2023-06-28 09:42:13 ET
Summary
- La-Z-Boy Incorporated is an undervalued company with strong operating performance and cash generation ability in the home furnishing space.
- The company has a long track record, pays dividends, and is expected to benefit from the post-COVID environment and demographic shifts.
- Risks include potential softness in consumer discretionary spending due to heightened interest rates and changing consumer tastes.
Summary
La-Z-Boy Incorporated (LZB) is an undervalued company despite strong operating performance and cash generation ability. This is a very established name in a mature industry that is performing well. I'm personally a fan of companies that have long track records, are cash accretive and pay dividends and LZB meets all these criteria. Further, I think there is promise in the home furnishing space in the current post COVID environment. I believe the move away from major metros and into larger living spaces in the suburbs will serve as a catalyst for demand going forward. The main risk with LZB is potential softness in the broader consumer discretionary sector due to the heightened interest rate environment putting pressure on US consumer spending. With respect to idiosyncratic risk, consumer tastes and preferences could tilt out of LZB's favor.
Business Overview
LZB, or La-Z-Boy Incorporated, is a global furniture company that designs, manufactures, markets, and distributes furniture products under the La-Z-Boy, American Drew, England, Kincaid, and Joybird brands. The company's products are sold through a network of company-owned and independent retail stores, as well as through online channels.
LZB was founded in 1927 whose hallmark product was the La-Z-Boy recliner. Currently, product offerings have expanded its product line to include other types of furniture, such as sofas, chairs, and tables. Today, LZB is one of the largest furniture companies in the world. It has over 10,000 employees and operates in multiple countries. The company's products are sold through a network of over retail stores and online channels.
Some of the key activities to consider include:
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Furniture design and manufacturing: LZB has a team of designers who create new furniture styles each year. The company also has a network of factories that manufacture its furniture products.
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Furniture marketing and distribution: LZB markets its furniture products through a variety of channels, including company-owned retail stores, independent retail stores, and online channels.
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Customer service: LZB provides customer service for its furniture products. This includes providing information about products, answering questions, and resolving problems.
LZB discloses financial results under three operating segments:
Wholesale : This segment manufactures and imports upholstered furniture, such as recliners and motion furniture, sofas and loveseats. It also imports casegoods (made from wood) furniture, such as occasional pieces, bedroom sets and dining room sets. Distribution of product takes places via combination of La-Z-Boy retail channels and partnerships with independent furniture retailers.
Retail : This segment sells upholstered furniture, in addition to some casegoods and other accessories to the end consumer through the retail network. It includes company-owned La-Z-Boy Furniture Galleries stores, independent La-Z-Boy retailers, and the Joybird online furniture marketplace.
Corporate and Other : This segment includes the shared costs for corporate functions, including human resources, information technology, finance, and legal.
Going down a level deeper, LZB sells under a few different brands including La-Z-Boy, which is the flagship brand and associated with the famous recliner. There is also an interesting one in Joybird, which offers products with more of a modern/contemporary look and feel. The table below summarizes some of the major brands sold by LZB.
This Isn't A Single Product Company
When La-Z-Boy comes to mind, the associated image that comes to mind is the single person recliner and this was the company's bread and butter for some time - or maybe I'm just dating myself. However, as most of the market has slept on Domino's Pizza's seamless app and order system over the years, La-Z-Boy has multiple points of entry into your living room. Omnichannel is the buzzword employed in recent years but LZB truly lives and breathes it. LZB does business in over 65 countries using various channels including partnerships with retailers & distributors, D2C via web as well as exposure on popular home furniture sites such as Wayfair.
Relevant Macro Themes
Before we get into the finer details, one thing should be clear - home furnishings is a cyclical name and industry. Furniture is generally considered a discretionary product and useful lives can be extended - I type this as my decade plus year old couch has been beaten, tattered and patched up after so much use. The blue line represents annual y/y GDP growth while the red line represents LZB y/y revenues and yellow represents the peer group (HOFT, BSET and WSM). As you can see, LZB highs and lows oscillate to a much greater degree. Despite this volatility, I believe LZB is currently in a unique position where a negative macro outlook still provides an uplift to current LZB prices based on historical multiples.
One of the key points to my investment thesis is the differentiation between pre and post COVID trends. The chart below illustrates COVID as an inflection point, putting consumer spend on furnishings and household items on a steeper trajectory going forward. Some of that may be due to COVID related stimulus, but I believe that demographic shifts out of major cities into the suburbs and more rural areas serves as a runway for additional growth - more living area = more furniture required. Coupled with this, I believe millennials will contribute to a growing furniture market as this generation enters the family formation stage and a decision is made to relocate to larger living spaces. Millennials have made up ~2/3rds of first time home buyers and I believe that trend will continue, with the reason being home affordability keeping a large percentage of millennials on the sidelines at the moment. The counterargument to my thesis is that furniture is a durable good that lasts for years, so the only ways to grow sales are by being extremely competitive on pricing and having products that appeal to a broad customer base. Let's assume furniture is purchased every 10 years in adulthood - for someone who is 30 years old and expected to live until 80, LZB has 5 opportunities to sell this customer product. That is not a lot of chances compared to a company selling bread on a weekly basis.
The final, quick point I want to make with respect to macro is the impact of raw material costs. Furniture manufacturers rely on raw materials such as leather and lumber to manufacturer finished goods. Unexpected spikes in raw material costs could put pressure on gross margins, such as the sharp spike in lumber in 2021. I am no commodity expert by any means, so the best I can do in my model is assume input prices stay the same in my base case scenario.
Revenue and Earnings Profile
Revenues have been growing at a healthy clip over the past decade at a ~8% CAGR.
Margins have historically been more volatile, with op margin dipping in 2019 before returning to a more normalized level in the high single digit range. 2019 was a bit of an outlier year since the impacts from the Joybird acquisition were still being worked into operating results as noted in LZB's 4Q19 earnings call .
Moving on to SG&A for the year. GAAP SG&A as a percent of sales increased 170 basis points in fiscal 2019 compared to fiscal 2018. Non-GAAP SG&A increased 150 basis points adjusted for acquisition-related costs for Joybird. Changes in our consolidated business mix increased SG&A by 200 basis points for the year, reflecting the growth of Joybird and Retail for the roughly three-quarters of the year that we own them. In addition, incentive compensation costs as a percentage of sales were 80 basis points higher for fiscal 2019, due to our improved financial performance against incentive targets. Partially offsetting higher SG&A was the improved leverage of fixed cost on higher sales dollars. - Melinda Whittington - Senior Vice President & Chief Financial Officer.
3Q'23 Earnings Takeaways
Continued top line revenue strength on top of continued strong demand based on resilient US consumer spending. However, can this trend continue despite inflationary and interest rate headwinds? I'll explain in more detail in the valuation and estimate sections below.
Strong sales and earnings: LZB reported net sales of $573 million for the third quarter of 2023 , up from the same period last year. Net income for the quarter was $43 million on a GAAP basis and $53 million on a non-GAAP basis, also up y/y.
On a consolidated basis, fiscal '23 third quarter sales increased to $573 million versus the prior year quarter, with pricing and surcharge actions and the positive effects of product and channel mix, offsetting lower unit volume. Consolidated GAAP operating income increased to $43 million and non-GAAP operating income increased to $53 million, a record for a third quarter and an increase of 34% versus last year's third quarter, primarily driven by strong performance in our Retail segment.- Robert Gerard Lucian -- Senior VP & CFO at La-Z-Boy Incorporated
Maintaining competitive pricing: LZB tweaked pricing to maintain competitiveness and didn't observe any broad reductions in pricing within the sector.
We've seen some companies, certain competitors roll back some prices. A lot of it had to do with the ocean freight rates going down. And some of those competitors are at the lower end of what I'll call the furniture industry from a price point perspective. As a result of that, we've taken some action as it relates to sharpening price points at some of our opening price point levels of products that we sell. And we've done that to maintain competitiveness against some of those lower-priced competitors that are taking some of the reductions. But we haven't seen a broad reduction across the entire industry. - Robert Gerard Lucian -- Senior VP & CFO at La-Z-Boy Incorporated
Strong retail sales: LZB saw strong sales growth in the third quarter, y/y and on a same store comp basis .
Total written sales for our retail segment were up 8% versus last year's third quarter and same-store written sales comp at a positive 3% for the period. We are extremely pleased to deliver positive written sales versus a year ago for our retail segment, even with challenging economic headwinds. - Melinda D. Whittington -- President, CEO & Director at La-Z-Boy Incorporated
Cautious outlook: No apparent signs of consumer slowdown has been showing up in performance metrics, but LZB is well aware that there may be upcoming macro headwinds.
It's that old crystal ball we keep looking for, right, Anthony. What I would tell you is, as you know as well as I, you can find a prognosticator that can give you a pretty wide range of the worst is behind us or we've only just begun, right? And I think you have to assume that things are going to continue to get tougher for the consumer certainly over this calendar year. Thus far, for our consumer, which is a little more on the upper end of sort of that middle end consumer, we simply haven't seen that. And so we're planning prudently. And that speaks, even to Bob's point, to Bobby's question around kind of a wide range of potential outcomes relative to how bad might it get out there…So I guess I'd say I'm cautiously optimistic, particularly for the things that -- where we can control our execution -- that I think we just continue to get stronger every day. But we recognize that none of us know exactly what the total external environment is going to look like over the next year. - Melinda D. Whittington -- President, CEO & Director at La-Z-Boy Incorporated
4Q'23 Earnings Takeaways
LZB printed just a few days before this note was written, but the initial reaction on June 20th seemed negative as the stock was trading down ~6% after hours on 6/20/23. 4Q'23 revenue printed lower than consensus which management is attributing to 1 less week of sales in 4Q'23 vs. 4Q'22.
When I initially constructed my LZB model, revenue was expected to land in the low to mid-$600 range but fell short. Despite this, EPS came in higher than my expectations by ~$0.09. It seems like I was a little too harsh on the company in terms of gross margins and SG&A spend, but this is actually a good thing since my forecast isn't reliant on a huge turnaround story or significant benefits in cost structure. Below is a comparison of the 4Q'23 print against my model estimates.
Financial Statements - Notable Items
For some LZB chooses to include Joybird financial performance within the Corp Other segment. However, some tidbits are buried in the footnote commentary such as sales - we'll dive into this deeper in a subsequent note. Joybird is just over a decade old and was acquired by LZB in 2018, leading me to believe that there are still some growing pains managing a relatively new, online-based brand.
Management has undertaken a strategy to buy out independent retail and distribution facilities in order to penetrate select markets in its Wholesale segment as noted in LZB's 3Q23 10-Q :
. ..grow our company-owned retail business and leverage our integrated retail model (where we earn a combined profit on both the wholesale and retail sales) in suitable geographic markets, alongside the existing La-Z-Boy Furniture Galleries network. - LZB 3Q23 10-Q
Gross margins have been improving due to an "improved consolidated mix" which I interpret as higher margin products and segments have been increasing as a share of sold product.
" Changes in our consolidated mix improved gross margin by 290 basis points and 240 basis points in the third quarter and first nine months of fiscal 2023, respectively, compared with the same periods a year ago, driven by growth of our Retail segment, which has a higher gross margin than our Wholesale segment. - LZB 3Q23 10-Q
The path forward on operating margins is a little fuzzier going forward - there was a manufacturing facility closure impacting SG&A expenses, which I view as transitory. In addition, management noted that growth in its Retail segment garnered additional SG&A expense and marketing spend has been reconfigured to pre-COVID levels. The good news is that overall growth is good and marketing spend is a lever management can pull if the economy turns.
Changes in our consolidated mix increased SG&A expense as a percentage of sales by 80 basis points and 150 basis points in the third quarter and first nine months of fiscal 2023, respectively, compared with the same periods a year ago, driven by growth of our Retail segment, which has a higher SG&A expense as a percentage of sales than our Wholesale segment.
Charges related to the closure of our Torreón, Mexico manufacturing facility resulted in a 160 basis point and 50 basis point increase in SG&A expense as a percentage of sales in the third quarter and first nine months of fiscal 2023, respectively, compared with the same periods a year ago.
SG&A expense as a percentage of sales was impacted during the third quarter and first nine months of fiscal 2023 by increased investments in marketing, to pre-pandemic levels as a percentage of sales, to drive written sales. The third quarter of fiscal 2023 was further impacted by higher selling expenses, as a percentage of sales, primarily driven by higher written sales in our Retail segment. - LZB 3Q23 10-Q
Dividends & Share Count Considerations
LZB has been a consistent dividend payer. Some may interpret this as a wasted opportunity to reinvest and grow as well as being tax inefficient, but I prefer to receive some of my capital back while still having the option of upside via stock price appreciation. It's like collecting rent on an investment property that's cash flow positive vs. burning through your cash and banking on price appreciation alone. Worst case scenario, my thesis is wrong but I'll have some capital return for the risk.
With respect to share count, management has diligently reduced the number of shares outstanding over the past decade by ~10m to 44m as of 2022. Even taking into account the Joybird acquisition in 2018, share counts still declined. However, share repurchases are on hold for the time being based on 3Q23 earnings call commentary and I appreciate management's diligent effort to conserve financial resources in uncertain times.
Year-to-date, we returned $27 million to shareholders through dividends and share repurchases. Given the uncertain macroeconomic environment, we have temporarily paused share repurchase other than to offset dilution to enable prudent capital investment in the business and maintain a strong balance sheet. - Robert Gerard Lucian -- Senior VP & CFO at La-Z-Boy Incorporated
LZB management has kept a strong balance sheet profile over the years so I don't see any material share dilution risks moving forward. A dividend cut would be disastrous barring any tail events such as COVID, when the dividend was paused for a single quarter. Again, I don't see any red flags to any future dividend cuts given the strong balance sheet and LZB's cash flow generation ability.
Valuation
To value LZB, I use a blended approach based on NTM earnings and NTM FCF. I typically opt to use a combination of approaches to root out any bias that may have crept up into my financial model. I also believe expectations on operating earnings and cash flow (burn) greatly impact a company's share price.
LZB is trading at ~9.4x forward P/E and ~7.7x forward P/FCF at the time of this writing per Seeking Alpha , which are below historical averages and provides for additional cushion on the downside. I believe multiples will expand to their historical multiples as valuations are slightly depressed despite no significant change in LZB fundamentals. As a value focused investor, I am looking for signs that operational performance is poor or will be poor in the future, yet I haven't seen any huge red flags here.
As shown below, the NTM P/FCF and P/E are averages calculated over the timeframe from 1Q19 through 3Q23.
How does LZB stack up against peers? Somewhere in the middle and closer to the more attractive companies from a valuation perspective, in my opinion. At face value, ETD has more attractive multiples, but I'm willing to settle for slightly less attractive multiples for LZB's greater market share, longevity of the brand and balance sheet strength that meets my filtering criteria.
Estimates vs. Consensus Estimates
Vs. Street, my revenue estimate for FY24 + FY25 is in line with consensus with a slight a slight improvement in the outer year. This is a reasonable assumption given the last 1-1.5 year of rapid FOMC rate increases still working its way through the broader economy. This is the consumer discretionary sector after all, and assuming anything other than flat or decreasing top line revenue is wishful thinking in my view.
Where I diverge from Street is everything below the top line for FY24. I'm typically conservative with my margin improvements unless management indicates they're closer to the upper end of their guide (will keep an eye out for additional commentary). Despite this, the upside is clear and LZB is undervalued based on what the fundamentals suggest using conservative estimates. For FY25, my revenue estimates are still well below Street, but still slightly improving as I expect management to focus
Below is a comparison comparing my top and bottom forecasts vs. Street as well as some of the baseline assumptions used in my financial model.
Catalysts/Risks
I want to re-emphasize there is a moderate amount of risk with this name given the cyclical nature of the industry. However, I think the idiosyncratic risk in this name is mispriced and the risk in this case is tilted to the upside. I do not have a crystal ball, but based on my research I'm not hesitant to call this a buying opportunity. The elephant in the room when it comes to taking a position in LZB rests with your outlook on US consumer spending power. Nonetheless, I believe the share price reflects a much more severe downside for a company that has the balance sheet strength LZB possesses. Shifts in taste and negative brand perception could hurt LZB but I can't predict where this will go in the future - I'm beholden to management to adapt to a changing environment and I believe they are doing a fine job catering to consumer preferences. Finally, an unexpected spike in materials costs could hurt gross margins in the short term as these costs would need to be passed onto the consumer. However, LZB has thrived in the currently inflationary environment and I believe there is considerable pricing power given the strength of LZB's scale and brand recognition.
Again, pointing towards my model and conservative assumptions, the table points to risk skewed to the upside based on current pricing. Off the bat, my base case already assumes a 20% y/y revenue decline for FY2024 and yet I still arrive at a $40 target. If margins come in softer, I estimate my downside to be somewhere around ~$20 a share and if my thesis holds, common equity should be valued somewhere around $40 a share or higher.
Summary
In summary, I consider LZB stock undervalued even after including some very conservative assumptions in my financial model. With prices trading in the mid- to high-$20s, I believe there is room to run higher if you're willing to stomach the risk on a cyclical name. LZB has been in business for close to 100 years, is self-sustaining on a cash basis, has a strong balance sheet and demographic tailwinds are in LZB's favor in my view.
For further details see:
La-Z-Boy: Own A Piece Of This Undervalued And Well-Run Company