As the economy improves and discretionary income goes up, people will have more money to spend. That's one of the biggest bull cases for the retail industry. However, there's one retail sector that will see the benefits of both a rising economy and rebounding housing market. With the housing market rebounding, there will be more people with houses to decorate and fill with various products.
Williams-Sonoma (NYSE:WSM) is one of the best companies to get exposure to the rebounding retail market and take advantage of the increase in housing demand. Williams-Sonoma is a retailer of high-quality products for the home.
Williams-Sonoma's investments in e-commerce are paying off for the company as the internet becomes the go-to avenue for shopping. Williams- Sonoma already gets slightly more than 45% of revenue from the direct-to- consumer segment. Over the next half decade, Williams-Sonoma expects its direct-to-consumer sales to grow to more than 50% of sales. Thanks to this, its operating margin is at decade highs over the trailing-12 months, at nearly 10.3%.
Meanwhile, it's also seeing strength in its retail business. Third-quarter results showed that operating income for the retail segment was up 12% year over year. This marked the first quarter in six that the company saw a year-over-year gain. And comparable-store sales were up 8.2%.
Why Williams is best in breed?
Williams-Sonoma's return on capital of above 23% is a new peak for the company, and it has an impressive free cash flow yield of right at 5%. The weak housing market put a damper on consumer spending. Yet, even through the downturn, Williams-Sonoma has kept inventory levels in check. Its inventory turnover ratio is back above 4 times after getting as low as 3.5 times in 2009.
A couple of other major home-goods retailers include Bed Bath & Beyond (NASDAQ:BBBY) and Pier 1 Imports (NYSE:PIR). Bed Bath & Beyond trades at less than 13 times earnings, while Pier 1 trades at 15.6 times. However, Bed Bath doesn't pay a dividend, while Pier 1's is 1.3%.
Bed Bath & Beyond is already down 20% year to date after offering a weaker-than-expected full-year outlook. However, investors can take solace in the fact that Bed Bath has zero debt. This is a much more advantageous balance sheet than some of its peers, including Macy's and its 132% debt-to-equity ratio. Bed Bath also customizes its merchandise offering to cater to specific markets.
Alex Smith took over as CEO in 2007 after leaving TJX. That same year, Pier 1 posted a $228 million loss. It lost money for two more years. After flirting with bankruptcy in 2009, Pier 1 has come roaring back. Pier 1 generated $32 million in profit in 2010 and has grown that number to $201 million as of fiscal 2013.
With a business model that supports strong cash flow generation and negligible debt, investors should look for Williams to return more cash to shareholders. It already pays a forward dividend yield of 2.3%. Over the last three years, Williams-Sonoma has managed to reduce its shares outstanding by 10% and up its quarterly dividend payment by 80%.
Williams-Sonoma is a solid investment and trades just below its five-year average multiple. Meanwhile, Bed Bath and Pier 1 could be solid investments for other reasons. Bed Bath offers home goods in the lower- to mid-priced range, while Pier 1 is still a turnaround story.
Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond and Williams-Sonoma. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.