Williams-Sonoma Earnings: Soft Demand Drives Near-Term Concern, but Profitability Holds Firm

We don’t plan any meaningful change to our $211 fair value estimate for narrow-moat Williams-Sonoma WSM after digesting first-quarter results that reflected consumer uncertainty. To start, sales contracted 7% to $1.8 billion, with all brands generating negative comps. Most disappointing was West Elm’s brand comp decline of 16%, which accelerated from an 11% downtick sequentially on weak demand for furniture and high-ticket product. While the magnitude of Williams-Sonoma’s sales slowdown could seem worrisome, we note first-quarter sales were still more than 40% above 2019′s levels, with West Elm’s sales 46% higher. Although Williams-Sonoma is seeing demand rationalize after stellar takeaway during the pandemic, we don’t view this lower demand level as a signal that merchandising is missing the mark or that there are fundamental issues with the business. Rather, we see this as a temporary shift in discretionary spending, impacted by both persistent inflation and share shift of wallet to previously impacted categories (travel, for example).

Moreover, despite an operating margin that contracted 420 basis points to 12.9%, this was still a 590-basis-point improvement over 2019. We expected some leverage to cede off robust 2022 volume (which saw sales lift 8% during the omicron variant) but contend that efficiencies in advertising and distribution, along with improved pricing measures (tactical discounting), should allow Williams-Sonoma to generate consistently higher profit levels than prior to the pandemic. While the firm held its 14%-15% operating margin outlook intact for 2023, we think this level should be easy to maintain over the longer term. Besides still-robust top-line opportunities in B2B, emerging brands, and global expansion, freight costs and other expenses are normalizing. As such, we view shares as very undervalued and suggest investors willing to withstand near-term volatility would benefit from building a position.