of the business model, they are able to suck up a tremendous amount of industry sales without burning alot of cash.  So, while Wayfair may ultimately turn out to be not particularly profitable, it can inflict alot of pain on everyone else while it figures that out.

 

So, in a nutshell, I saw in Williams Sonoma a company that is likely to face continuing gross margin contraction and the main lever it has pulled to deal with that in the past (cutting advertising spend) is only further strengthening the competitor that is pressuring gross margins.  I don't think that's a good position to be in.

 

Finally, you mentioned the dividend and stock buybacks.  That type of capital return appears to be management's strategy.  It's difficult to go to war with Wayfair when you're following that type of capital allocation strategy.

 

[rb]

Thanks KJP. I was looking at Williams Sonoma too the other day and was intrigued. Was getting ready to do a deep dive. Your comment saved me a lot of time.

[KJP]

I looked at Williams Sonoma briefly last year.  I thought that there was a significant risk that the economics of the business would continue to decline, particularly because of Wayfair. 

 

Here's a high level summary of the company's income statements for 2012 and 2016:

 

Category: 2012/2016

Revenue: $4,042 billion/$5,083 billion

Gross Profit: $1,592 billion/$1,883 billion

Gross Margin: 39.4%/37%

Operating Income: $409 million/$472 million

Operating Margin: 10.1%/9.3%

 

So, over those five years, the company lost 240 bps of gross margin, but only 80 bps of operating margin, meaning they managed to cut SG&A by 160 bps.  The bulk of that savings came from cutting advertising, which fell more than 100 bps (the raw numbers are $318 million in 2012 and $347 million in 2016). 

 

Meanwhile, during that same timeframe, Wayfair (perhaps the company's most dangerous competitor) ramped it's advertising spend from $65.5 million in 2012 to $409 million in 2016.  That spending helped Wayfair's revenue explode from $600 million to $3.8 billion.  In other words, Wayfair grew from a pimple to a company nearly as large as Williams Sonoma in just five years, and it's continuing to grow rapidly.

 

But it wasn't just advertising spend that allowed Wayfair to grow so rapidly.  It's also it's negative working capital business model.  For example, Wayfair generated $3.8 billion in sales on essentially no inventory, while Williams Sonoma had to carry about $1 billion in inventory to generate $5 billion in sales. 

 

Finally, Wayfair's business model is to sell at about 25% gross margins.  I don't know whether Wayfair will ultimately be successful with that approach, but because of the negative working capital nature of the business model, they are able to suck up a tremendous amount of industry sales without burning alot of cash.  So, while Wayfair may ultimately turn out to be not particularly profitable, it can inflict alot of pain on everyone else while it figures that out.

 

So, in a nutshell, I saw in Williams Sonoma a company that is likely to face continuing gross margin contraction and the main lever it has pulled to deal with that in the past (cutting advertising spend) is only further strengthening the competitor that is pressuring gross margins.  I don't think that's a good position to be in.

 

Finally, you mentioned the dividend and stock buybacks.  That type of capital return appears to be management's strategy.  It's difficult to go to war with Wayfair when you're following that type of capital allocation strategy.

 

Williams-Sonoma is up big today to $85/share at one point.  With dividends, that represents a CAGR of about 25% in the roughly three years since I wrote the quite skeptical post above.  In other words, great returns for WSM shareholders.  Given that I implied that shareholder returns would more likely be single digits annually (or worse!), I think it’s worth a post-mortem on why I got the last three years of returns on WSM so wrong.

 

My 2017 thesis was that WSM was facing a competitor in Wayfair that would continue to grow very fast because of, among other things, its negative working capital business model and willingness to sell at lower gross margins than WSM.  To me, this implied that WSM’s gross margins would continue to erode and it would not be able to continue to make up for that by cutting advertising.  As a result, WSM’s operating margins would continue to decline, causing revenue growth not to produce significant additional profits. 

 

Despite what you’d expect from WSM’s share performance, that is a fairly accurate prediction of what has happened.  Wayfair’s sales have continued to explode from $3.38 billion in 2016 to $9.13 billion in 2019 (that includes some non-US business).  That has allowed Wayfair’s advertising budget to grow from $409 million in 2016 to $1.1 billion in 2019 (again, includes some non-US advertising).

 

Meanwhile, WSM hasn't exactly been firing on all cylinders.  Here's an update of the WSM chart I included in my original post to include its 2019 numbers

 

Category: 2012/2016/2019

Revenue:  $4,042 billion/$5,083 billion/$5,898 billion

Gross Profit: $1,592 billion/$1,883 billion/$2,139 billion

Gross Margin: 39.4%/37%/36.3%

Operating Income: $409 million/$472 million/$466 million

Operating Margin: 10.1%/9.3%/7.9%

 

As predicted, WSM had continued gross and operating margin compression, leading to roughly flat EBIT despite a 16% increase in sales between 2016 and 2019. 

 

At the time of my 2017 post, WSM was trading at roughly $45/share and had bout 86.7 million shares outstanding, for a market cap of $3.9 billion, no financial debt and about $100 million in cash.

 

Today, there are about 77.2 million shares outstanding and they traded today at $85/share, for a market cap of about $6.6 billion, with $861 million in cash and $786 million of debt. 

 

So, despite apparently deteriorating economics, stagnant operating profit and COVID-19 uncertainty, people are willing to pay 70% more for WSM’s business than they were three years ago.  What is going on here?

 

Well, one big item I omitted is taxes.  WSM is a US business, so tax reform was quite helpful.  The 9.3% operating margin in 2016 produced a 6% net margin, while the 7.9% operating margin in 2019 also produced a net margin of 6%.  Because revenue was up 16% between 2016 and 2019, net profit was also up 16% (from $305 million to $356 million). 

 

As the falling share count discussed above suggested, the company's buybacks also reduced its shares outstanding by about 11%.  Combine the increase in net income with the decreasing share count and you get a 31% increase in earnings per share from $3.51 to $4.61 (these are slightly different than what’s reported in the annual reports because I’m using year end share counts, rather than weighted averages).

 

Based on a $45 share price and $3.51 per share in earnings, WSM was trading at 13x earnings in 2017, not obviously wrong for a company that appeared then and continues to appear now to have rather stagnant or perhaps even deteriorating economics.     

 

At 13x 2019 earnings of $4.61, WSM would be trading at about $60/share.  But today, it hit $85 per share, putting it at about 18.5x 2019 earnings.  For a bit of context, in July 2017, the yield on the 30-year US Treasury was about 2.9%.  Today it’s about 1.4%.

 

I’m not sure what lessons should be gleaned from all of this.  On the one hand, thus far I appear to have been roughly right on the trajectory of WSM’s business, and most of the shareholder returns appear to be attributable to (i) tax reform that couldn’t be known at the time (the tax cut didn’t pass until 5 months after my post), and (ii) multiple expansion, which seems a rather flimsy foundation for an investment in a stagnating business that isn’t trading at a single-digit multiple.  On the other hand, everything in the preceding sentence sounds like a stubborn mind trying to paper over the fact that it was wrong. 

 

I welcome input from anyone who has followed WSM and can offer any further insight about whether, given the information known at the time, an investment in the company in July 2017 would have been wise or foolish.

 

[BG2008]

I should be doing work, following up with people etc and not responding to this.  But here I am. 

 

I cook a lot, think Instant Pot, Stargazer Cast Iron Pans, and I just bought a 15 lb veal breast from Baldors last week.  I love browsing William Sonoma.  I just love the store.  But I only buy from their bargain bin and some of the small tools.  I look for deals.  That is simply who I am as I grew up learning to buy off price and to shop at restaurant supply stores.  I have been toying with starting a "ValuEats" cooking channel that explores cooking the rare cuts of meat like hangar steak, oxtail, veal breast, chicken thighs, etc. 

 

When I go to the mall with my wife and kiddo, I always stop by William Sonoma.  Most of the time, it is just to pick up a veggie peeler, a cookbook, or some sort of specialized tools like a nut cracker for cracking lobster claws.  I love the experience.  Everything in the store is well curated.  It is very well laid out.  They will even boil mulling spice with cinnamon during the fall.  It smells like a yummy apple cider factory.  I know I know, I sound like a British grandma.  What do you expect from a guy who cooks about 10-18 meals a week and often for his whole family? 

 

What you can expect from buying stuff from William Sonoma is that everything in the store is quality made.  When you get to be my age, late 30s, you learn to buy the higher quality knives, peelers, pots, pans, spatulas etc.  Because why deal with the aggravation of something not working?  If you want sturdy and precise kitchen tools, pay up for them.  You buy it once and you will likely leave it to your kids.  I intend to give my son my Stargazer cast iron pan.  Those are heirlooms.  I know I sound really British.  So I am not their prototypical customers, but I deeply appreciate the experience, the quality, and the curation of their products.  They have a way of arrange ceramics, dishes, knives, spices, etc.  I'm a sucker for a beautiful and functional kitchen. 

 

I almost forgot there's Ruth who works there. She is always the opposite of Karen.  She's asking me if I need help.  I bragged to her about how I make pho with oxtail, beef bones, and brisket with charred ginger, onions, and toasted cinnamon, star anise, and cloves.  I told her that the onion breaks down and the cloves gets everywhere.  So she shows me a mulling spice ball.  They literally sell a mulling spice ball that holds the onions and the spices together while you simmer the oxtail and bones for 3-4 hours.  Jackpot!!! This is a very high end experience! This is a fun and a pleasure to shop at.  Ruth is very helpful.  They are knowledgeable.  Ruth jokes with me if I am going to invite her over for dinner.  I almost did. 

 

https://www.williams-sonoma.com/products/mulling-spice-ball/?sku=4114336&cm_ven=PLA&cm_ite=4114336&cm_cat=Google&cm_pla=Local&gclid=CjwKCAjw5cL2BRASEiwAENqAPsqOMx9FRUGl8vJDxTxDOaNzTUliCgujIS3ctcRwEedwL3rq0asOTxoCxJkQAvD_BwE

 

For those people who don't know that they can get very good knives on sale and build products over time, I am sure that WS is a great place for newly weds to register their wedding.  For those on the high end/luxury side, it is a much better experience to shop at WS.  I can't imagine the serious cooks going to Walmart and asking a 18 year old on minimum wage to help them pick out a mulling spice ball or why Le Creuset cast iron pots are great for stir frying at home because the cast iron pots retain so much heat that it in essential mimic the 1 giga BTU that comes out of a wok at a Chinese restaurant. 

 

Hope this is helpful from a qualitative aspect. 

[sleepydragon]

Yeah, missed this one. Up 3x from low.

When TT bought RH, my wife wondered when they didn’t buy WSM instead. She likes the furnitures at Pottery Barn. They are copycat of RH but are made with better and more consistent quality and at cheaper prices.

 

[SHDL]

I like the stores too and often visit them when my wife is shopping at other, more challenged retailers in the mall.

 

One problem with quality cookware though is that they tend to be one-off purchases. You buy a nice pot and it lasts you a lifetime if not multiple generations. That is not good for business. People were worried not too long ago that iPhones were so well made that Apple’s long term revenue was destined to fall off a cliff. I think that “problem” is quite relevant here, though yes they do sell other things that depreciate faster. 

 

Anyway I think what happened with the stock is that it was part of a very popular trade (“long AMZN, short anything else retail”) that subsequently got unwound to an extent as the survivors in the space became apparent. You can see some evidence of this if you look at how the short interest in not just WSM but also WMT, TGT, COST, TJX, etc, spiked around 2017. (Edit: see thepupil’s post from 2017 above too)

[rb]

KJP,

 

In order not to spam the thread I will not quote your whole post.

 

I will say this. I looked at your analysis in 2017 and passed on WSM. Looking back I don't regret doing that. The stock is higher. But I don't invest in stocks, I invest in businesses. The business doesn't seem to me to be a much better than back then. The just levered up (from a very conservative position i will concede), did some accretive EPS stuff, etc. But really it just looks like the same business just at a higher price. So I'm good.

 

On the model, just like BG I tend to cook a lot and I absolutely love WSM stores. I just don't buy a lot from there - I'm thinking that value investors are probably not their target customer. I do appreciate high quality kitchen tools but i find that I can usually buy them at a fraction of what I would spend at WSM if you know what you need. You can get basics at Wal-Mart, Canadian Tire (hardware/homeware store) regularly has deep sales of some really good stuff, and I absolutely love Think Kitchen gear (Canadian kitchen producer/retailer). I don't think Think Kitchen has been very successful but their stuff is really good.

 

Aside from that I will say that at this point after reading the posts a dinner at BG's place sounds pretty awesome!

[Spekulatius]

Yes, I can understand BG2008 loves the shopping experience at WSM. My wife always gets stuck in their stores as well, it is a unique and differentiated shopping experience.

 

As far as the stock is concerned, It worked because of Tax tailwinds and multiple expansion. That’s really the story of our stock markets he last few years, but WSM has done better than many peers (even though not great in absolute terms it seems) and that go rewarded.

 

I am not really sure what I can learn from this.

[KCLarkin]

As far as the stock is concerned, It worked because of Tax tailwinds and multiple expansion. That’s really the story of our stock markets he last few years, but WSM has done better than many peers (even though not great in absolute terms it seems) and that go rewarded.

 

That's not what I'm seeing.

 

- Written off for dead in 2017

- High earnings yield

- Modest multiple expansion

- Tax benefit (but this isn't 1:1*).

- Reasonable sales growth

- Buybacks

- Above average dividend yield

- improved RoC

 

* In competitive industries, the tax benefit should be competed away over time.

[valuedontlie]

there are a lot of struggling competitors out there that are in or going to BK (such as Pier 1)... this could/should benefit remaining players...

 

WSM has a great balance sheet

 

WSM has a significant online presence (even prior to COVID-19)

 

I don't think people shopping at WSM/PB/WE are the same folks that would switch to stuff at Wayfair... my wife feels the stuff at Wayfair looks/feels considerably "cheaper" in comparison... completely anecdotal, I know...

[LC]

Not WSM but Sur la table (similar demographic IMHO):

 

https://www.washingtonpost.com/business/2020/07/09/sur-la-table-bankruptcy-coronavirus/

 

 

[KJP]

Not WSM but Sur la table (similar demographic IMHO):

 

https://www.washingtonpost.com/business/2020/07/09/sur-la-table-bankruptcy-coronavirus/

 

Most of the recent comments here have focused on the Williams-Sonoma brand.  But for those browsing this thread, I'll just note that, despite the company's name, 80% of the business is Pottery Barn and West Elm (which are primarily furniture).  The Williams-Sonoma brand is only about 20% of sales.  So, WSM is primarily a home furnishings business rather than a cookware business, though 20% of sales isn't nothing.