Note: All new or revised material since the last update is highlighted.
Reason for Report: Changes in Estimates
Prev. Ed.: June 16, 2008; 1Q08 Earnings Update (broker materials considered till June 11, 2008)
Brokers’ Recommendations: Neutral: 74.0% (17 firms); Positive: 17.4% (4); Negative: 8.6% (2) Prev. Ed.: 17; 4; 1
Brokers’ Target Price: $23.64 (↓ $0.44 from the last edition; 14 firms) Brokers’ Avg. Expected Return: 21.7%
*NOTE: Though dated July 15, the share price and broker material are as of July 3.
Portfolio Manager Executive Summary
Williams-Sonoma, Inc. (WSM) is a national specialty retailer of high quality, home-centered merchandise that operates four core concepts: Williams-Sonoma, Pottery Barn (including Pottery Barn Kids and PBteen), West Elm and Williams-Sonoma Home. The company markets its merchandise through retail stores, direct mail catalogs, and e-commerce websites.
Of the 23 firms covering WSM, 4 firms gave positive ratings, 17 firms provided neutral ratings, and 2 gave a negative rating. 14 brokerage firms provided target prices, and most of them used P/E as the basis of valuation. Target prices range from $18.00 to $28.00.
The outlook of the brokerage firms on WSM is dealt within the following paragraphs:
1) Neutral or equivalent (74.0%; 17/23 firms): The target prices range from $20.00 (Deutsche Bank) to $26.00 (UnionBankSwitz.). The firms acknowledge that WSM has a strong port folio and believe that over the long term, the company will benefit from its diverse portfolio of strong brands. However, the firms maintained their neutral stance due to a difficult macro environment. They do not expect a recovery in the macro trends in the near future and believe a tough environment will put further pressure on WSM shares for the remaining of FY08 and further into FY09.
2) Positive or equivalent (17.4%; 4/23 firms): The target prices range from $24.00 (Thomas Weisel) to $28.00 (Bernstein; Raymond James). The firms remain positive based on the belief that WSM is a better company than it was in the earlier years, given its more diversified revenue base due to its variety of brands and its larger portion of revenue driven by its unique direct to customer segment. Although the firms are not looking for a near-term rebound in sales, they believe that the company’s operating improvements, such as upgrades in technology, redesigns of websites, and distribution centers will benefit the margins and the returns in the long term. They are of the opinion that the stock is attractively valued at current levels.
3) Negative or equivalent (8.6%; 2/23 firm): Only one firm provided the target price of $18.00 per share. The firms maintain negative rating based on weakening market and top line pressure on the company’s core brands.
July 15, 2008
Recent Events
On June 20, 2008, WSM announced that its Board of Directors declared a quarterly cash dividend.
On June 04, 2008, WSM reported its 1Q08 financial results. Net revenue was $781.8 million in 1Q08, down 4.2% from $816.1 million in 1Q07. Net income in the quarter was $10.4 million or $0.10 per share, compared to $18.2 million or $0.16 per share in 1Q07.
Overview
Analysts identified the following factors for evaluating the investment merits of WSM:
Key Positive Arguments / Key Negative Arguments· WSM’s multi-brand and multi-channel strategies help it to gain market share.
· Emerging brands are expected to drive future growth as the core brands mature.
· Merchandising initiatives across all brands expected to fuel growth at WSM.
· Supply chain initiatives and improved distribution network are expected to help margin expansion.
· WSM has a good competitive position serving the middle and upper income demographics.
· Launching of new websites and increasing catalog circulation are expected to drive sales.
· The large Direct-to-Consumer business offers a significant competitive advantage.
· Management aims to balance investments for future growth with expense and inventory control efforts in 2008. / · Variability in the prospects of the company implied by its newly broadened brand portfolio is a major concern.
· Intense competition is expected from non-traditional retail chains like discount stores.
· Rising interest rates and other macro uncertainties like a slowdown in the housing market limit WSM’s prospects.
· Lighter comps and reduced outlook put the shares under pressure.
· Deteriorating housing environment and consumer spending.
Williams-Sonoma, Inc. (WSM), headquartered in San Francisco, California, is a nationwide specialty retailer of high quality products for home. The company operates in two segments, Retail and Direct-To-Customer. The Retail segment sells products for home through its six retail concepts: Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, and Williams-Sonoma Home. The Direct-To-Customer segment sells similar products through its eight direct mail catalogs: Williams-Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Bed+ Bath, PBteen, West Elm, and Chambers, as well as through six ecommerce websites: williams-sonoma.com, wshome.com, potterybarn.com, potterybarnkids.com, pbteen.com, and westelm.com. Currently, WSM operates 603 stores primarily under the Williams-Sonoma and Pottery Barn banners throughout the United States. This includes Williams-Sonoma, Pottery Barn, Pottery Barn Kids, and West Elm units. The company’s website address is http://www.williams-sonoma.com/. Its fiscal year ends on January 31.
June 16, 2008
Revenue
Provided below is a summary of total revenue as compiled by Zacks Digest:
Revenue ($ M) / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 2007A / 2008E / 2009E / 2010ERetail Sales / $453.3 / $846.7 / $433.7 / $481.1 / $2,281.2 / $2,216.4↑ / $2,328.5↓ / $2,589.8
Direct-To-Customer Sales / $362.7 / $527.8 / $348.2 / $353.0 / $1,663.8 / $1,545.5 / $1,603.9 / $1,773.3
Total Revenue / $816.1 / $1,374.3 / $781.8 / $834.4 / $3,935.6 / $3,758.0↑ / $3,917.9↑ / $4,228.0
Y-o-Y Growth / 2.7% / 9.5% / -4.2% / -2.9% / 5.6% / -4.5% / 4.3% / 7.9%
Q-o-Q Growth / -35.0% / 53.5% / -43.1% / 6.7%
Digest High / $816.1 / $1,374.4 / $782.0 / $841.3 / $3,957.7 / $3,783.1 / $4,088.3 / $4,441.1↓
Digest low / $816.0 / $1,374.0 / $781.8 / $828.0 / $3,744.9 / $3,704.1 / $3,772.0 / $3,934.3↓
The Zacks Digest average revenue in 1Q08 was $781.8 million, down 4.2% from $816.1 million in 1Q07 and 43.1% from $1.37 billion in 4Q07. Core brand revenue decreased 7.0% y-o-y, led by sales declines at Pottery Barn (-7.9%) and Pottery Barn Kids (-11.1%), while Williams-Sonoma’s sales were down just 1.7% y-o-y. Emerging brand revenue increased 16.3%, led by West Elm, Williams-Sonoma Home, and PBteen (+29.4%).
Segmental Revenue
Retail: As per the Zacks Digest model, revenue at the retail division declined 4.3% y-o-y to $433.7 million in 1Q08. This decrease was driven by a 9.0% reduction in comparable store sales, partially offset by a 6.9% y-o-y increase in retail leased square footage, including 19 net new stores. West Elm and Williams-Sonoma Home were the only brands in the retail segment that generated y-o-y growth in net revenue.
Direct-To-Customer (DTC): Direct-to-customer net revenue (comprised both catalog and Internet revenues), as per the Zacks Digest model, declined 4.0% y-o-y to $348.2 million in 1Q08. This decrease was driven by declining net revenue in all brands except PBteen and West Elm. Internet revenue in 1Q08 increased 8.7% to $251.5 million from $231.5 million in 1Q07.
A graphical representation of the revenue segments is given below:
Outlook
WSM expects 2Q08 revenue in the range of $828.0 million to $846.0 million, down from the previous guidance range of $850.0 million to $868.0 million. This represents a projected decrease in net revenue in the range of 3.7% to 1.6% from $859.4 million in 2Q07. Retail net revenue in 2Q08 is projected to be in the range of $478.0 million to $488.0 million, compared to previous guidance range of $493.0 million to $503.0 million. Change in comparable store sales in 2Q08 is projected to be in the range of -10.0% to -8.0%, down from the previous guidance range of -6.0% to -3.5%. Direct-to-customer net revenue (comprised of both catalog and Internet revenue) in 2Q08 is projected to be in the range of $350.0 million to $358.0 million, versus previous guidance range of $357.0 million to $365.0 million.
The company expects net revenue for FY08 in the range of $3.738 billion to $3.804 billion, down from the previous guidance of $3.793 billion to $3.877 billion. The new guidance represents a decrease in the range of 5.2%-3.6% from net revenue of $3.945 billion in FY07. Comps are projected in the range of -8.3% to -6.3%, compared to the previous guidance range of -5.5% to -3.0% and FY07 comp growth of 0.3%. Comparable stores exclude new retail concepts. For FY08, the company expects to exclude West Elm and Williams-Sonoma Home.
The company expects retail revenue for FY08 in the range of $2.207 billion to $2.245 billion, compared to previous guidance range of $2.250 billion to $2.298 billion. Direct-to-customer net revenue (comprised of both catalog and Internet revenue) in FY08 is projected to be in the range of $1.531 billion to $1.559 billion, compared to previous guidance $1.543 billion to $1.579 billion. Catalog circulation is projected to decrease in the range of 19.0% to 14.0% y-o-y, unchanged from previous guidance.
One firm (Merrill) expects a 4.4% decline in total revenue to approximately $3.77 billion, predicated on a retail sales decline of 2.5%, (impacted by the additional week in 2007), a 7.1% decrease in Direct-to- Customer sales, and a 7.5% same-store sales decline. However, the firm expects in 2009 total revenue to increase 4.6% y-o-y to approximately $3.94 billion, predicated on retail sales growth of 4%, a 5.5% increase in Direct-to-Customer sales, and a 1% increase in same-store sales.
The Digest model forecasts total revenue of $3.75 billion for FY08, $3.91 billion for FY09, and $4.22 billion for FY10, with y-o-y decline of 4.5% in FY08, and y-o-y growth of 4.3% in FY09 and 7.9% in FY10. This represents a three year compounded annual growth rate (CAGR) of 2.4% on realized FY07 revenue.
Please refer to the Zacks Research Digest spreadsheet on WSM for more details.
Margins
As per the Zacks Digest model, gross margin in 1Q08 was 35.4%, compared to 37.0% in the prior year period. The y-o-y decrease in gross margin was primarily driven by deleverage of fixed occupancy expenses due to declining sales and an increase in cost of merchandise sold, partially offset by reductions in replacements and damages.
Provided below is a summary of margins as compiled by Zacks Digest:
Margins / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 2007A / 2008E / 2009E / 2010EGross Margin / 37.0% / 41.6% / 35.4% / 34.3% / 38.8% / 36.9% / 37.2% / 37.7%
Operating Margin / 3.5% / 14.3% / 1.1% / 1.6% / 8.0% / 6.2% / 6.6% / 7.4%
Pre-Tax Margin / 3.7% / 14.4% / 1.1% / 1.5% / 8.0% / 6.2% / 6.6% / 7.4%
Net Margin / 2.2% / 9.1% / 0.7% / 1.0% / 5.0% / 3.8% / 4.1% / 4.8%
SG&A expenses increased as a percentage of total revenue during 1Q08, driven by deleverage of employment and advertising costs due to declining sales.
As per the Zacks Digest model, operating income in 1Q08 was $8.7 million, compared to $28.3 million in 1Q07 and $197.2 million in 4Q07. The operating margin in the quarter was 1.1%.
Net Interest income in 1Q08 was $0.2 million, compared to $1.9 million in 1Q07. The effective tax rate in the quarter was 39.4%, compared to 39.6% in 1Q07.
According to the Zacks Digest model, net income in the quarter was $5.4 million, compared to $18.3 million in 1Q07 and $124.7 million in the previous quarter.
Outlook
The company lowered its gross margin guidance for 2Q08 to 34.0%-34.4%, from its previous guidance range of 35.0%-35.4%. For FY08, the company lowered the gross margin guidance to 36.8%-37.0%, from the range of 37.1% to 37.3%.
One firm (J.P. Morgan) expects gross margins to remain under pressure, given the promotional environment, big ticket weakness, and the need for the company to manage down its inventory, which has been growing at more than 2x the pace of sales.
One firm (Oppenheimer) expects gross margin contraction in 2Q08 and throughout FY08 due to several near term gross margin pressures like, markdown risks to slower moving inventory, increasing COGS with the rising Euro, as well as labor, freight, and material costs both in Europe and Asia, mix shift to new, lower ticket price points, and new shipping rates at West Elm.
SG&A expenses on a GAAP basis as a percentage of net revenue in 2Q08, including the gain on the company’s sale of a corporate aircraft (on May 16, 2008), are expected to be in the range of 30.8% to 31.2%, down from the previous guidance range of 31.5% to 31.9%. SG&A expenses on a non-GAAP basis as a percentage of net revenue in 2Q08, excluding the gain on the sale of a corporate aircraft, are expected to be in the range of 32.7% to 33.1%.
The company expects to post interest expense of $0.0 million to $0.5 million in 2Q08. Earlier, the company provided guidance of interest expense in the range of $0.2 million to $0.6 million. The income tax rate in 2Q08 is expected to be in the range of 31.0% to 32.0%, compared to previous guidance range of 38.9% to 39.2%.
SG&A expenses on a GAAP basis as a percentage of net revenue are expected to be in the range of 29.7% to 30.0% in FY08. The company’s previous guidance range was 30.2% to 30.5%. SG&A expenses a non-GAAP basis as a percentage of net revenue are expected to be in the range of 30.4% to 30.7% in FY08. The company expects interest income in the range of $0.0 million to $1.5 million and tax rate in the range of 38.1%-38.5% for FY08. The company’s previous guidance was in the range of interest expense of $1.0 million to interest income of $1.0 million and income tax rate of 38.7%-39.0%.