Williams Sonoma Stock Could Be Ripe for a Short at Current Levels

Key Points

• A recent report shows that as real estate weakens, Williams Sonoma faces a dangerous headwind in the furniture industry.
• Financials show some cracks that could lead to lower margins and EPS in the future; Wall Street forecasts also reflect this risk.
• Rising short interest and discounts to peers have driven price targets to reflect near double-digit upside in the stock.

Investors can save a lot of money and even boost their potential returns when they realize that there is one major difference between a stock and a business. Apple Inc. NASDAQ: AAPL might be an amazing business and brand, but if its stock is too high or volatile, it won’t make for a good investment. In this way, shares of Williams-Sonoma Inc. NYSE: WSM present a similar set-up today.

While the company's long-term financial record would point to a potential value play or a stock that investors wouldn’t want to let go of, changing industry dynamics and the current stock price might force the price to come down. Now, investors don’t have to short the stock if that’s too complex or uncomfortable a process, but just like an institutional fund manager, investors can either avoid the stock or consider selling it if they owned it through its massive rally over the past two years.

For reasons that will become clear in just a bit, investors will find out why the furniture industry, as an extension of the real estate sector, is starting to come up against headwinds to significantly compress the potential growth of both Williams Sonoma stock, which might be why markets have placed their bets when it comes to the relative value of this name against peers like Wayfair Inc. NYSE: W and RH NYSE: RH, a sign for investors to consider in the coming months.

Breaking Down the Latest Trends in the Furniture Industry: What’s Happening at the Top?

There is one economic report for retail investors to consider, one that professional traders at the big banks use to generate ideas and spot potentially outsized returns. This report is the manufacturing PMI index, which breaks down 18 industries, making it easier to spot the growers and laggards.

Two significant furniture industry trends create a bearish bias toward all stocks operating in that space. The first is new orders, which are contracting for furniture companies, but that only takes care of the demand side. If supply is also tightening, then prices remain stable enough to protect profit margins.

But that’s not the case. Inventory levels are also on the rise in the furniture industry. Rising supply and slowing demand could cause furniture stocks to see their profit margins and earnings per share (EPS) significantly lower in the coming months, and that’s where Williams Sonoma comes into play.

However, investors now have to ensure that the company reflects the same level of rising inventories coupled with lower demand so that the thesis can be strengthened further. Here’s what that looks like.

A Closer Look at Williams-Sonoma’s Financials Uncovers Trouble Ahead

Figuring out the demand side for Williams Sonoma can be done through revenues reported in the latest quarterly earnings report, which do show a slight slowdown. A contraction of 4% over the year confirms the same industry dynamic of slowing demand.

This may be an extension of the weakening state of real estate demand, as seen through falling home building permits and housing starts. More than that, the mortgage market index is now at a 1996 low, showing no new pipelines for new homes that need furnishing, affecting not only the present but also the future of Williams Sonoma.

Now, for the supply side, this can be checked through the company’s cash flow statement. This section shows an outflow of $154 million last year in inventory, meaning sales and supply tightening. However, this year’s quarter shows a net inflow of $1.4 million, a $156 million increase from last year’s inventory cash flow.

Investors now understand that Williams Sonoma is experiencing slower demand along with higher inventories. This will trickle down into thinner margins and, therefore, lower EPS, something the market is already starting to bet on.

Market Sentiment Shifts on Williams Sonoma as Investors Reassess

To gauge how the market feels about a stock, investors can compare it against peers through metrics like forward P/E ratios and EPS growth forecasts, where Williams Sonoma is underperforming both Wayfair and RH.

On a valuation basis, Williams Sonoma stock trades at a Forward P/E ratio of 18.6x today, while RH stock commands a premium above that stock with its 37.8x multiple. Wayfair is similar, as the stock is now valued at a 26.0x forward P/E.

Markets may be willing to discount Williams Sonoma against its peers because of its EPS growth forecasts. Wall Street analysts now think that Williams Sonoma can deliver just under 3% growth this year while expecting over 100% for Wayfair and 85% in RH stock instead.

For these fundamental reasons, bearish traders decided to raid Williams Sonoma stock and take on this view, as the company’s short interest rose by 3.8% over the past month alone. More than that, today’s consensus price target on the stock would reflect a net 6% downside from where it trades today.

Fundamentally, technically, markets and investors are turning bearish on Williams Sonoma stock, and so should retail investors as the trend keeps developing.