Midteens Operating Margins Still Feasible for Williams-Sonoma Despite Cost Pressures

We plan to lower our $233 fair value estimate for narrow-moat Williams-Sonoma WSM by a high-single-digit percentage as we temper our operating margin forecast to reflect continued macroeconomic uncertainty and the ongoing consumer shift to services over goods, resulting in lower demand across the home furnishings industry. Slower sales growth and inflation are now expected to lead to a 14%-15% operating margin in 2023, below the 17% we had forecast. Additionally, the firm’s long-term outlook for operating margins of above 15% will push our long-term expectation (16%) down by about 100 basis points. However, it’s clear that even with a moderating outlook, cash flow generation is unlikely to be sacrificed; the board of directors declared a 15% increase to the quarterly dividend (to $0.90 per share) and lifted the buyback authorization to $1 billion. The near-term issues that are softening demand at Williams-Sonoma are not tied to the company’s long-term fundamental potential, and as such, we see the shares as significantly undervalued.

Fourth-quarter results largely coincided with patterns seen across numerous consumer discretionary categories. Brand comps contracted 0.6%, lapping 10.8% growth last year, leading to a sales decline of 2%. West Elm, which caters to a more fragile income demographic, saw a 10.7% brand comps decline, although we note the brand still captures a sales base that is 30% higher than the same period in 2019. While Williams-Sonoma also saw a bit of a slowdown (brand comps fell 2.5%), the Pottery Barn portfolio continue to trend positively, with namesake comps of 5.8% and teen and kids 4% higher. The fourth quarter marked the second sequential period of adjusted operating margin contraction (down 110 basis points to 19.9%), as well-controlled operating expenses weren’t enough to offset significant pressure (to the tune of 380 basis points) in gross margin from input and shipping costs.