Two Alternative for Cramer’s Ethan Allen Pick

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

Two Alternative for Cramer’s Ethan Allen Pick

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.

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