Strong Momentum Should Continue for Williams-Sonoma, but Is It Sustainable?

Williams-Sonoma has seen stock appreciation of 36.68% over the past year, outperforming Bed Bath & Beyond and Pier 1 Imports  which have seen stock appreciation of 32.58% and 15.29%, respectively. However, that doesn't mean Williams-Sonoma is the best investment option of the three going forward. 

Recent results
Williams-Sonoma recently delivered a strong third quarter, with revenue jumping 11.3% to $1.05 billion year over year. More impressively, comps grew at an 8.2% clip, indicating continuous demand for the retailer's merchandise.

Breaking down the comps results, every Williams-Sonoma brand performed well. Its namesake brand saw comps increase 1.4%. That's not bad in a challenging consumer environment, but it's nothing compared to Pottery Barn, which saw comps increase 8.4%. Comps at Pottery Barn Kids, West Elm, and PBteen improved 3.9%, 22.2%, and 16.7%, respectively.


With those comps numbers in mind, consider what Williams-Sonoma is doing with its store counts. Its Williams-Sonoma store count will total 245 in fiscal year 2013, down from 253 in FY 2012. Pottery Barn's FY 2013 store count will total 193, up slightly from 192 in FY 2012. The total store count for West Elm at the end of FY 2013 will total 58, up from 48 in FY 2012.

The company is building its best-performing brand while reducing its larger brand's store count. Williams-Sonoma is wisely doing this at a methodical pace, which avoids an overreaction to any short to medium-term trends.

Additionally, Williams-Sonoma returned $115 million to shareholders in the third quarter, with $85 million in the form of buybacks and $30 million in dividend payments. As of November 3, Williams-Sonoma had $534 million of a $750 million stock buyback program still available. Williams-Sonoma currently yields 2.10%. 

Up until this point, it would seem absurd to think another retailer could outperform Williams-Sonoma over the long haul. Also consider that I wrote bullishly about Williams-Sonoma on October 12: "A Lot of Good News for this Specialty Retailer." I expect the good times to roll, at least for a considerable amount of time. To add to the near to medium-term optimism, let's take a look at the company's guidance.

Future expectations
Williams-Sonoma has confidence in its fourth-quarter momentum. It expects fourth quarter net revenue of $1.37 billion-$1.43 billion, with comps increasing 3%-6%, year over year. Earnings per share is expected to come in between $1.30 and $1.37.

Looking at the bigger picture, Williams-Sonoma has raised its FY 2013 guidance and now expects revenue of $4.29 billion-$4.35 billion, with comps increasing 5%-7%. EPS is expected to come in between $2.76 and $2.83.

The big picture
The primary reason for the company's strong performance is the strength of the high-end consumer. As you might already know, there has been a frightening divergence between the haves and the have-nots. The middle class is slowly dissipating.

Plus, record low interest rates have led to a ton of liquidity being pumped into the system, which then drives up stock and real estate prices. This, in turn, has made the wealthy feel wealthier, perhaps increasing their propensity to consume.

With the Fed intending to keep interest rates at record lows through 2017, the upward trend in the markets might continue. This isn't a guarantee, but continuous record-low interest rates are supportive. The problem is that a trend doesn't stay intact forever. Interest rates will eventually increase, and debts must be repaid. This would lead to a drop in the broader market and reduced discretionary income for high-income consumers, which would negatively impact Williams-Sonoma. 

Fortunately, another home furnishing store offers just as much top-line potential as well as more resiliency.

Bed Bath & Beyond and Pier 1
Bed Bath & Beyond offers more resiliency for one simple reason: by offering a broad range of products at different price points, it attracts a wide range of consumers. However, that's not the only reason.

Bed Bath & Beyond might not pay a dividend, but this decision has led to the company being one of the most fiscally responsible retailers in the world. Bed Bath & Beyond has $921.65 million in cash and short-term equivalents vs. no long-term debt. It also generated $1.22 billion in operating cash flow over the past year. Therefore, if things head south, Bed Bath & Beyond will be capable of returning capital to shareholders, and it will have the option of aiming for inorganic growth. Furthermore, Bed Bath & Beyond is currently trading at 14 times forward earnings, making it more appealing than Williams-Sonoma from a valuation perspective, which is trading at 19 times forward earnings.

Williams-Sonoma is also fiscally responsible, with $128.76 million in cash and short-term equivalents vs. $3.76 million in long-term debt. It has generated $450.42 million in operating cash flow over the past year. Therefore, its dividend should remain intact.

As far as Pier 1 goes, it has $124.85 million in cash and short-term equivalents vs. $9.50 million in long-term debt, and it has generated $162.45 million in operating cash flow over the past year. Therefore, its 0.90% yield appears to be safe. That said, unlike Bed Bath & Beyond, discretionary items make up almost all of Pier 1's offerings.

Pier 1 has greatly outperformed Williams-Sonoma and Bed Bath & Beyond in regard to shareholder return over the past five years:

WSM Total Return Price Chart

WSM Total Return Price data by YCharts

However, keep in mind that smaller companies often see the greatest stock appreciation during raging bull markets. The chart above doesn't match the chart below, which indicates that demand for Bed Bath & Beyond products has far exceeded that for the products of Pier 1 or Williams-Sonoma:

WSM Revenue (TTM) Chart

WSM Revenue (TTM) data by YCharts

The bottom line
Williams-Sonoma should continue to see stock appreciation in the near to medium-term, but if you're looking for growth potential with a safety net, then you should consider Bed Bath & Beyond. 

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The article Strong Momentum Should Continue for Williams-Sonoma, but Is It Sustainable? originally appeared on Fool.com.

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond 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.

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