ETD - Ethan Allen Interiors: Lock In The Nearly 10-Year High Dividend Yield Of 5.3%

2023-06-28 12:23:53 ET

Summary

• Ethan Allen Interiors has outperformed the market over the past year, more than doubling its dividend over the last three years, and offering a nearly 10-year high dividend yield. Despite slowing business momentum, the company's low price-to-earnings ratio makes it an attractive investment.
• The company has recovered from the pandemic thanks to pent-up demand, government stimulus packages, and the work-from-home trend.
• Despite potential business deceleration next year, Ethan Allen Interiors' valuation is attractive even when calculated based on future earnings. The company's low payout ratio and strong balance sheet suggest it will continue to grow its dividend in the coming years. The primary risk is a prolonged recession, which could put pressure on the stock.

Ethan Allen Interiors ( ETD ) has outperformed the broad market by an impressive margin over the last 12 months. During this period, the stock has rallied 35% whereas the S&P 500 has gained only 12%. This outperformance may lead some investors to think that the interior design company has become unattractive, particularly given its slowing business momentum. However, Ethan Allen Interiors has more than doubled its dividend over the last three years and thus it is currently offering a nearly 10-year high dividend yield of 5.3%. Given its remarkably low price-to-earnings ratio ( 7.0 ), the stock remains attractive, despite its rally.

Business overview

Ethan Allen Interiors is a manufacturer and retailer of home furnishings in the U.S., Mexico, Canada and Honduras, with a history of nearly 100 years. The company sells its products through its network of more than 300 design centers but it has also established a strong online presence. Its retail division generates 81% of its total revenues while its wholesale division generates the remaining 19% of its revenues.

Ethan Allen Interiors sells consumer durable products and hence it is highly vulnerable to recessions. During rough economic periods, consumers tend to curtail their discretionary expenses and postpone the purchase of durable goods and hence the demand for these products significantly decreases.

Indeed, Ethan Allen Interiors was severely hurt by the coronavirus crisis. In fact, that crisis was especially severe for the company, as it forced the interior design company to shut down its stores for months. Consequently, Ethan Allen Interiors incurred a 65% plunge in its earnings per share in 2020.

However, the company has fully recovered from the pandemic thanks to pent-up demand, the stimulus packages offered by the government and a persistent work-from-home trend, which has led consumers increase their spending on home furnishings. Thanks to all these factors, Ethan Allen Interiors nearly quintupled its adjusted earnings per share, from $0.49 in 2020 to an all-time high of $2.37 in 2021. Even better, it grew its earnings per share by another 66% last year, to a new all-time high of $3.93.

On the other hand, Ethan Allen Interiors has begun to face tough comparisons due to the exceptionally strong demand for its products over the last two years, when the economy began to recover from the pandemic. As a result, in the third quarter of fiscal 2023, which ends in June, the company saw its retail and wholesale sales decline by -10% and -6%, respectively, over the prior year’s quarter while its gross margin edged down from 60.4% to 59.9% due to lower economies of scale. As a result, earnings per share slipped from $0.93 to $0.86.

On the bright side, the company has beaten the analysts’ earnings-per-share estimates by a wide margin for 7 consecutive quarters. In addition, with only one quarter left for fiscal 2023, Ethan Allen Interiors is expected by analysts to post just a -0.8% decrease in its earnings per share this year, from an all-time high of $3.93 to $3.90.

A potential threat for Ethan Allen Interiors is the accelerating expansion of a major competitor, Ikea, in the U.S. Ikea is a Swedish home goods retailer that is well-known for its extremely lean business model, which results in exceptionally attractive product prices. It is virtually impossible for the competitors of Ikea to match its prices. Ikea recently announced that it intends to increase its U.S. store count from 51 to 68. To this end, the retailer plans to spend more than $2.2 billion over the next three years and create a dominant presence in the southern part of the country. Notably, after this expansion, the U.S. will become the largest market for the Swedish retailer. This development is negative for Ethan Allen Interiors, whose product prices are much higher than those of Ikea.

However, Ethan Allen Interiors has manufacturing operations that help the company manufacture products of much higher quality than the quality of the products of Ikea. In addition, Ethan Allen Interiors can customize its products according to the preferences of its customers. It thus has a well differentiated business model from that of Ikea and hence it has a significant business moat. Overall, the effect of the expansion of Ikea on the business of Ethan Allen Interiors is likely to be limited.

Valuation

Ethan Allen Interiors is currently trading at only 7.0 times its expected earnings per share in fiscal 2023. This earnings multiple is much lower than the 10-year average price-to-earnings ratio of 16.2 of the stock. In fact, the current price-to-earnings ratio is a nearly 10-year low for this stock.

The cheap valuation has resulted primarily from the nearly all-time high earnings per share of the company this year. Due to the fading tailwind from the pent-up demand after the pandemic and the economic slowdown caused by the aggressive interest rate hikes implemented by the Fed, analysts expect Ethan Allen Interiors to incur a -22% decrease in its earnings per share next year, from $3.90 to a more normal level of $3.05. This means that the stock is now trading at 9.0 times its expected earnings in 2024. Nevertheless, this valuation level is still much cheaper than the historical valuation of the stock.

Overall, Ethan Allen Interiors is likely to experience deceleration in its business next year due to fading tailwinds but its valuation is attractive even if it is calculated based on the future earnings of the company.

Dividend

Ethan Allen Interiors temporarily suspended its dividend in 2020 due to the impact of the coronavirus crisis on its business. As a result, it has grown its dividend for only three years in a row. On the other hand, it is important to note that the company has quadrupled its dividend over the last decade. It is thus now offering a nearly 10-year high dividend yield of 5.3%.

Moreover, the company has a markedly low payout ratio of 31% . Furthermore, it has a rock-solid balance sheet. In contrast to the vast majority of retailers, Ethan Allen Interiors does not pay any interest expense while its net debt (as per Buffett, net debt = total liabilities – cash – receivables) is standing at $116 million . This amount is less than twice the annual earnings of the company and only 17% of the market capitalization of the stock and hence it is negligible.

To cut a long story short, thanks to its healthy payout ratio and its pristine balance sheet, Ethan Allen Interiors is likely to continue growing its dividend meaningfully in the upcoming years. Therefore, investors should lock in the nearly 10-year high dividend yield of the stock.

Risk

As mentioned above, Ethan Allen Interiors is highly vulnerable to recessions due to the durable nature of its products. Therefore, the primary risk factor is the adverse scenario of a prolonged recession. In such a case, the stock is likely to come under pressure for an extended period. However, a prolonged recession is unlikely, as the Fed has repeatedly proved that it is closely monitoring the economy and is always ready to stimulate the economy whenever a recession shows up. It is also important to note that Ethan Allen Interiors has always emerged stronger after every recession. Therefore, in the event of a recession, investors will just need to be patient. On the other hand, this means that Ethan Allen Interiors is suitable only for patient investors, who can stomach stock price pressure for a considerable period.

Final thoughts

Ethan Allen Interiors has begun to face tough comparisons due to its record earnings in the last three years. However, the stock is exceptionally cheaply valued and is offering a nearly 10-year high dividend yield of 5.3%, with a wide margin of safety. Therefore, investors should consider purchasing the stock around its current price.

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