Williams-Sonoma could deliver an average adjusted return on invested capital

Business Strategy and Outlook

Williams-Sonoma has carved out a solid position in the $750 billion global home category and the $80 billion U.S. B2B industry. It has historically launched most of its brands organically in underserved segments and its brand intangible asset has been the supporting factor in its top- and bottom-line growth. Its ability to drive repeat business relies on customer loyalty and smart marketing and merchandising and the firm has access to some of the best analytics in retail. This should help Williams-Sonoma outperform its competitors and grow its market share, aided by new category expansions.

In recent years, Williams-Sonoma has set its sights on expanding its total addressable market outside of furniture and home furnishings, via B2B and marketplace efforts, categories with robust end markets that remain fragmented. These white-space business lines, along with faster growth from both franchise and the e-commerce channels (which accounted for 66% of 2021 sales) should help Williams-Sonoma near its $10 billion sales goal by 2024.

Furthermore, the aforementioned categories have the ability to deliver better operating margins than the historical brick-and-mortar business (which is on track to decrease its store base by 25% between 2020 and 2025), allowing mix to offer a natural lift to profitability. Such efforts, along with lower costs from an improved supply chain (when COVID-19 constraints subside), better distribution network (from direct sourcing and furniture delivery operations), as well as higher productivity of its store fleet (as underperforming locations close and older leases are renegotiated) should allow for operating margins that are consistently at a midteens rate. Despite a solid competitive edge, it is not alleged that the company is insulated from the proliferation of e-commerce peers such as no-moat Wayfair pushing harder into the home furnishing space, bounding upside potential. Even with robust competition in the category, it is held narrow-moat Williams-Sonoma could deliver an average adjusted return on invested capital, including goodwill, averaging 30% over analysts’ forecast, well ahead of analysts’ 9% weighted average cost of capital estimate.

Financial Strength

Williams-Sonoma is in fine financial health, with plenty of cash on hand, ending its first quarter with $325 million on its balance sheet. Given the strong free cash flow it has been able to generate, it is unprobeable the firm will have to tap the equity or credit markets for liquidity anytime soon, and there is currently no long-term debt outstanding, liberating excess cash flow for a return to shareholders. Over the past five fiscal years, the company has produced cumulative free cash flow of $3.4 billion. Williams-Sonoma’s cash requirements are primarily for inventory, property, plant, and equipment, advertising and marketing, technology, share repurchases, and dividends, which is likely to mostly be funded by cash generated from operations. Free cash flow to equity has averaged about 10% of revenue during the past five years, which is likely to be decent for a company that can produce somewhat volatile results that are closely tied to the performance of the housing market. The company resumed share repurchases in the fourth quarter of 2020, and the board authorized a $1.5 billion share buyback program in March 2022, which should facilitate continued buybacks ahead (in fiscal 2021 the company repurchased $899 million in shares, well ahead of any other year in the past decade). Additionally, it pays a dividend of $0.78 per quarter, representing a payout that was raised 10% in March 2022, illustrating the board’s confidence in the strength of the underlying business. Over the next decade, it is projected, the firm to average 7%-8% EPS growth (increasing modestly faster than sales), bolstered by continued top-line growth, a favorable sales mix shift, and stringent cost controls. Williams-Sonoma is positioned to earn an average of around $1.1 billion in free cash flow (cash from operations minus capital expenditures) over the next five years.

Bulls Say’s

Less discretionary categories such as cookware and small appliances offer some resiliency amid macroeconomic cyclicality. Registries in categories such as wedding and baby offer a steady source of customers.
The firm opened company-owned stores abroad in Australia in 2013 and has since expanded to the U.K. International opportunities (owned and franchised) could provide location and sales growth and elevated brand awareness.
Around two thirds (or more) of sales has stemmed from the e-commerce channel in recent years, which helps minimize store expenses and maximize operating margins.

Company Profile

With a wide retail and direct-to-consumer presence, Williams-Sonoma is a leader in the $300 billion domestic home category, focused on expanding its exposure in the B2B, marketplace, and franchise areas. Namesake Williams-Sonoma (175 stores) offers high-end cooking essentials, while Pottery Barn (188) provides casual home accessories. Brand extensions include Pottery Barn Kids (52) and PBteen. West Elm (121) is an emerging concept for young professionals, and Rejuvenation (9) offers lighting and house parts. Williams-Sonoma also has a business-to-business team that supports projects that range from residential to large-scale commercial.

(Source: MorningStar)

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