As consumer sentiment and spending rise and inflationary pressures cool, investors begin to eye the retail sector as a viable option for their portfolios. However, as economic headwinds like the ongoing conflict in the Red Sea continue for both consumers and retailers, picking the right retail stock may seem daunting.
Wedbush Retail Analyst Seth Basham joins Yahoo Finance for the latest installment of Good Buy or Goodbye, helping investors navigate which retail stock is positioned well for their portfolios.
Basham says his Good Buy is Williams-Sonoma (WSM) citing the company's operating margins will exceed consensus forecasts. He expects the home furniture retail sector to grow after improving inflation, a cooling housing market, and Williams-Sonoma's bigger focus on its e-commerce business.
Basham says his Goodbye is RH (RH) because the company raised prices by over 50% from 2018 to 2022, compared to similar products, which raised initial margins but ended up alienating its consumer base. This ultimately resulted in a huge drop in market share. In addition, the company has a huge risk associated with the company transitioning almost all of its products this year and attempting to expand into Western Europe.
Catch more of Good Buy or Goodbye here, or you can watch this full episode of Yahoo Finance Live here.
Editor's note: This article was written by Nicholas Jacobino
Video Transcript
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JULIE HYMAN: It's a big noisy universe of stocks out there. Welcome to Good Buy Or Goodbye. Our goal, to help cut through that noise, to navigate the best moves for your portfolio. Well, several retail names potentially facing material pressure stemming from the Red Sea crisis and Panama Canal drought restrictions. Among that list, we're placing two companies on investors' radar when looking at investing place in retail and home furnishings retail, in particular. Joining me now is Seth Basham, Wedbush Securities Managing Director of Equity Research. Thanks so much for being here.
SETH BASHAM: Thanks for having me.
JULIE HYMAN: So let's get to your good buy, the one you like, first of all, and that is Williams-Sonoma. And Williams-Sonoma, interesting case here because, first of all, the stock has already done quite well over the last year. But let's get right to your investing case here. And first of all, it is that you think margins are going to do better even than the street is estimating. What's going to drive that?
SETH BASHAM: That's right. Margins are at peak level, and driven the stock to new highs. But we think margins are going to continue to go higher, at least 70% to 90 basis points higher than the street in 2024. And the primary driver of outperformance relative to street expectations is supply chain costs. We actually have lower supply chain costs embedded in our inventory in the balance sheet. As they sell that inventory, it's going to increase gross margins and operating margins. So we see nice upside there in 2024.
JULIE HYMAN: Interesting. OK, and then also, you think, generally, there's going to be growth in the home furnishing sector, and, I suppose, specifically also for Williams-Sonoma.
SETH BASHAM: Yeah, certainly. So the sector itself was very strong during the pandemic. We had people staying at home, redoing their homes. Housing took off. And of course, over the last 18 months or so, it's been a quite opposite picture. As we move through 2024, we expect housing to start to grow again, interest rates to come down to help fuel that, and home furnishings to start to increase in sales. So that could be a nice plus for the stock too, as we move through 2024.
JULIE HYMAN: And then also, there's the idea that Williams-Sonoma has kind of changed how it's done business. It is not discounting as much as it once was. It's kind of holding the line on price. And a lot of people are shopping online for their stuff, right?
SETH BASHAM: That's right. There are changes that took place in this company that began before the pandemic. They stopped doing site-wide promotions. They also started pushing their e-commerce business more, which is now 2/3 of their sales. And the margins the e-commerce business are much higher than the stores business, so their operating margins are now higher structurally and should stay higher.
JULIE HYMAN: My understanding also is that they've also sort of expanded. When you talk about home furnishings, decor is also something they've leaned into a little bit. Furniture, yes, but also selling lots of other stuff--
SETH BASHAM: Yeah, that's right.
JULIE HYMAN: --that goes in your house.
SETH BASHAM: Yeah, certainly. About half their business is furniture, half is decor. It varies by brand. But for one, the furniture-heavy brands, like West Elm, they're starting to move more into decor. And that should help re-accelerate growth in that brand.
JULIE HYMAN: Let's talk about what could go wrong, as we like to do here. And there is the risk of higher supply chain costs because of what's going on globally, right?
SETH BASHAM: Yeah, that's right. Certainly, the Red Sea crisis is sending ocean freight rates up materially right now. There are surcharges on current rates. However, as we get into the contract renegotiation this spring, our experts, including the supply chain head at IKEA, thinks that will only see a 10% to 20% increase in freight rates for 2024. And that's not enough to really dial back all that margin improvement that we forecast.
JULIE HYMAN: Gotcha. OK, and then let's get to your stock that you don't like as much in this space, and that is RH. And this stock has already had quite a roller coaster over the past year or so, is down significantly from its highs, as we can see. Here, the company raised prices pretty aggressively. And what happened as a result of that?
SETH BASHAM: Very aggressively. They fired a lot of their core customers, what we call aspirational luxury customers were priced out of RH. They increased their prices by 50% in our sample of goods from 2018 to 2022. And last year, the company's CEO admitted they probably went too far with price increases. So they're on to the next phase.
JULIE HYMAN: So the next phase, though, where they are now, did it happen too late? I mean, can you bring those people back? Or can you attract new people who can afford to pay those prices?
SETH BASHAM: Yeah, it's not going to be easy. So they are introducing more value-oriented merchandise, so lower price, a little bit lower quality in some cases, and trying to bring that customer back. It remains to be seen whether or not they'll be successful. It's early stages. They plan on reinventing pretty much all of their merchandise, touching every single collection in 2024. So it's a mammoth feat.
JULIE HYMAN: And everything has to go right, I guess, when you're talking about that. They're also expanding geographically in Western Europe. So what are you watching to see, maybe, if they're going to execute well on all of this?
SETH BASHAM: Yeah, so we're watching how the product resonates in the stores. First, if it gets in the stores on time, peak inflection is expected in the second quarter. But with the shipping delays, that could be delayed. And with execution risk, that could be delayed. As it relates to the expansion in Europe, they have stores so far and a couple countries. The first country they entered, United Kingdom, their store has been a bust. So, far off from meeting their sales expectations. And right now, we don't have a huge degree of confidence that the other stores will be super successful.
JULIE HYMAN: Interesting. OK, then there's another point that you made, which is how the stock is valued, and especially valued versus Williams-Sonoma. So RH is up here. And then you have Williams-Sonoma, that is at a much lower valuation, here. And that's been-- I mean, they were closer. But RH, with its earnings troubles, has gotten a lot-- is a lot more expensive now than it was.
SETH BASHAM: Yeah, that's right. We're talking about forward PE on our numbers, about 22 times for RH, 13 times for Williams-Sonoma. That makes Williams-Sonoma a much more attractive in our view. We don't expect a V-shaped recovery in Rh earnings. So with that in mind, Williams-Sonoma is a better buy.
JULIE HYMAN: Well, with all of that said, we also like to point out, just like we pointed out the risks for Williams-Sonoma, the risks to the downside-- your downside case for RH. And that's-- things could go right, in theory. What would need to go right, though, for RH?
SETH BASHAM: Yeah, so, execution for one. So if they execute on the product revamp, if they execute on the store expansion, those would be two good things. And the second thing is just the luxury housing market, which they play into. So if luxury housing comes back faster than we forecast, faster than the existing home sales overall, that could be a plus for them.
JULIE HYMAN: All right, but obviously you don't think that's the case at this point. So let's just summarize what you're telling investors here. Buy Williams-Sonoma, you say. Operating margins are expected to come in above consensus. The home furnishings retail sector expected to grow this year. On the other side, you say avoid RH. It remains to be seen if the company can win back its core customers or even expand its customer base for that matter. Seth, thanks so much for coming in. Really appreciate it.
SETH BASHAM: You got it. Thanks for having me.
