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Two Alternative for Cramer’s Ethan Allen Pick

He likes the home furnishing company, but these two look good too

   

Mad Money’s Jim Cramer was pushing Ethan Allan (NYSE:ETH) Dec. 20, suggesting that the stock’s 7% pullback the week prior presented an opportunity for investors. A week later, it’s still trading around $25, so the opportunity is still there for the taking.

While I like Ethan Allan as a company,let’s take a look at two alternatives in the home furnishings industry.

First up: American Woodmark (NASDAQ:AMWD), a supplier of kitchen cabinetry to both Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW). At the height of American Woodmark’s success back in 2004, its market cap was $719 million — putting it safely in small-cap territory. Since then it’s had three years (2005, 2007, 2011) of losses greater than 40%. After hitting a bottom in 2011, it’s up 103% in 2012 — the perfect argument why the housing sector recovery is real.

In November, American Woodmark announced its second quarter results and they were extremely encouraging. Net sales rose 24% to $159.8 million, its gross profit increased by 54% to $24.8 million and most importantly, it produced a $3.5 million operating profit compared to a $4.6 million operating loss in the same quarter in 2011.

Since Q2 2010, it’s improved its gross margin 570 basis points from 9.8% to 15.5%. In 2004, its Q2 gross margin was 21.4%, only 590 basis points higher than Q2 2012. In two years it was able to recover half the necessary profits to equal its best years as a company. I see no reason why it can’t get back there in another two. If so, a valuation of $719 million would translate into a 78% return over 24 months. I’ll take that every day of the week and twice on Sunday.

By fiscal 2011, housing starts had reached a 50-year low of 554,000, down 74% from the 2.1 million housing starts in fiscal 2006. Single-family housing starts for the first six months of fiscal 2012 increased 28% year-over-year, hence the significant revenue gains in the first half of the year. On the remodeling side of its business, it managed to deliver double-digit revenue increases despite a flat market for existing home sales.

American Woodmark is taking market share. Ultimately, the lessons learned over the past five years will help it build towards $1 billion in revenue over the next five years. I expect big things from its stock.

My second pick is Tempur-Pedic (NYSE:TPX) — the 53rd worst performing U.S. stock (over $300 million market cap) in 2012. That’s 53rd out of 2,383 stocks … and not the kind of recognition you want if you’re CEO. It’s been a strange year for the mattress manufacturer, which has lost 42% since 2012 kicked off. Despite that tumble, it will still finish the year with a market cap of $1.8 billion, which makes it the third largest publicly traded home furnishings company in the U.S. behind only Fortune Brands Home & Security (NYSE:FBHS) and Leggett & Platt (NYSE:LEG).

Despite the somber state of its stock, Tempur-Pedic announced at the end of September that it was acquiring Sealy (NYSE:ZZ) for $1.3 billion, including the assumption of $760 million of debt. The combination, if approved by the Federal Trade Commission, would create a business with $2.7 billion in annual revenue, $504 million in adjusted EBITDA and annual free cash flow of $222 million in the trailing twelve months.

Morningstar uses the term “cash return” to determine a company’s return on enterprise value regardless of capital structure. Of the 17 publicly traded home furnishings and fixtures stocks within the consumer goods sector, Tempur-Pedic has the highest cash return (Free Cash Flow plus Interest Expense divided into Enterprise Value) at 7.5%. Interestingly, working in the Sealy numbers, the cash return jumps to 9.4%. Anything above 10% is excellent; above 15% is out-of-this-world. With a little tweaking, a combined TPX and ZZ should make its way well above 10%.

Bringing Sealy’s lower-priced models together with Tempur-Pedic’s higher-end products should enable it to capture greater market share at all price points. With its stock bouncing between $20-$30 most of 2012, investors will see it regain its footing in the coming year. Rest easy — Tempur-Pedic will soon be back on top.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/12/two-alternative-for-cramers-ethan-allen-pick/.

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