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March 23, 2010

With many retailers nearing or exceeding peak EBIT margins following a year of incredibly tight inventory management, cost cutting, curtailed store growth, and capital preservation, there are few companies that standout as candidates for moving beyond prior margin highs.  One such name that stands out in this camp is Williams-Sonoma. 


With many retailers nearing or exceeding peak EBIT margins following a year of incredibly tight inventory management, cost cutting, curtailed store growth, and capital preservation, there are few companies that standout as candidates for moving beyond prior margin highs. One such name that comes to mind is Williams-Sonoma. After reporting another strong quarter of upside across the top and bottom lines, one key item stood out to us. Management explained how it believed the company could achieve prior peak margins and ultimately exceed them. We agree.

The formula to achieve EBIT margins of 10-12% (vs. peak of 10.2%) is the by-product of a few key variables.

  • For perspective, 2009 reported EBIT margin was 5.2%, or 500 bps below 2005 peak levels. The bulk of the decline is confined to gross margins, of which 415 bps has been negatively impacted by occupancy expense. Within occupancy expense, 50% of the impact is due to escalating costs and 50% due to sales deleverage. The remaining gross margin degradation is the result of a 225 bps hit on selling gross margins offset by 140 bps of supply chain efficiencies.
  • Leverage on central infrastructure, which has seen capacity reduced by 1.2 million square foot in 2009 should continue to drive supply chain efficiency/gross margin improvement. At the very least, leverage should continue through the first half of the year given that capacity reductions have not been fully anniversaried. After that, modest sales growth on a substantially reduced distribution network will continue to yield gross margin gains.
  • Recognize that advertising costs reductions are permanent. Recall that the company substantially reduced catalog circulation over the past year and is in favor of lower cost, higher return digital marketing. It is clear that the ecommerce business is the most profitable growth vehicle the company has and the legacy costs associated with catalog distribution are a way of the past. Circulation was down 20% for the year, representing a permanent cut to costs.
  • Close marginal stores that are saddled with rent escalations that would otherwise pose a drag on overall margins. This is a 150-200 bps opportunity alone. Clearly the current real estate environment affords flexibility and opportunity to reduce costs. Furthermore, growth opportunities in the highly profitable direct business takes pressure off of management to grow retail for the sake of growth. Management is focused on closing stores and we expect this to continue over the next 1-2 years, at least.
  • SG&A is not really a key variable here, provided it remains consistently well managed. Over the past 5 years, SG&A is actually down 10 bps as a % of sales, despite the major decline in total topline sales.
  • Positive mix shift towards higher margin, higher turning home furnishings vs. a more traditional reliance on furniture. While still early in this process, this should be gross margin accretive vs. the historical mix which was more in favor of lower margin furniture.
  • Importantly, on a lower cost structure (primarily supply chain and advertising), topline assumptions do not need to be heroic to continue to drive margin expansion. A low single digit increase in sales over the next three years would allow margins to expand to near peak levels. Clearly momentum is stronger at the current time (and compares are still easy), which suggests the ramp should be steeper in the near-term (even after the huge move off the bottom).

 R3: WSM - Contemplating Post Peak Upside - WSM SIGMA 


  • Tiffany noted that it will launch its collection of leather accessories and handbags later this year. Recall that the line is being designed by Richard Lambertson and is the first line to be brought to market since TIF acquired Lambertson’s company out of bankruptcy just about one year ago. The line will launch with limited distribution in the US stores as well as online.
  • Wal-Mart is adding back some SKU’s it recently cut as part of its effort to rationalize underperforming brands, reduce clutter, and improve profits. Apparently consumers have lashed back, and have expressed their displeasure with the company’s efforts to eliminate SKU’s. Interestingly, Hefty’s One-Zip sandwich bags are on the list of items to make their way back onto the shelves. Recall that we originally flagged the company’s decision to narrow the bag assortment to one national brand (Ziploc) and their own Great Value offering.
  • An interview with J Crew’s creative director, Jenna Lyons, revealed that the company is focused on developing a partnership with a beauty brand. She went on to note that she is seeing “an insatiable appetite for nail polish”. While no deal or strategic partnership is imminent, it won’t be surprising if we begin to see some limited beauty products making their way into the stores. Importantly, if done properly, beauty can be a high margin, traffic driving business.


Supply Chain Forum - The recession forced executives to reexamine their supply chains and find new efficiencies. Cutbacks in inventories and the culling of suppliers that brands and retailers engaged in to survive the downturn present a challenge to growth. Today, companies are scrambling for capacity. The industry is in a classic bullwhip effect. Companies have relied heavily on Asian sourcing for decades; however, Asia, and China in particular, are quickly developing into powerhouse consumer markets which has significant ramifications for sourcing. Commodity inflation is a likely result of an economic recovery and a surging Asian consumer population.  “In a world where the source countries are seeing GDP growth at a rapid rate, and the mature countries are having slow to no growth, the pinch point becomes clear,” McBreen said. Companies are focusing on improving its speed to market and implementing product life cycle management techniques that allow it to break away from a seasonal delivery mind-set. Retailers have adjusted by focusing on its supply chain and moving away from areas where deliveries had been unreliable, such as Pakistan. Such thing as reducing time spent unloading containers became critical.  “You may think that you’ve got down to your source and this is the best you can do with your supply chain. I feel there’s still a lot of work to do,” he said. “The U.S. is far behind the Europeans. They’re closer and they have their supply chain rates and percentage much more economical and understandable.” <wwd.com/business-news>

Supply Chain Forum 2: Sourcing Companies - The economic downturn has forced retailers to reevaluate how to utilize the role of the sourcing company, resulting in suppliers being under greater pressure to inject more value into the overall packages they deliver to boost their competitiveness. Rockowitz said manufacturers will have to increase investment in technologies such as automated equipment in production lines, advanced management systems and computerized systems for research and development in order to boost overall capabilities. There also will be a greater push toward connectivity. Li & Fung has developed a wireless system that gives all those involved in the supply chain access to real time information for improved efficiency. Christina Ong, textiles and garments division director at HSBC, believes developing product design capability is essential to survive in the supply chain in the coming years. Bundling design and merchandising services will enable sourcing companies to attain higher profit margins and customer loyalty. This also helps fend off competition as buyers become dependent on the agent for product development. New technologies now have become inextricably linked with sustainability. Ong said consumers are more aware of environmental matters and expect retailers to provide products manufactured by compliant factories and will have to look to reforming highly polluting and resource-consuming industries such as tanning, dyeing and electroplating. <wwd.com/business-news>

China's long term growth plan recovery - China has started to regain momentum in manufacturing and exports this year, both of which were dealt heavy blows by the global financial meltdown. But the longer-term damage of the world economic crash may lie in disrupting the central government’s ambitious plans to transform China’s economy into one based on innovation by 2020. The first two months of this year show a fledgling recovery taking root in China’s manufacturing sector, with renewed growth in exports, according to recent government statistics. The index used to measure manufacturing output held steady, while China’s exports during January and February soared 46 percent from the same months last year. Yet, as Premier Wen Jiabao warned in his annual state of the union address on March 5, the future is littered with mine fields. Amid its drive to balance exports and imports and rebalance the entire economic structure, China faces an uphill road in improving the content and quality of its exported goods. The central government, Wen said, will commit special efforts to 10 key industries in 2010, including textiles. But there’s no denying the downturn somewhat derailed China’s detailed economic development plans, which could mean more of the same in manufacturing. <wwd.com/business-news>

New Leather Tannery Cluster to be Built in Fuxin, China: The China Leather Industry Association (CLIA) has confirmed the country's official policy to locate new tanneries to specialised tanning clusters as it aims to tighten up the regulations to build new sites. China has been promoting the new tanning cluster in Fuxin, Lioning province of Northern China. The Fuxin cluster so far has three or four new tanneries either planned or under construction including the new beamhouse plant for Shanghai Richina Leather. A new central effluent treatment plant is also under construction to cater for the tannery waste. The Lioning cluster is due to be fully operational by 2011 and is close to the shipping ports, which is ideal import and export of goods. The CLIA spokesperson said that in the future it will be more difficult for tanners to obtain permits to build new plants and therefore the tanning clusters offer the best chance to a permit to be granted. The Association also added that the growth of new tannery construction in China is expected to slow down in the future as they focus on improving the environmental performance of existing tanneries. <fashionnetasia.com>

China: Li Ning bullish on the mainland sportswear retail market - Chinese sportswear retail giant Li Ning reported an impressivley strong 2009 performance and said the market also looks strong for 2010. The company expects to increase sales by more than 16% this year with a 10% rise in same-store sales as the company produced an impressive set of fiscal 2009 figures, with group revenue increasing by 25.4% to RMB 8,386.9m for the year ended December 31.  "2009 was an extremely challenging year with economies around the world swept by the global financial crisis. China was also impacted by this crisis in 2009, especially in the first half of the year. In addition, the post-Beijing Olympics effect impacted the pace of growth of the sporting goods industry during the year," said Li Ning, Chairman of the Group. "Against the backdrop of a challenging operating environment, the Group, under the excellent leadership of the management and relentless efforts of our staff, reinforced its financial strength and boosted its competitiveness in key areas including its brands, products and new sports category, thus achieving solid business and financial growth." As the Group's core brand, LI-NING brand sales accounted for 91.7% of the total revenue, grew by 21.1% to RMB 7.69 billion. Sales of LI-NING brand footwear products, apparel products and accessories grew by 19.1%, 22.3% and 27.4% respectively.  <fashionnetasia.com>

Japan Fashion Week: Two factors are working in local designers’ favor — a growing contingency of buyers and consumers from other Asian countries and Japanese department stores’ newfound willingness to place orders and decrease their dependency on European luxury labels. "Every single store carries the same names, the same merchandise, and the customers and the buyers are a little bit tired of seeing the same,” he said. “The market condition is terrible, but it’s in a good condition for the young designers.” About 40 runway shows, along with dozens of presentations and other related events, will take place this week around the city. Like in seasons past, small home-grown brands with names such as Somarta, Mint Designs and Motonari Ono dominate the lineup. But a growing number of men’s labels, such as Discovered, Factotum, Phenomenon and Yoshio Kubo, also is joining JFW’s ranks, underscoring a widely held belief that men’s designers here are overshadowing their women’s wear counterparts, both in terms of buzz and commercial success. <wwd.com/retail-news>

REI Profits - REI (Recreational Equipment, Inc.) released its audited 2009 financial results showing it earned net income of $29.8 million, up 106% from $14.5 million in 2009. The company's direct sales channel, which includes online and catalog sales, grew by nearly 5%, while comp store sales declined by 3.5%, outperforming an expected 5% decline. <sportsonesource.com>

NRF Makes Statement on Health Care Legislation - The National Retail Federation in a statement expressed extreme disappointment at the House's passage of sweeping health care reform legislation over the weekend, saying added labor costs under the bill will cost many retail workers their jobs.  <sportsonesource.com>

Dick's Sporting Goods has declared May as Dick's Sporting Goods National Runners' Month with the sponsorship of ten major running-event sponsorships.   <sportsonesource.com>

Protests Against Nike - Maryland University became the latest college to see campus protests erupt against Nike over the closing of two factories in Honduras that had been operated by Nike subcontractors. Activists at the University of Wisconsin-Madison, Cornell University and Purdue University have also protested alleged illegal wage practices following the closure of the Hugger de Honduras and Vision Tex factories in January 2009.  <sportsonesource.com>

UK Retail Sales Grow 2nd Month in a Row - Retail sales have grown for the second consecutive month, and growth is expected to continue at a similar pace through Easter, according to the CBI Distributive Trades Survey. <drapersonline.com>

Zappos’ customer service draws raves in a new report - The online shoes, clothing and accessories retailer had the top-ranked customer service in a new study commissioned by customer service ratings agency StellaService. <internetretailer.com>

Tiger Woods and Sponsors - Tiger Woods may have lost a few key sponsors since his November car accident and the resulting fallout, but he continues to draw attention for those that have stood by him. Woods, who granted five-minute interviews to ESPN and Golf Channel, wore a Tiger Woods hat, Nike sweater and Tag Heuer watch during the interviews. Eric Wright of Joyce Julius & Associates claimed the branding exposure for the combined Nike brands is worth an estimated $2.4 million. Tag Heuer, which received a four second close-up as Woods modeled his new Buddhist bracelet, received $5,000 worth of exposure. <cnbc.com>

Google Cleared of Trademark Infringement in Vuitton Case - Google Inc. did not violate trademark law by allowing advertisers to buy keywords corresponding to registered names such as Louis Vuitton, the European Union’s highest court has ruled. However, the court said advertisers who use such keywords must make patently clear to Internet users where the goods they are selling originate, a victory for luxury goods makers vying to stamp out counterfeits online. <wwd.com/business-news>

Rapper T.I. Sued Over Apparel Line - An Illinois media firm has brought a trademark lawsuit against rapper T.I. over the name of his apparel line, Akoo. Akoo International Inc. says it has used the name since 1999 and trademarked it in 2007. The company, based in the Chicago suburb of Elmwood Park, provides music video programming to public spaces such as malls, restaurants and college campuses. TI launched his clothing line under the moniker — short for A King of Oneself — in 2008. <wwd.com/business-news>

Tod's SpA Gains in 2009 Driven by Footwear and Asia - Tod’s SpA noted performance of its footwear division and growth in Italy and Asia as drivers behind revenue and profitability growth. Approached 2009 with rigorous control of discount sales and a more and more selective wholesale distribution. Shoes, the group’s core business, continued to grow, with sales rising 4.2% percent to $506.1 mm in 2009 while leather goods and accessories showed a 12% drop to $154.8 million, sales of apparel inched up 0.5% to $132 mm. Geographically, sales in Italy gained 5.5%, while Europe fell 6.4%. Revenues in North America declined 21.7%, Asia saw sales rise 7.5%. <wwd.com/business-news>