Efficiencies across the supply chain benefit the narrow-moat company's margins.
Given the cadence of promotional spend by retailers recently, we expected weak gross margin results at narrow moat Williams-Sonoma
; however, the firm bucked the trend thanks to improving merchandise margin. With a secular shift in consumer behavior since the last recession, as end users wait more patiently for discounts, expanding the gross margin solely through pricing could remain difficult. However, efficiencies across the supply chain allow the ratio to rise to 37.9% over our forecast, averaging just over 10 basis points per year; still below prerecession gross margins around 40%. That said, we expect scale and the rising franchise revenue should help leverage SG&A expenses, around 70 basis points to 26% over time, below the rate of more than 30% that was generated in the 2000s, leading to operating margin expansion. We still view the business model defensibly, with 52% of revenue coming from the e-commerce channel and plan to maintain our $73 fair value estimate. Shares remain compelling, trading at more than a 30% discount to our fair value.
Jaime Katz, CFA, is a senior equity analyst for Morningstar.
We plan to lower our 2017 topline modestly, from 5.5% previously to 3.2%, as the housing cycle strength moderates, leveling off spending and revenue growth, which averaged 8% in 2010-2015. Admittedly, we were most disappointed that 2017 will be another year of depressed operating margins, with management forecasting 9.4%-9.6% versus our forecast for 10%. With 2017 revenue growth at a low-single-digit pace, and EPS rising 3% at the midpoint of guidance, the firm’s three-year goals calling for mid- to high-single-digit sales and low-double-digit or better EPS growth remains elusive. Considering the persistence of price competitiveness, our model incorporates mid-single-digit top-line and high-single to low-double-digit earnings growth longer term, lower than long-term company targets. In turn, our long-term operating margin forecast is for more than 11%, helped by leverage from scale and better merchandising.
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