Williams-Sonoma, Inc. (WSM) — Well Done But Over-Cooked

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Williams-Sonoma, Inc. (NYSE:WSM) has been around for 57 years, starting with one store in Sonoma, California.  While the brand is far from a new, fast-growth concept, they continue to add to the Williams-Sonoma stable of brands for growth.

The company acquired Pottery Barn in 1986 and expanded the concept into Pottery Barn Kids stores in 2000. West Elm was launched in 2003.  WSM has seven concepts with bricks-and-mortar stores. PBteen and Rejuvenation have only half a dozen stores between them. All the concepts send catalogs and are online. The top five revenue producers are Pottery Barn, Williams-Sonoma, Pottery Barn Kids, West Elm, and PBteen (direct to consumer only).

Williams-Sonoma, Inc. (NYSE:WSM)

The store base is shrinking from a high of 627 in 2009 to 584 in Q3 2012—7% fewer retail stores. Seeing the trend, you might assume Williams-Sonoma is looking to become less focused on a retail bricks-and-mortar presence with the emphasis on direct to consumer (DTC). The company circulates fewer catalogs (down 2% in 2011), but with e-commerce taking off, DTC is now 47% of revenue (up from 39% in Q4 2010), pushing DTC to ever bigger percentages of combined revenue. While it appears that WSM is transitioning to an Amazon.com, Inc. (NASDAQ:AMZN) e-commerce model, that’s probably not the case with management’s intention to keep retail stores as part of the WSM growth story.

From the conference call:

At the beginning of the year, we outlined for you our three key strategic initiatives for driving sustainable profitable growth and increasing shareholder value. They are growing our existing brand, global expansion, and launching new businesses.

I was expecting an initiative to continue closing stores and making retail outlets essentially showrooms for online sales, as in the case of Best Buy Co., Inc. (NYSE:BBY)/Amazon. Amazon.com, Inc. (NASDAQ:AMZN) is considered a category killer, destroying most companies in direct competition with it. Best Buy is a great example of one such destroyed company. Best Buy’s revenue has declined precipitously in the last few quarters after disappointingly flat revenue growth for several years. The price per share has cratered along with the declining earnings to $15 per share after 2010 highs of over $40.  Meanwhile, Amazon continues to trade near its all time high around $280.  That being said, Amazon has not been able to kill WSM as effectively as it did Best Buy.  Amazon does directly compete, carrying some of the same brands, and that may be why the Williams-Sonoma brand stores, heavy into cookware, are comping lower than West Elm and Pottery Barn stores, which have fewer products in common with Amazon. The diversity of Williams-Sonoma across its various concepts is keeping it alive.

That’s not to say Williams-Sonoma is without serious competition. Bed Bath & Beyond Inc. (NASDAQ:BBBY) competes across almost all of WSM’s segments, including cookware, kitchen accessories, furniture, kids’s furniture, bedding and home decor. BBBY has a far larger store base at 1,173 and manages to turn in better margins even without the emphasis on e-commerce that WSM is transitioning to.  They do  more than twice the revenue of WSM and have faster growth with consistently high same store sales.  WSM has beat BBBY’s comps the last two quarters.  Bed Bath & Beyond currently sells at a P/E of around 13 compared to Williams-Sonoma’s 19. BBBY is still largely bricks-and -mortar, but sees high returns on its invested capital at greater than 30%.

WSM’s strong presence in bricks-and –mortar is not cash consuming either, with 2011 returns on invested income at 17%. The capital is split between PP&E and working capital (mainly inventory) nearly evenly. Most of the property is in the stores, with only 17 distribution/customer/corporate HQ care centers.  They own only $138 million in land and buildings, and lease the rest.

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