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Mega-Purchase Suggests Williams-Sonoma Will See Plenty of Upside; Plus 3 Dividend Plays, One Savvy Insider, Several Real Estate Plays and More

By Michael Brush
Exclusively for InvestorIdeas.com
September 14, 2006

Here at Insiders Corner, we like to focus on micro-cap names with big insider buying – because the signal carries more weight down at this end of the market.

But once in a while a purchase comes along at a larger company that’s so compelling its impossible to ignore. That’s what we have with Williams-Sonoma (WSM), the retailer. (We’ll take a brief look at over a half dozen interesting buys in small-cap land in a moment.)

Williams-Sonoma is an upscale home furnishings retailer that also caters to lower income spenders through Pottery Barn. The company’s stock has been a disaster since early May when it traded north of $44. But this kind of sell off is often a good set up for profits after an insider buy signal.

Since May, worries about the impact of a slower economy on the consumer – plus lowered guidance for the rest of the year – took Williams-Sonoma stock well under $30. Down there, chief executive Howard Lester loaded up on $10 million worth of stock.

That’s an interesting purchase for several reasons beyond the sheer size. First off, the last time Lester was active in the stock he was selling – and much, much higher. Lester sold $22 million worth of stock last December for around $44, according to Thomson Financial. What’s more, he’s got over 1.5 million options – most of which are exercisable – with a value in the tens of millions of dollars, according to company filings.

In short, this septuagenarian has a lot of exposure to the stock, and at a time when he should be looking forward to selling to cash in options, he’s buying instead on the dip, and big time.

Why the stock will reverse

Williams-Sonoma has all the bases covered. It is part upscale retailer – selling goodies like the KitchenAid Artisan Stand Mixer in “Sonoma green” for $300. You can get matching cushion-back diner stool’s for $219 each. Shoppers hunting for a more modest splurge can buy Halloween truffles for $14 (set of four), or a s’mores kit for $24.50.

At the same time, however, Williams-Sonoma gets about half its revenue from sales of more moderately priced home furnishings through its Pottery Barn stores. That’s where the problem lies. Sales in these stores weakened throughout the summer, and were down slightly for the second quarter compared to the year before. In its August conference call, the company also guided expectations down for the next two quarters.

Yes, this is bad. But here’s why it’s not the disaster investors think it is: Williams-Sonoma is a savvy retailer that knows how to deal with merchandising problems.

The company has already made changes in Pottery Barn floor plans and merchandise displays, changes which are improving matters. It also revamped the Pottery Barn catalogue. Many retailers print their catalogues once for a season and hope for the best. But Williams-Sonoma is smart enough to print once a month. So it can adjust catalogues that produce a weak response. This is crucial, because Williams-Sonoma gets 44% of its revenue from direct to consumer sales – through catalogues and websites.

Patrick Connolly, the chief marketing officer, recently tried to reassure investors at a September 6 Goldman Sachs Global Retailing Conference. “Our chairman and chief executive Howard Lester and myself have been here for almost 28 years. We've seen the tide rise and fall many times, and we know what to do,” he said.

To cynics, that may sound like a lot of hot air. But this team has the track record to back it up. The retailer has grown at about five times the rate of the overall home furnishings market over the past three years. That’s a record that says it’s safe to bet that Williams-Sonoma will get out of this jam – especially when insiders are betting the same way.

Of course, a big part of the decline in sales at lower-end Pottery Barn stores was linked to the higher gasoline prices for most of the last quarter. But here the company is getting some help, as well.

October crude-oil contracts were recently below $65 a barrel, from above $77 a barrel in early August. The average retail price of gasoline has fallen to $2.67 from $3.08 a gallon, according to the U.S. Energy Information Administration. This should help Williams-Sonoma right where higher gasoline prices have hurt the most: With the lower-end consumer who shops at Pottery Barn.

Here are some other reasons I like Williams-Sonoma stock right here.

Lemming-like selling has put downward pressure on the stock. Williams-Sonoma recently got downgraded by at least three brokerages -- one in the end of July and two in August. Wall Street analysts are shooing investors out of the stock and creating untoward downward pressure while insiders are buying – exactly what we like to see. It’s typically a winning bet to go with the insiders in this scenario.
The insider buying is huge. The big one was the $10.3 million purchase by chief executive Lester at $29.46 on August 31. On September 8, however, a director also bought $147,000 worth for $29.50. The company also recently announced an additional $149.5 million share buyback, enough to purchase about 5 million shares at around current prices.
This is supposed to signal that management “sees value” in the stock at these levels. But I’m less enthusiastic about the buyback because Williams-Sonoma issues so many options. The buyback just offsets the dilution. The company granted 1.2 million options last quarter. It has 10.3 million options outstanding, 6.7 million of which are exercisable. Still, the buyback is better than nothing at all – because at least it will help offset the dilution of all those options.
The stock looks cheap. Williams-Sonoma has $187 million in cash or $1.60 per share. It has a price-earnings to growth ratio of .83, and a price to sales ratio of 1. It carries a forward price earnings ratio of about 14.7. All of these valuations are quite reasonable for a leading retailer on a growth path. Managers have complained recently about trouble finding suitable real estate for expansion. But presumably that will change now that real estate demand is softening.

The bottom line: I’d buy this stock right here. But as always, you’ll want to have a time frame of at least a year or more.

The quick and dirty

There were several interesting insider purchases at other companies recently. Here’s a quick and dirty roundup.

Dividend plays. For those looking for income-producing stocks, it might pay to follow insiders into the single-family residential mortgage lending company Thornburg Mortgage (TMA) which now carries a forward annual dividend of 11.9% because of the recent sell off. Two other options include brand name manager Cherokee (CHKE) which has an annual dividend of 7.1%; and Nicor Inc. (GAS), a utility that pays a 4.40% dividend.
One savvy insider. Martek Biosciences (MATK) director Robert Flanagan has great timing with his company’s shares. In 2002 and 2003 he made purchases that were up 64% and 95% in six months, according to Thomson Financial. Earlier this week he bought 52,000 shares at $20.84 after the stock gapped down from $30. Will this time be a repeat?
Two housing plays. Insiders at manufactured housing company Fleetwood Enterprises (FLE) and an urban-oriented builder called Tarragon (TARR) were recently buying after their stocks got massacred.
A real estate play. Insiders have continued to purchase at Pep Boys - Manny, Moe & Jack (PBY) since I wrote about them as a play on hidden real estate assets (http://articles.moneycentral.msn.com/Investing/CompanyFocus/7StocksSittingOnRealEstateRiches.aspx)
Despite the gains, storage companies are still buys. The self-storage companies Public Storage (PSA) and U-Store-It Trust (YSI) are up at least 20% since I wrote about them here on June 8 (http://www.investorideas.com/insiderscorner/Articles/060806.asp). Despite the healthy advance, insiders are still buying, suggesting these stocks have further to go. Insiders have also been buying recently at another one in the space called Extra Space Storage (EXR).
MasterCard. Shares of Mastercard (MA) are up about 30% since I mentioned them as a buy in June 8 (http://www.investorideas.com/insiderscorner/Articles/060806.asp). Despite the gains, insiders were still buying recently – suggesting the stock has further to go.
Two more home-related buys. Shares of Fastenal (FAST) are up about 8% and Pool (POOL) is about flat since I wrote about them on July 27 (http://www.investorideas.com/insiderscorner/Articles/072706.asp). Since then, insiders have bought more, confirming the original buy signal.
Asset manager still a buy. The asset manager Westwood Holdings Group (WHG) took a quick trip to $20 from $19 right after I wrote about it here on Sept. 7 (http://www.investorideas.com/insiderscorner/Articles/090706.asp). Buyers were presumably loading up to be shareholders of record for a special 85 cent a share dividend. That would explain why the stock promptly dropped back to $19, after the record date. Anyone who owned got the dividend. But even if you missed it, the stock is still a buy.

Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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