by Will Ashworth | July 12, 2014 6:45 am
Lumber Liquidators (LL) fell off a cliff Thursday, dropping almost 22% on 10 times its normal volume.
The last time it generated anywhere near this kind of volume was a similar shearing — on July 7, 2011, Lumber Liquidators cut its 2011 earnings estimate by 13%, and LL stock took a 23% bath.
Momentum investors have long since left the building. Oddly enough, now the question remains whether Lumber Liquidators has entered value territory or not.
LL stock has been public long enough (seven years come November) that it’s beginning to show some trading patterns that are likely to repeat themselves in the years to come. So what’s happening here? Is this a repeat of 2011, or is there something else responsible for the 50% drop since October 2013?
Here’s what Lumber Liquidators’ then-CEO Jeffrey Griffiths had to say about its business almost three years ago to the day:
“Our second quarter net sales were weaker than expected … We had not anticipated the rapid softening in customer demand …”
Here’s what current CEO Robert Lynch said yesterday:
“Customer traffic to our stores was significantly weaker than we expected … The improvement we experienced beginning in mid-March did not carry into May, and June weakened further.”
The words and sentiment are almost identical. This tells me the flooring market can sustainably handle about three years of growth, then consumer demand softens.
Lumber Liquidators plans to open as many as 37 stores in 2014, slightly less than the 40 it opened in 2011. So, it’s clearly not store growth that’s responsible for the change in its outlook.
What about same-store sales growth?
Lumber Liquidators ended 2013 with same-store sales guidance of high-single to low-double digits. When LL reported Q4 2013 results in late February, its comp estimate hadn’t changed. About two months later when it announced its Q1 2014 results, Lumber Liquidators had given up any hope of a double-digit comp for this year but were still fairly confident about the growth in sales.
And then yesterday’s guidance hit.
Lumber Liquidators is calling for same-store sales to change in the low single digits either positive or negative.
That’s right: Sales could actually contract at stores open more than 12 months when only seven months earlier, LL was predicting comps as high as 10% or more. That’s a huge change in sentiment.
In 2011, the shift wasn’t nearly as significant. In November 2010, Lumber Liquidator’s guidance called for low-single-digit comp growth. By February, it was looking at low to mid-single digits. The same held true in late April 2011. Another 71 days later, and Lumber Liquidators was calling for a decrease in the low single digits.
It’s significant, but it can’t be compared to the sea change that’s taken place this past year. Especially if you consider that the economy in 2011 was arguably in worse shape than it is today. So, at the end of the day, investors were right to give LL stock a smackdown.
But that doesn’t mean you should abandon it altogether. Here’s why:
LL stock closed that fateful day in July 2011 at $18.32 per share. There were approximately 28.5 million shares outstanding, which put the market cap at $522 million. Lumber Liquidators had no debt and about $33 million in cash at the end of Q2 for an enterprise value of $489 million. Its EBITDA for the trailing 12 months (for simplicity, I’ve annualized the six-month numbers for Q2 2011) was $44 million, providing an EV/EBITDA multiple of 11.1.
Fast forward to today, and you’re looking at a virtually identical EV/EBITDA multiple of 10.8. This tells me LL stock was hugely overvalued when it traded around $120 last November.
About the same time, hedge fund manager Whitney Tilson made a presentation at the Robin Hood Investors Conference that explained why he was short Lumber Liquidators stock. His major premise: The company’s margins were extraordinarily high because it was buying illegal wood from China. Paraphrasing his words — it was too good to be true.
Yesterday, Tilson told Value Walk via email, “Another day, another retailer bites the dust.”
Tilson definitely was right about one thing. Gross margins were 41% in 2013, 580 basis points higher than two years earlier, while operating margins more than doubled to 12.6%. While this margin expansion isn’t unheard of, it is rather unusual. That doesn’t mean his premise is right, but it certainly makes you think.
Motley Fool contributor Rich Greifner makes a reasonably balanced rebuttal of Tilson’s views in a November 2013 article. Greifner argues that Tilson provided no proof that the company had done anything illegal; furthermore, CEO Robert Lynch has made a substantial difference to the company since joining as COO in 2011.
Certainly, he has a good pedigree in this kind of retail with stints at Home Depot (HD) and Lowe’s (LOW) Orchard Supply Hardware division.
I think he’ll be able to guide the company successfully through any stormy conditions that it might encounter in its dealings over the illegal wood issue, but it’s disconcerting just the same.
If you remove from the equation the future potential legal issues Lumber Liquidators might face, you’re left with a stock whose valuation is the same as it was two years ago when margins weren’t nearly as healthy.
I’m not saying LL stock is worth anywhere near $120, but I do believe it’s attractively priced at this point, and should it drop into the $40s in the coming days and weeks, Lumber Liquidators would become an honest-to-goodness value play.
However, if you can’t stand any kind of controversy associated with the stocks you own, you’ll probably want to take a pass.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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