Williams-Sonoma is the retail value play, here’s why

Key points

• Williams-Sonoma reports its first quarter 2023 earnings results, pointing to many fundamental metrics improving from within, enabling further upside to be realized in the subsequent stock price.

• As the company beats earnings expectations, management guidance showcases a path to the business returning to its peak levels of profitability. Other macro environment developments will come to aid operating margins further. 

• Showcasing its cheapest valuation in more than a decade, WSM stock is set to blow past, current analyst targets, as these compressed valuation metrics would show. The stock price is hovering near a heavily traded support level to amplify these effects. 

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Williams-Sonoma (NYSE:WSM) investors are celebrating a 2.3% rally in WSM stock today; the bullish reactions at the market open on Tuesday morning come after the company reported its first quarter 2023 earnings results.

As the company outperforms competitors like RH (NYSE:RH) on both a technical and fundamental basis, the upside assigned by analysts today gives way to some overdue upgrades. Williams-Sonoma has outperformed RH by as much as 3.8% during the past twelve months, as measured by the relative stock charts.

On a deeper level, and more importantly, for investors considering the competitive effects that RH may impose on WIlliams-Sonoma, ROIC (return on invested capital) metrics also showcase an attractive gap in favor of the latter. 

Despite some negative results within the company’s press release, investors and other participants are focusing on the more optimistic guidance provided by management within this report.

Apart from the recession of 2008 and the primary stock market sell-off during 2020 amid COVID-19, Williams-Sonoma presents its lowest valuation in more than a decade. Yet, it poses the most profitable prospects in company history. These price and value disconnect create the perfect storm for those seeking to generate alpha. 

Recession cancelled 

Analysts have been surprised as Williams-Sonoma surprises them with total earnings per share of $2.64 relative to expectations for $2.40, representing a 10% beat. As management understood the implications of tight supply chains and a challenging macro environment, as seen in the increased costs of goods sold, proper capital allocation was implemented to satisfy growing demand.

As a result, gross margins declined from 43.8% in 2022 to 38.5% for the first quarter of 2023; operating margins tell a similar story by coming off their 2022 levels of 17.1% to end the quarter at 11.4%. In addition, customer satisfaction is one of the tenets of Williams-Sonoma judges itself; thus, increasing payouts to employees and suppliers to ensure timely inventory replenishment and deliveries became a viable expenditure. 

Moving forward, management expects operating margins to recover to a more normalized level. Guiding toward 14% to 15% operating margins for the remainder of the year, these levels would place the company back to its five-year averages, as Williams-Sonoma financials would show.

Despite allowing for some negative assumptions regarding revenue growth, investors are still seemingly bullish on the stock’s future. A comparable sales decline of 6.0% should have been enough to send the store crashing down, as comparable sales growth rates are a primary key performance indicator (KPI) for the retail industry. 

Management put things into perspective within their release, as more beneficial trends shadow a 6% sales decline. Two-year comparable growth stood at 3.5%, and four-year comparable growth at 46.5% to account for COVID-19 slowdown effects.

Moreover, there is one other significant tailwind that the company can ride on moving forward, which can significantly boost margins even higher than management’s guidance would suggest as ZIM Integrated Shipping Services (NYSE:ZIM) reports their expectations for average freight and shipping rates, near-term outlooks for costs are set to decline, giving way for Williams-Sonoma’s operating margins to rise.

As management attributes margin contractions to “… higher inbound and outbound shipping and freight costs…”, it would seem that recovery in these elevated costs can significantly boost profitability moving forward.

Discounts to deep value

Placing margins and sales assumptions aside, investors should take note of just how profitable this business is. On a ten-year basis, Williams-Sonoma has never had a losing year and has delivered an average return on equity (ROE) of 40%.

Compounding these double-digit returns over the decade, it would seem apparent that this stock will command a rich price-to-earnings multiple as it showcases stability and uninterrupted growth. However, this is not the case, as the stock is merely trading at a 7.0x P/E multiple to place it below other less profitable competitors like RH, who trade at a nearly double valuation of 13.2x P/E.

Williams-Sonoma analyst rating points to a 12% upside from today’s prices. However, a top-side price target of $185 per share is a more realistic scenario considering this business’s momentum. On a technical basis, the WSM stock chart will outline the intense support levels it is about to enter. On a historical basis, there is high liquidity and heavy trading volume around the $110-$118 channel. With bottoming weekly RSI and Stochastic indicators, investors have one of the most profitable retailers on a silver platter.