Williams-Sonoma, Inc. Healthy Fourth Quarter Despite Noisy Backdrop

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Williams-Sonoma fourth-quarter operating EPS of $1.38 exceeded our $1.36 estimate, the $1.35 consensus, and the $1.30-$1.37 guidance. Upside reflected stronger-than-expected revenues, which were only partly offset by a lower-than- expected gross margin rate.

Revenues increased 9.7% (same-week), reflecting 2.7% growth in retail and 19.0% growth in direct-to-customer (DTC). Comparable brand revenues rose 10.4%, sharply ahead of our 4.8% estimate, the 4.3% consensus (according to StreetAccount), and the 3%-6% guidance; growth comprised +14.6% at Pottery Barn, +11.2% at Pottery Barn Kids, +18.3% at West Elm, +9.6% at PBteen, and +2.3% at Williams-Sonoma (the first increase in a fourth quarter since 2010).

Operating margins declined 11 basis points to 14.8% (in line with consensus), with DTC up 180 basis points and retail down 170 basis points. Gross margin declined 66 basis points to 40.6%, modestly below the 40.8% consensus, due to lower overall selling margins (although they were up in DTC) and deleverage of occupancy costs (the latter primarily because of one less selling week and investments in global expansion). Operating expenses were leveraged by 55 basis points.

Inventories increased 17% year-over-year (adjusted for timing differences), reflecting efforts to optimize safety-stock levels (primarily in the fastest-growing brands and in core items that carry less seasonality and fashion risk) and invest for growth. Markdown risk should be contained.

Management’s initial 2014 EPS guidance of $3.05-$3.15 (7%-11% growth) is below the $3.20 incoming consensus and assumes 5%-7% comparable brand revenue growth and operating margins of 10.2%-10.4% (flat to down 20 basis points, due to investments in supply chain and global expansion). First-quarter EPS guidance of $0.41-$0.44 (flat to up 7%) is below the $0.46 incoming consensus and assumes 4%- 6% comparable brand revenue growth and a slight decline in the operating margin, based on incremental expenses related to global growth (including the planned opening of a new Dallas distribution center in the first half) and the impact of widespread severe winter weather on the retail channel in February and a continued promotional environment. We view guidance as conservative. Management also reiterated its three-year financial targets issued a year ago, which call for average annual revenue growth in the mid- to high-single-digits and average annual EPS growth in the low-double-digits to midteens.

Finally, the company announced plans to increase the annual dividend by $0.08 (or 6.5%), to $1.32, representing a 2.2% yield. We have trimmed our 2014 EPS estimate by $0.04, to $3.18 (12% growth), and have established a preliminary 2015 EPS estimate of $3.60 (13% growth).

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