Homebodies Hoist Williams-Sonoma
By Heesun Wee
Small Tiki lampshades resembling grass skirts for $24 a pop. A Luau quilt adorned with tropical plants starting at $129. Palm-tree sheet sets beginning at $79. These are samples of the latest Hawaii-theme merchandise featured at Pottery Barn, the chain of home-furnishings stores that's part of San Francisco retailer Williams-Sonoma (WSM ).
While the "Aloha" goods may appear too seasonal and not practical enough to attract customers, the items actually have been a big hit at Pottery Barn, which markets to the urbane crowd. Its strong sales helped Williams-Sonoma record net income of $15.4 million, or 13 cents a share, in its fiscal first quarter, compared with $492,000, or breakeven, a year earlier. (The per-share figures were adjusted for a 2-for-1 stock split effective May 10.) The quarterly results easily surpassed analysts' mean expectation of 9 cents.
"The Hawaii stuff flew off the shelves," says Kristine Koerber, an analyst who covers Williams-Sonoma for WR Hambrecht. Investors have been paying attention: The retailer's shares hit a 52-week high of $33.35 on May 28. Some profit-taking has occurred since, with the stock retreating to around $31.
Given the recent runup, it's natural to wonder if any upside is left. Two-thirds of the analysts who follow Williams-Sonoma think so, and believe its shares could hit the high-$30s range the next 12 months, for as much as a 25% gain -- not too shabby in a sideways market.
The company's designers and merchandisers are producing what consumers want. In addition to improving the assortment of products, analysts say management has streamlined operations -- namely, reduced inventory and higher productivity. Plus, other divisions have room to grow. Pottery Barn Kids, part of the lucrative and growing market for quality children's furniture, is exceeding expectations.
"At this point, the bet is on sustainability of earnings," Dave Ricci, an analyst with William Blair & Co., noted in a research report. Ricci added that he's anticipating earnings per share of $1.03 for 2002 and $1.25 for 2003. Williams-Sonoma recently guided the Street higher for fiscal 2002 earnings, saying it estimates diluted earnings per share to be in the range of 95 cents to 98 cents, compared with the previous 85 cents to 88 cents (on a post-split basis).
HITTING NEW NOTES.
Following a period of ho-hum styles and muted colors, designers and merchandisers -- and those at Pottery Barn in particular -- have been churning out jazzier, more colorful merchandise. "Pottery Barn has its buzz back," Merrill Lynch analyst Mark Friedman wrote in a recent research note. Led by Pottery Barn, Williams-Sonoma's net retail sales increased 20% in the first quarter, to $267.6 million, vs. $223 million a year ago. Comparable-store sales increased 6.2% in the period, after a 2.8% decrease in the first quarter of 2001.
Williams-Sonoma happened to be in the right place at the right time. Like other home-furnishings and accessories stores, retail experts say, it's benefiting from the nesting trend that started after September 11, with folks opting to lay low at home. And interest rates are still near record lows, allowing many homeowners to refinance their mortgages at attractive rates.
That money saved is being reinvested into homes and a lot of it on furnishings, says Derek Leckow, a retail analyst at Barrington Research Associates. The Commerce Dept. recently reported that Americans increased their spending by 0.5% in April -- on top of a 0.3% gain in March -- as incomes rose 0.3%. Consumer confidence edged higher in May, according to The Conference Board.
Williams-Sonoma has been busy expanding into new markets. Pottery Barn Kids sales rose 50% in the first quarter, due largely to the addition of 22 stores, bringing the total to 31. While children's furniture is available through retailers ranging from Toys 'R' Us to Ethan Allan and Neiman Marcus, Pottery Barn Kids has carved a niche for itself by selling quality products at reasonable prices, says analyst Koerber of WR Hambrecht. Pottery Barn Kids offers a large collection of furnishings and accessories -- even entire outfitted rooms, from rugs to cribs.
In addition to hitting the merchandising mark, Williams-Sonoma management has made good on operating initiatives launched in 2001. (Chief Executive Dale Hilpert was not available for comment.) Inventories were down 12.3% in the first quarter compared with the same period a year ago, notes David Magee, an analyst for SunTrust Robinson Humphrey. During a conference call following the release of first-quarter results, management said distribution productivity has improved, with packages shipped per man-hour up 16% in the first quarter. The execs also cited a 20% cut in freight costs from the distribution center to stores.
Still, some analysts worry that margin gains from cost-saving efforts may be less dramatic in the future. Plus, the stock is getting a bit pricey. Now trading at 32 times the low end of Williams-Sonoma's earnings estimates for 2002, the stock is at the high end of its historical multiple. AG Edwards & Sons analyst Brian Postol still views Williams-Sonoma positively, but he's not recommending adding to current positions.
The company's West Elm division also faces some uncertainty. In April, Williams-Sonoma launched the brand by mailing some 680,000 catalogs, and it recently mailed roughly 500,000 more, says retail analyst Dana Telsey of Bear Stearns. Koerber says the West Elm strategy seems to be 80% Pottery Barn quality, 60% Pottery Barn price.
The fear is that the new brand could cannibalize Pottery Barn's core business, as has happened with Gap's Old Navy brand. "It's a risky strategy, of course. But what they're trying to do is reach a broader audience of consumers they don't have right now," says Leckow.
West Elm is targeted at young professionals aged 25 to 35, with incomes of $45,000 and below, says Koerber. In contrast to Pottery Barn, which features a wide variety of furnishings, West Elm offers lots of accessories like pillows and candles, and some furnishings that require assembly. Competitors include Ikea and Pier 1. Telsey notes that Williams-Sonoma may decide later this year whether to open a West Elm retail test store in 2003. It hasn't divulged further details.
It's too early to tell whether consumers will embrace West Elm. But if Williams-Sonoma's recent quarterly performance is any indication, the retailer still has room to increase earnings growth and its stock price.
Wee covers financial markets for BusinessWeek Online in New York
Edited by Beth Belton