Monday, May 11, 2009

Williams-Sonoma (NYSE:WSM): Downgraded at Merrill/BAM and Sanford Bernstein

Williams-Sonoma (NYSE:WSM) is getting two downgrades today:

- Merrill Lynch/BAM is downgrading WSM to Neutral from Buy with a $13 tgt noting that while WSM’s LT viability and strong brand identity remain intact the shares up substantially since December as a result of the realization of numerous factors, which are reflected in today's share price, the current risk/reward ratio is not as compelling. The balance sheet has strengthened, cash flows have improved, the dividend is intact, bank agreements have been renegotiated, inventory levels significantly reduced, capex reduced to a minimum, comps sequentially improved from Oct 2008 lows.

- Sanford Bernstein is out with a U.S. Retail downgrade taking their rating down on WSM, HD and LOW (from OP to MP).

Early cycle retail call is rapidly running its course, leading them to shift their overweight sector
positioning to a more balanced market-weight. As evidence continues to accumulate that the cyclical downturn in the broader economy and the consumer sector is beginning to bottom, the rationale for overweighting the early cycle retail / consumer discretionary sector is waning. Broadly, the leading indicators have turned positive, and weekly jobless claims have now been in a downtrend for over a month, both of which in the past have preceded the official conclusion of prior recessions. Firm notes their are not explicitly calling an end to the recession, but they are very cognizant that 12-month relative returns for the retailers have turned negative around the conclusion of past recessions. As the probability increases of an end to this recession in 2009, the investment case for a Retail sector overweight deteriorates, which argues for a more selective approach to Retail.

Within the context of overall retail, the home-related retailers have tended to be the earliest of the early cycle names, given housing's typically leading characteristics. This cycle has been similar, with HD and LOW among the best performing stocks in firm's coverage in 2008 (outside of the more defensive auto parts retailers).

With this strong relative performance and significant multiple expansion, these two stocks
are now already discounting a majority of a recovery to fair value. Based on our view of normalized margins in the 9.5% range for both, blended fair value framework suggests only 20% to 30% upside to true fair value. While this still represents meaningful upside, they would argue that relative returns could pale in a true economic recovery and that still significant uncertainty in the timing and pace of recovery to normalized margins should keep the stocks at some reasonable discount to true fair value.

WSM is a somewhat different case as the stock performed relatively poorly in 2008 (- 31% relative) as liquidity concerns pressured the stock, but year to date, WSM is up ~80% versus the market. Bernstein sees normalized margins in the 7% range (in line with WSM's 15-year average), which implies a fair value of ~$15 or approximately 15% upside to FV from current levels. Given more significant and lingering structural questions around WSM's business model and competitive positioning, they would need to see more significant upside opportunity to continue to recommend the stock.

Notablecalls: Two downgrades will do their damage to WSM's stock price today. I see it going to about $12-ish (or slightly below) where it will find buyers and squeeze higher again.

Going short retail is going to be the next crowded trade, I suspect.

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