It seems odd, in a period of global turmoil and questions about the stability of the world economy, that some of the best stocks in the U.S. market could be those of companies dedicated to selling people more stuff to put into their homes.
And yet this may be the case, according to Morningstar. The research firm lists Bed Bath & Beyond Inc. and Williams-Sonoma Inc. as five-star stocks in its rating system, with Restoration Hardware just behind, with four stars. (As of Thursday, there are just 15 stocks with the top five-star rating out of more than 950 rated names at Morningstar.)
In doing so, the firm is going deeply against the grain of Wall Street, where a majority of analysts covering each of the companies have either "hold" or "sell" ratings on the shares. The recommendations also cut against investor sentiment, as the three stocks are anywhere from a third to nearly three-quarters below their 52-week highs.
Consider them, then, picks for the contrarian, long-term investor who has faith in the near-term future for traditional bricks-and-mortar retail.
Before we examine each company, a word or two about the Morningstar system. Wall Street analysts' ratings are typically driven by a 12-month target price and where a stock sits relative to that amount. By contrast, Morningstar calculates a fair value based on its analysts' estimate of the company's long-term future cash flow. Its star ratings depend on how large a discount, if any, at which the stock currently trades. Riskier stocks – classified by Morningstar with a higher "uncertainty" rating – require a bigger discount to fair value to earn more stars. Stocks can move among the ratings quickly as their share price changes – as all three of these names did, spending time at either four or five stars in the past 12 weeks, according to Morningstar data.
With this background, you can understand that, while Morningstar analyst Jaime Katz has some concerns about the current performance of the three companies, she still estimates long-term cash flows that are worth a lot more than where the three stocks are trading.
Let's start with the most solid of the three names, Williams-Sonoma, on which Ms. Katz places a $76 (U.S.) fair value, versus Thursday's close of $54.02. The company is known as the owner of the eponymous line of cookware stores as well as Pottery Barn and its brand extensions.
What is less known is that Williams-Sonoma was into "big data" decades before anyone used the phrase. Ms. Katz writes that the company "has a nearly 20-year lead on most retailers, collecting insights on end users for more than 25 years, at a granular level (collecting more than 100 data points on each transaction)." This "deep knowledge," as she calls it, ultimately leads the business to operate more efficiently and turn over its inventory faster than its peers. (The company also gets slightly more than half of its sales online, illustrating its e-commerce bona fides.)
In its most recent quarterly results, Williams-Sonoma reported positive same-store sales growth (sales at locations open at least one year) at all of its brands, with an average result of 4.5 per cent. This is in contrast to Bed Bath & Beyond, which surprised investors last month with a first-quarter comparable sales figure of negative 0.5 per cent. It's a blemish for a company that Ms. Katz has considered "one of the better-operated companies in the retail industry," one that survived while past competitor Linens 'n Things closed all its stores in 2008.
Bed Bath & Beyond has, Ms. Katz says, "a best-in-class decentralized merchandising strategy," an improving online presence and "untapped international growth opportunities." The June earnings report prompted her to re-evaluate the company's competitive position, and reduce her fair value estimate for the shares to $64 from $70. Investors, however, have pushed the shares down far further, closing Thursday at $44.07.
While Ms. Katz pegs the uncertainty at Williams-Sonoma and Bed Bath & Beyond as "medium," she describes it as "high" at Restoration Hardware, making it a pick suitable for only the gutsiest of investors. The seller of high-end home furnishings has just 70 stores, and is still young enough in its life cycle that it hasn't yet earned a return that exceeds its costs of capital, in her estimation. It has been gaining market share while expanding into new lines, such as one targeting teens, while also building awareness of its brand. Like Williams-Sonoma, more than half of its sales come online or through other sales channels outside its brick-and-mortar chain.
The company's most recent quarterly results, however, were "dismal," she notes, and she cut her fair value estimate to $48 from $61. As with the other names, however, investors have been far more pessimistic: At Thursday's close of $29.84, Restoration Hardware is 38 per cent below Ms. Katz's fair-value estimate, and nearly 75 per cent off its 52-week high of $106.49.
To use a retailing cliché, these stocks are in the bargain bin, and if the economy turns south or competition gets even tougher, these stocks may stay there. But as discount-oriented shoppers know, sometimes there are gems among the markdowns; if Morningstar is right, these three may qualify.