Williams-Sonoma Earnings: Firm’s Firm Stance on Discounting Offers Profit Upside; Shares Attractive

Given low home inventories, weak housing sales due to rising interest rates, and the bankruptcy of Bed Bath & Beyond, narrow-moat Williams-Sonoma WSM is facing some near-term pressure on sales growth. However, the firm has stood firm on its brand positioning, avoiding massive discounts. In its second quarter, sales fell 13%, to $1.9 billion, on a 12% brand comp decline, with West Elm posting a disappointing comp decline of 21% given its disproportionate exposure to furniture. Although the top line languished, cost controls were impressive. The gross margin of 40.7%--down 280 basis points from last year, but up 530 basis points from second-quarter 2019--remained healthy, as price integrity remained a priority. Additionally, operating expenses continued to deleverage (down 30 basis points to 26.1%) due to better labor and advertising costs, leading to an operating margin of 14.6%. These results led the firm to lower its sales forecast to a 5%-10% decline and lift its profit outlook to 15%-16% growth in 2023, not far from our 3% sales decline and 14.4% EBIT increase forecast preprint. We don’t plan a material change to our $209 fair value and view shares as cheap, even after a double-digit pop postprint.

We expect operating profits to remain higher than before the pandemic. In the near term, we see a lift from the reversal of inflated supply chain costs, set to normalize in the back half of 2023. Longer term, Williams-Sonoma’s higher mix of e-commerce sales, an optimized retail footprint (with 50% of its leases coming due over the next three years), better advertising capabilities, and productivity initiatives on operating expenses should allow the firm to capture mid-teen operating margins. While the firm has set its long-term operating margin floor at 15%, we incorporate a more modest outlook for 14%-15% profit margins, given the fragmented and competitive landscape Williams Sonoma competes within, which will force it to innovate to maintain its brand relevance.