Williams-Sonoma: Not Invited to Dinner

 | Aug 25, 2011 | 11:00 AM EDT
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Investors have kicked Williams-Sonoma (WSM) out of their portfolios like an unwelcome dinner guest. The stock is down 36% from its 52-week high of $45.48, which incidentally, was set back in May. What is going on?

On the surface, the company's second-quarter results looked pretty solid. For the quarter ending July, the company reported that profits rose 28% to $39.3 million or $0.37 per share. Revenue rose 5.1% to $814.8 million. Gross margin increased from 37% to 37.9% and company-wide same store sales rose 6.5%. E-commerce revenue increased 18% to 39% of total company revenues. West-Elm comp sales increased 29% on top of a 19% jump last year. Same-store sales at kitchen gadget store Williams-Sonoma rose 0.7%. Pottery Barn's sales rose 3.6% and Pottery Barn Kids grew 8%, year over year. And then, on top of all the good news, the company boosted guidance to $2.17 to $2.22 a share from its May forecast of $2.13 to $2.21. Why all the selling?

Well, I see a few problems that concern me. First, the increased gross margin came from reduced occupancy costs, which seem one-time in nature. The company closed a bunch of stores, cut some expenses and received a temporary benefit. To grow, retailers need to open lots of stores. That benefit will reverse once they open more stores. Second, revenue came in at the low end of analyst expectations. There was no real blowout here. Third, comp-store sales at the flagship Williams-Sonoma brand were very weak.

In the year-ago quarter, W-S sales were up 6.6%; now they are at just 0.7%. In fact, comp-store sales have been decelerating across the entire company. For example, at Pottery Barn Kids, same-store sales in the fiscal second quarter of 2010 grew 24.9%. In 2011, they were up just 8%. The slowdown was even more pronounced at Pottery Barn, where same-store sales grew 19.1% last year and just 3.6% this year. Total company second-quarter same-store sales have fallen like a bad soufflé. Last year, total same-store sales grew 16.5% and this year the company was only able to cook up 6.5% growth.

Investors have been getting out of Williams-Sonoma because it is clear that its business has been slowing. Furthermore, I am concerned that gyrations in the stock market and uncertainty over the direction of the economy may derail our fragile economic rebound. Despite some recent relief at the gas pump, I think business at the company will continue to slow. I believe the shares will leave a bad taste in your mouth.

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