This Retailer Could be the Perfect Income Pick

Part of investing is taking advantage of temporary opportunities while they last. For the past several years, corporations have been able to issue debt at super-low rates to fund share buybacks, which in turn, boosts earnings per share.

Along with dividends, buybacks have contributed to a huge amount of cash being returned to shareholders, helping make up for a sluggish global economy and anemic sales growth. With low interest rates likely to persist, we still have a chance to play this theme.

However, buybacks and dividends aren’t enough to keep investors from losing money in the long run if a company offers nothing more than financial parlor tricks. That’s why I look for companies with strong brand leadership and attractive valuations, which should help me capture capital gains in addition to consistent income.

And I’ve found just such an opportunity in the recent retail sales meltdown.

Williams-Sonoma (NYSE: WSM) is a leader in the $100 billion home furnishings market with more than 600 retail locations and a solid online presence. The company owns a number of popular brands including Williams-Sonoma, Pottery Barn, Pottery Barn Kids, PBTeen and West Elm.

With 90% of the company’s products designed in-house, its merchandise is unique, which helps support the brand and pricing power in an otherwise commoditized retail environment.

Williams-Sonoma’s e-commerce segment is unusually strong compared with traditional retailers, accounting for half of total revenue. This helps the company reduce operating costs and take advantage of the steady migration to online shopping. What’s more, its West Elm, Pottery Barn and Williams-Sonoma sites took the top three spots in a recent Wells Fargo (NYSE: WFC) survey of consumer experience and brand popularity for online retailers.

Despite the decline in WSM and the broader retail sector over the past year, the company boasts rock-solid fundamentals. It has $194 million in cash on its balance sheet and no long-term debt, though it has used debt for financial leverage in the past.

According to a recent investor presentation, Williams-Sonoma’s sales have vastly outpaced its peers, growing at a 7% compound annual rate since 2000, more than 10 times the average for furniture and home furnishings stores.

The company has made returning cash to shareholders a priority, with steady dividend increases and generous share buybacks.

In March, it increased its quarterly dividend by 5.7% to $0.37 per share for a current yield of 2.5%. Management also approved a $500 million, three-year share repurchase plan, in addition to the remaining $62 million available from the previous authorization. The share count has decreased by roughly 15% over the past five years thanks to consistent repurchases.

Turn This Cash Machine Into a 49% Annualized Return

Shares of Williams-Sonoma look relatively cheap, trading at 17.5 times trailing earnings against a five-year average of 20.7. And they may be an even bigger bargain when we consider the potential for this year’s earnings.

Analysts expect earnings to increase 5.9% to $3.57 per share this year, but I think that estimate is too low given expected sales growth of 4.8% and the potential reduction in share count.

If the new $500 million share repurchase authorization is spread evenly over the three years, that will amount to $167 a year. And the remaining $62 million from the previous authorization is likely to be worked through in two years or less. That’s a total of almost $200 million a year in buybacks. This is easily supported by free cash flow, which stood at $341 million at the end of the fiscal year in January.

With the estimated $200 million in share repurchases over the next year, we could see the share count reduced by another 3.4 million.

If the company maintains its 6.2% profit margin, expectations for sales of $5.21 billion would translate to earnings of $3.75 per share when accounting for the reduction in share count. Even on a more conservative EPS estimate of $3.65 and 17.8 price multiple, shares would be worth $65, which is 11% above the current price.

Now, there is a way to boost your income even further, and that is with a simple options strategy known as a covered call. While it requires you to step outside your comfort zone a bit, average traders are using it every day to skim hundreds, if not thousands, of dollars from the stock market. You can get started doing the same immediately by clicking here.

With WSM trading at $58.60 per share at the time of this writing, we can buy 100 shares and simultaneously sell one WSM Aug 65 Call, which is trading around $1.50 ($150 per contract). This gives us a cost basis of $57.10 per share, which is 2.6% below the current price.

If WSM closes above the $65 strike price at expiration on Aug. 19, our shares will be sold for that price. In this case, we will make $6.40 in capital gains, plus the $1.50 we received for selling the call and the July dividend payment of $0.37, for a total return of $8.27 per share.

This represents a profit of 14.5% over our cost basis of $57.10. Since we’d earn that in 107 days, it works out to an annualized return of 49%.

Williams-Sonoma is expected to report earnings during the third week of May, so shares could be volatile around the release. Eighty-seven percent of consumer discretionary companies that have reported Q1 earnings so far have beaten expectations. The sector is expected to post 17.7% year-over-year growth, which could help bring investors back to strong brands like Williams-Sonoma.

Originally Posted at Profitable Trading

— ProfitableTrading

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