I’ve never been a fan of WSM, its business model, or its management team, but I’ve gotta give credit where it’s due. This print was awesome. We expected the top line to be robust – and the 26% comp certainly didn’t disappoint. We’ve had this name on our Short Bias list waiting for the right moment (and right amount of froth on what we perceived to be unsustainable earnings) to make it an official Best Idea Short. But we’re pivoting, and pulling it off our Short Bias list. It’s not the comp that’s prompting us to do so – but the gross margin that WSM just put up is simply amazing, and likely sustainable. It put up a 42.1% GM, which is 200bp better than the best GM the company has put up in at least 10-years. That’s 448bps better than last year (when Covid wasn’t a factor yet), and is a huge nod to the renegotiation of the company’s leases, less promotional selling, and becoming more profitable with its ecomm business (grew 49% this quarter) – much of which is permanent. Mind you, when e-comm spikes it usually evaporates margins for retailers, but the opposite happened here. Also note that it is closing 25% of its store fleet as it sizes up e-comm. Smart move. The higher margin came in spite of the excess freight and logistics costs that we’re seeing due to West Coast port congestion. And while management did not give explicit guidance, the way we read the tea leaves, it suggested that the right number for FY21 is $10/share in earnings – well ahead of our prior $7.75 (and the Street at $7.72).
While I’ll say again that I’m not a fan of WSM management, I can’t recall this team ever sounding so bullish and confident about the go-forward trends in the business. And in fairness, this team usually does what it says it’s going to do. They’re clearly banking on the focus on the Home being a multi-year trend, and are guiding accordingly. That’s where there’s ample room for debate. If you are in the camp that as we anniversary Covid then comps go solidly negative, then you want to short this stock at $150 with impunity. But that’s not our view as it relates to the home furnishings business (we’re much more bearish on the TREND sustainability for the Home Improvement space, and are short HD and LOW). The company also laid out a 5-year model of $10bn in revenue (vs $6.8bn today) and a 15% EBIT margin, which equates to about $15 in earnings power. But then you gotta account for the cash – of which there is plenty. This company usually sits on a cash balance of about $300-$400mm, and peaked at $300mm in repo in a single year. But given the excess cash flow from the outsized comps and margins, WSM is sitting on $1.2bn in cash with no debt. We think it will amp up its stock repo to $600mm/year, and sustain that rate annually -- at a price as high as $235/shr by year 5 of our model. That gets us to an incremental $3.50 per share in earnings over a TAIL duration. All in, we think that management just guided to $18-$19 per share in underlying earnings – and half the Street probably doesn’t even realize it.
We’re coming out a bit more conservative with our numbers than the implied near-term and long-term guide . But are still coming in at $9.55 for 2021 vs $9.04 in its Covid year. In no way did we think that WSM had a chance in hell to have an up year in ’21, but the incremental Gross Margin upside alone gets us to an added $1.50 per share in earnings, and the stock repo gets us to an extra $0.40 ps above our previous forecasts. Looking out over a TAIL duration, we’re at $15.75 in EPS (including $3.50 from share repo) -- suggesting about a 10x p/e based on where the stock is trading after hours. We’d easily give this a 15x p/e given the margin and return characteristics – suggesting a stock of $235 in 3-4 years. Discount that back to a 12-month forward value today and it suggests a stock between $150-$175. That’s what we call ‘not a short.’ Long side, we’d rather own more RH, which we think is in a completely different growth, margin and return league than WSM, and we think that the stock more than doubles over a TAIL duration. But based on these WSM numbers and how the margin story changed, we wouldn’t try to talk anyone out of owning it.
-- McGough
