Despite a 35% draw down from peak-to-tough, a less than impressive performance in the ‘junk rebound rally’ we’re seen over the past six weeks, AND a generally positive predisposition toward the name longer-term, we simply can’t get excited about WSM over the near-term.
Yes, there are a few positive factors – let’s get those out of the way.
1) The RH blowup earlier this quarter was much less about macro and more about execution hiccups/burps/projectile vomiting associated with launching new concepts. The promotional fears are real, but we’d argue that’s what drove the negative bifurcation in performance between the home furnishings names and the broader retail index starting in mid-November.
2) Numbers printed out of LZB, PIR, KIRK, and ETH have looked better than feared – pretty much across the board. Granted, this is not the most appropriate sample (though RH is not either), but the average PM probably throws them all in the same bucket – for better or worse.
3) WSM is lapping its own set of executional headwinds caused by the West Coast port delays in 1H15 which cost the company $30-$40mm on the top line and 50bps+ of margin in each of the first two quarters of 2015. Normalized product flow should allow the company to recapture a large portion of that, at least on the margin side. We’d really argue that its own complex operational structure (between e-commerce and B&M) simply could not handle the stress of an event like a Port Strike (why are there fewer than five companies in all of retail that repeatedly talked about this, despite the fact that everyone sources from the same place?). Nonetheless, an easy comp is an easy comp.
While all that matters, the unfortunate reality is that the growth story and stock drivers for WSM are almost entirely hinged on the West Elm concept. That might sound strange given the fact that the brand is only 17% of sales but a) it’s the only concept in the portfolio of brands actually growing square footage, and b) West Elm has accounted for ~50% of incremental growth for the better part of two years, which is evidenced by the first chart below. We think that’s potentially at risk.
We triangulate several sources for every company each quarter to gauge the online sales curve vs a year ago. These sources have tracked West Elm well in the past. They’re the same sources that are suggesting to us that 50% of growth might have meaningfully decelerated, as outlined in the second chart below. The quarter might still be fine, as the Street is looking for just 4% EPS growth. But in 1Q expectations accelerate to 14%, which might lead WSM to an underwhelming guide. Does the Street know this with short interest at a 5-year high and 10.5% of the float? Probably. But we’re not suggesting that this is a great short here. We’re simply saying that despite our temptations, our process tells us that this is absolutely not a buy before the event.