ETD - Ethan Allen: A Rich And Sustainable Dividend

2023-06-29 02:21:35 ET

Summary

• Ethan Allen Interiors Inc. offers a promising dividend yield of 5.10%, significantly higher than the S&P 500 average of 1.66%.
• Despite a downturn in consolidated net sales, the company's free cash flow and liquidity are strong, indicating that the modest declines in revenue and earnings per share should not hinder future dividend payments.
• The company also lists several competitive advantages, including a wide selection of custom-made products and a strong retail network.
• However, there are potential headwinds to consider, such as a slowdown in consumer income, new home starts, and remodeling efforts, as well as the risk of material shortages or pricing issues due to its vertical integration.
• Despite these challenges, the company is considered undervalued, with a Buy rating from Seeking Alpha and Wall Street analysts and a Strong Buy from Quants.

For income investors, there’s nothing like a rich dividend from an established and profitable company.

Ethan Allen Interiors Inc. ( ETD ) offers shareholders that sort of promise. At the close on June 28, 2023, with the share price at $28.27, the yield was 5.10%. That’s well above the S&P 500 average of 1.66%.

The furniture and interior design firm also has been growing its dividend payment; by 13% in the most recent quarter. The payout ratio comes in at 48.84%, leaving ample room for future increases, as well.

What’s more, the small-cap firm also has issued special, or irregular, dividend payments since January 2018:

• January 2018: $0.31
• January 2019: $1.00
• 2020: no special dividend
• May 2021: $0.75
• August 2021: $0.75
• August 2022: $0.50.

Assuming Ethan Allen pays a special dividend again this year, that would boost the yield. For example, adding $0.50 to the existing $1.44 ($0.36 quarterly), the total dividend would add up to $1.96. Dividing that by the current price of $28.27 produces a yield of 6.93%.

However, don’t count on that premium until it is officially announced—if one is announced. As the firm noted in its 10-K for fiscal 2022,

Although we expect to continue to declare and pay comparable quarterly cash dividends for the foreseeable future, the payment of future cash dividends is within the discretion of our Board of Directors and will depend on our earnings, operations, financial condition, capital requirements and general business outlook, among other factors. Our credit agreement also includes covenants that includes limitations on our ability to pay dividends.”

Needless to say, its ability to pay both regular and special dividends depends on its free cash flow, which in turn depends on revenue and earnings.

Fundamentals

In its third-quarter fiscal 2023 earnings release (for the period ended March 31, 2023), the company reported that consolidated net sales totaled $186.3 million, down from $197.7 million in the same quarter of last year. That continued a downturn that began last year, which CEO Farooq Kathwari attributed to a “slower economic environment”:

Note the two slightly lighter-colored bars on the right side of the chart above. They represent estimates of future revenue and indicate slight improvements in the fourth quarter of fiscal 2023 and the first quarter of fiscal 2024.

What drives sales and revenue at furniture and home furnishings businesses? According to an article at the Common Thread Collective, the three main drivers are consumer income, new home purchases, and remodeling initiatives.

Switching to EBITDA, the Seeking Alpha system gives Ethan Allen a B-minus for growth (on a forward basis). The company’s growth rate is 6.54%, compared with 3.74% median for the consumer discretionary sector.

Next, what effect has slipping revenue had on earnings per share? This chart provides an overview of EPS estimates and actual results over the past five years, with estimates for this and the next fiscal years:

On the positive side, free cash flow has been recovering after slipping in 2021 and 2022:

Turning to liquidity, Ethan Allen had this optimistic take on the future (10-K for 2022),

We believe that we have a strong balance sheet with $121.1 million of cash and investments, no outstanding borrowings as of June 30, 2022, and a credit agreement that provides for a $125 million revolving credit facility, which we believe will provide sufficient liquidity to continue business operations in the long-term.”

That optimism was backed up by a dividend increase of 13%, announced along with the Q3 earnings.

Given its free cash flow and liquidity, the modest declines in revenue and earnings per share should not be a hurdle to future dividend payments.

Overall, it appears the dividend is sustainable, and it is possible we may also see a special dividend in this calendar year.

Headwinds and tailwinds

The company lists six competitive advantages in its annual filing for fiscal 2023:

• A wide selection of custom-made products.
• Its complimentary design service, coupled with technology.
• North American manufacturing, which facilitates customization and quality through craftsmanship.
• A strong retail network that includes both company-operated and independent licensees.
• Its logistics network of national distribution centers and retail home delivery centers.
• A vertically-integrated network in which it controls everything from the sawmill to the showroom.

To that list, I would add Ethan Allen’s long-established brand and reputation for quality.

There are also multiple headwinds to consider:

• As noted above, home furnishings demand is driven by consumer income, new home starts, and remodeling efforts. A slowing in any one or all of these factors could depress the company’s revenue.
• Since it is vertically integrated, it could face material shortages or pricing issues at any stage between the sawmill and the sales floor.
• It does carry $133.1 million in debt, however that should not be a problem as it also carries $156.2 million in cash and short-term investments.
• Although the COVID-19 pandemic has largely passed, there is still the risk of a resurgence or the emergence of yet another crippling health crisis. As a chain that depends heavily on in-store sales, another epidemic that forces it to close its doors could be serious.

Valuation

The Seeking Alpha system gives Ethan Allen a valuation grade of A-minus. A couple of specifics explain why: the P/E Non-GAAP ratio, TTM basis, is 6.34, well below the consumer discretionary median of 12.67. The PEG GAAP ratio, again on a TTM basis, is 0.26, compared to the sector median of 0.62. By both measures, the stock is deeply undervalued.

The price/sales ratio clocks in at 0.84, which is the same as the sector median. The price/book ratio, TTM, is 1.53, while the sector median is 2.13.

And, a look at the 10-year price chart shows that the current share price is much the same as it was at the beginning of the past decade:

Indeed, one might argue that the firm needs a high dividend to offset the lack of capital gains.

Other perspectives

SeekingAlpha and Wall Street analysts give Ethan Allen a Buy rating, while Quants offer a Strong Buy.

Institutional investors are bullish; they hold 88.25% of shares outstanding. Over the past year, insiders have bought 126,257 shares while selling 134,361 shares. CEO Kathwari’s interests align with those of shareholders; he held 1,790,747 shares at the end of the last quarter.

Also of note, the firm was founded 90 years ago, giving it a solid base of experience and expertise. That can be useful in difficult times, such as during the pandemic, and it reduces the chances of financial distress in the future.

Conclusion

When searching for above-average dividends, the challenge is to find companies that can sustain the yields. Ethan Allen Interiors appears to be one of those companies. It has a 5.26% yield that is backed up by relatively consistent revenue, earnings per share, and free cash flow. The sticking point, though, is the paucity of capital gains over the past decade.

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