LL - LL Flooring: Book Value Is Diminishing Quickly Due To Weak Results

2023-11-29 11:15:28 ET

Summary

• LL Flooring Holdings reported -20.5% comparable store sales and -7.9% adjusted operating margins in Q3 2023.
• It was also hit with $16.2 million in additional costs related to antidumping duty changes on certain imports from 2012 to 2013.
• LL Flooring has limited its near-term cash burn with the help of drawing down its inventory.
• Book value has decreased from near $9 per share at the end of 2022 to a bit over $6 per share at the end of Q3 2023.
• Tom Sullivan has made another offer for LL Flooring, but at a significantly reduced price compared to his May 2023 offer.

LL Flooring Holdings' ( LL ) Q3 2023 results show that it is dealing with serious challenges. LL Flooring's comparable store sales were down -20.5% year-over-year and -27.8% on a two-year stack. Its product margins were decent, but the significant decline in sales resulted in its adjusted operating margins coming in at -7.9% for the quarter.

In addition, LL Flooring was also hit with an unfavorable antidumping duty rate change (related to 2012-2013) that is costing it $16.2 million (including interest).

This combination of weak results and additional charges have pushed LL Flooring's book value down from nearly $9 per share at the end of 2022 to a bit over $6 per share now.

The latest offer for LL Flooring from Tom Sullivan (F9 Investments) may provide support for its share price at $3 per share , but I believe there is a high chance that LL Flooring attempts to continue with its turnaround efforts on its own. I had previously estimated LL Flooring's intrinsic value at around $4 per share based on trends until the end of Q1 2024. LL Flooring's trends haven't changed much, but the unexpected antidumping duty rate change reduces its end of Q1 2024 value to around $3.50 per share. If LL Flooring is unable to meaningfully increase sales (or reduce costs) from current levels, then its estimated value would fall to just over $2 per share by the end of 2024.

Q3 2023 Results

LL Flooring's year-over-year comparable store sales declined by -20.5% in Q3 2023 . This was actually a slight improvement compared to Q2 2023's -22.2% comparable store sales decline. However, LL Flooring's Q3 2022 results were below expectations, with -7.3% comparable store sales, so its two-year stacked comps is around -27.8%, demonstrating how far LL Flooring's sales have fallen.

LL Flooring's adjusted operating margins were -7.9% in Q3 2023, a slight decline from its -7.5% adjusted operating margins in Q2 2023. LL Flooring's adjusted gross margins have been fine (at 37.5% in Q3 2023).

While LL Flooring's product margins have been decent, its problem is that SG&A costs have increased sharply as a percentage of sales as its sales have plummeted. LL Flooring's adjusted SG&A (in total dollars) declined by -2% in Q3 2023 compared to Q3 2022. LL Flooring's net sales went down by approximately -20% over the same period, resulting in adjusted SG&A increasing from 37.1% of net sales in Q3 2022 to 45.4% of net sales in Q3 2023.

LL Flooring's adjusted numbers for Q3 2023 also do not include certain items such as the $1.6 million in incremental costs related to the US Customs detentions of some vinyl flooring products due to the Uyghur Forced Labor Prevention Act. As well, LL Flooring was hit by $10.7 million in unfavorable antidumping duty rate changes (related to 2012-2013) and $5.5 million in related interest costs (for a decade's worth of interest on that $10.7 million).

Notes On Inventory

LL Flooring's inventory went down from $332 million at the end of 2022 to $283 million at the end of Q3 2023. This drawdown of inventory helped significantly reduce LL Flooring's cash burn during 2023. It reported $8 million in positive operating cash flow during the first three quarters of 2023, along with $14 million in capital expenditures.

LL Flooring talked about having around 2.0x to 2.5x inventory turns per year. If LL Flooring's new normal for merchandise sales is around $750 million per year (a -22% decrease from 2022 levels), then it would need to carry around $235 million in inventory to end up doing 2.0x turns per year. This assumes 37.5% gross margins on merchandise, resulting in $469 million in merchandise cost of goods sold per year.

Thus LL Flooring can potentially draw down its inventory further if its sales levels don't improve. A rebound in sales would require it to carry more inventory.

I believe LL Flooring should have sufficient liquidity for 2024, helped by further inventory drawdowns if its sales levels don't improve.

Acquisition Offers

I haven't heard much more about Live Ventures' $5.85 per share cash offer for LL Flooring, although I had previously noted that there were various barriers that would likely prevent that offer from resulting in an eventual deal. I won't discuss that offer more in this report.

Founder and former CEO Tom Sullivan (F9 Investments) has also returned with another offer , this time at $3.00 per share in cash, compared to his May 2023 offer at $5.76 per share in cash. This lower offer is attributable to "LL Flooring’s deteriorating financial and operational performance." This offer is said to be fully financed via cash on hand and borrowings under an existing credit facility.

Sullivan's May 2023 offer involved a 39% premium to its closing price before the offer announcement. Sullivan's latest offer involves a 6% premium to LL Flooring's closing price on November 13th.

Given the low premium to LL Flooring's pre-offer closing price and LL Flooring's previous rejection of Sullivan's much higher (92% higher) offer that was made six months ago, I am quite doubtful that Sullivan's latest offer will be accepted at $3 per share.

An offer of $4+ per share may be given more consideration, although LL Flooring may still be reluctant to accept a price that is markedly less than what it turned down earlier this year. Sullivan may also be reluctant to increase his bid by that much given that LL Flooring's book value is trending to drop below $4 by mid-2024.

Notes On Valuation

LL Flooring's book value was reduced to a bit above $6 per share at the end of Q3 2023 due to its operational losses and the antidumping duty rate change. This was down from approximately $8.95 per share at the end of 2022. Thus its book value has gone down by nearly $3 per share during the first three quarters of 2023, although this was partially affected by items such as the antidumping duty rate change.

If LL Flooring's business results don't improve, its book value will be reduced to approximately $4.70 per share by the end of Q1 2024. This does not include any impact from additional one-off charges. A 0.75x multiple to that would result in a value of around $3.50 per share for LL Flooring.

LL Flooring's book value could then be reduced to around $2.75 per share by the end of 2024 if its business results don't improve, resulting in a value of a bit over $2 per share at a 0.75x multiple to book.

At its current price of $3.60 per share, I'd consider LL Flooring to be relatively risky. LL Flooring's upside from an acquisition is probably not more than $4 per share at this point, while if it continues to go it alone, it could have an intrinsic value of around $2 per share by the end of 2024 without business improvement.

Conclusion

LL Flooring reported poor Q3 2023 results with another quarter of worse than -20% comparable store sales growth and adjusted operating margins that ended up at -7.9%. LL Flooring's unadjusted operating margins were at -13.7%, largely due to an antidumping duty rate change related to imports from a decade ago.

LL Flooring's estimated intrinsic value is at $3.50 per share based on current trends lasting until the end of Q1 2024. This is a reduction of $0.50 per share from before due to that antidumping duty rate change, which cost it $16.2 million including accrued interest.

If LL Flooring Holdings, Inc. cannot meaningfully improve its business results, its intrinsic value would drop to near $2 per share by the end of 2024.

Tom Sullivan has made another offer for the company at $3 per share, but this is likely to be rejected due to the limited premium versus the pre-announcement trading price and the significant reduction from his May 2023 offer of $5.76 per share. Sullivan may be willing to increase his offer a bit, but I am currently skeptical that a deal can be achieved.

For further details see: