Time to Buy or Sell This Hot Stock?

Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It’s been a good quarter for housing related stocks and Williams-Sonoma’s (NYSE: WSM) results were no different. The company has managed to execute from an operational standpoint and is starting to benefit from favorable end market dynamics as the housing market is in recovery mode. However, profitable investing is so much more than buying a stock at the top of its performance in a hot sector, and history is littered with people who piled in at the peak. Is WSM one of those stocks or is there further to run here?

What the Industry is Saying

Home Depot (NYSE: HD) kicked off the sector’s reporting season with a bullish set of results which I covered in an article here. HD is seeing an increase in spending on discretionary items and good broad based comparable sales growth with some kickers from Sandy to come. In the link provided, you can see how full year sales guidance has been progressively raised throughout the year. All of which is fine, but was it just a case of stealing market share from Lowe’s (NYSE: LOW)?

The answer has to be ‘no’ because Lowe’s reported a pretty good set of results too. I covered them in this article, and I think the key takeaway is that favorable end markets are giving it the breathing room to enact initiatives designed to simplify its product offerings in order to drive product sales. It appears to be working, and the stock is a compelling value proposition.

However, it is not all plain sailing as Bed, Bath and Beyond (NASDAQ: BBBY) continues to struggle to gain sales traction. I discussed its issues in an article here.  The company is being hit with the double whammy of slowing same store sales growth while rising costs are eroding its margins. As a consequence, investors have a right to be skeptical over the aggressive expansion strategy. Do you feel confident with your management rolling out new stores when the existing ones are not doing great even while the competition is doing well?

Special situation investors at the value end of the investing spectrum will be attracted, but for more growth orientated investors it might be worth avoiding.

Williams-Sonoma’s Growth Strategy

BBBY’s problems all lead back to the point that a company’s prospects aren’t just about its end markets. Indeed, Williams-Sonoma has been executing even when conditions were tough. At the heart of its current initiatives is a commitment to

  • growing the existing brands
  • expanding internationally
  • launching new businesses

I would add e-commerce initiatives to this list because I happen to think that, whether the industry likes it or not, online competition is coming. Amazon.com (NASDAQ: AMZN) via its subsidiary Quidsi launched casa.com this year with the idea seemingly being to do to BBBY and WSM what it did to Best Buy with consumer electronics.  I view Amazon as a very serious threat in the future because the percentage of spending dollars within a population that has been gleaned from e-commerce is only going to grow in the future. Consumers are used to shopping around, and Amazon knows how to play this game. Furthermore, it is no accident that Pier 1 Imports and WSM (e-commerce revenues jumped 17% in the quarter) are expanding strongly here.

It’s something to keep an eye on for the long term.

Execution?

In terms of growing existing brands, WSM is seeing the strongest growth in its innovative and exclusive brands. It’s a good way to differentiate its offering, and Q4 prospects look good as it declared that it would be launching a ‘significantly higher’ percentage of exclusive products in the quarter.

It’s not hard to see that growth is being driven by West Elm and Pottery Barn. Interestingly, the West Elm stores are the only ones seeing a significant expansion this year. Clearly WSM is executing well in terms of generating growth at its existing stores.

As for international expansion, new stores have been opened in Kuwait and four retail stores are under construction in Australia. It’s always comforting to expand in a country that speaks the same language, and Australia’s housing market has been showing signs of strength recently.

The launch of West Elm Market, a neighborhood store version of West Elm with an emphasis on a ‘sense of community,’ is a very interesting development which I think many retail companies should look at. Indeed, Wal-Mart is expanding into neighborhood stores, and I think these sorts of things do fill a social need. They are also easier to do when a rampant housing market isn’t increasing rental costs for businesses.

Where Next for Williams Sonoma?

As ever, the current quarter is the key to the full year, and I think investors should be optimistic. The housing recovery seems real enough and WSM is doing all the right things by differentiating its offerings and trying to create an air of exclusivity about its product range. Longer term, I have some concerns about possible margin erosion from the likes of Amazon or other online retailers but this also provides opportunities for WSM to improve inventory management and working capital via its own online sales. Moreover, online competition is not likely to affect matters much in the near term.

In conclusion, the stock is not particularly expensive on a cash flow or EBITDA basis, and I think a good Christmas could see this stock up to a $50 handle. As such, the recent pullback makes it very interesting because I think there is some upside surprise potential here.


SaintGermain has a position in The Home Depot. The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services recommend Amazon.com, Bed Bath & Beyond, The Home Depot, Lowe's Companies, and Williams-Sonoma. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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