2023-05-01 15:30:04 ET
Summary
- La-Z-Boy is a well-known furniture manufacturer with over two decades of consistent profitability and well positioned for continued growth in the future.
- The overall market sentiment and the expectation of an impending recession seem to have discounted La-Z-Boy's stock to an unusual level.
- Conservative growth assumptions and a potential multiple expansion to historical levels make LZB a low-risk investment with likely above-market returns a decade from now.
- The short-term investment in La-Z-Boy is yielding nearly 4% in combined dividends and share buybacks.
Relax. Not As Bad As It Looks
The streak was almost broken in 2022. It seemed like that for the first time since 1990 La-Z-Boy ( LZB ) was going to end the year with negative free cash flow ((FCF)), but things held up against the supply chain woes and the company wound up with a thin $2.42 million of cash for the full fiscal year. It's not great, but up-and-comers in the industry like Lovesac ( LOVE ) are still chasing cashflow profitability, and more seasoned ones like Leggett & Platt ( LEG ), although profitable, also felt the hit, and LEG, in particular, is struggling with a debt level six times the last five years' FCF. With no debt on the balance sheet and FCF already showing signs of recovery, 2022 is likely a blip in the radar that should not be a cause for major concerns. The strong balance sheet and consistent profitability, coupled with middle to high single-digit revenue CAGR over the last five and ten years make La-Z-Boy a low-risk investment even when considering the headwinds the sector is facing.
Plenty Of Room To Stretch
Numbers are what they are, but let's play the game of adjusting FCF for the sake of argument, and see if "there is any there there".
One of the big culprits for the big drop was inventory purchasing. The logistics nightmare was real. When companies like ZIM Integrated Shipping Services ( ZIM ) grew revenue by over 150% after COVID, it is no wonder that those on the other side of the logistics game took measures to prevent disruption by growing inventories accordingly. If we look at the cash outflows for inventory purchasing before COVID, we see that these alternated with cash inflows. For 2019 and 2020, the net cash for inventories was about $29 million. In 2021 and 2022 (red rectangle in Fig.1) the same line item amounts to an outflow of $146 million. Looking at 2022 alone, the outflow for inventory-related expenses was ($49.5) million. The quarterly average between 2015 and 2020 is about $1.3 million. The "there" is indeed "there"! Unless we have a COVID-type event every year, this disruption should be seen as what it is, an unfortunate one-off event.
Fig.1: LZB Inventories (Author)
The second culprit was capital expenditures. The average yearly capex spending between 2015 and 2021 was about $40.6 million. In the 2022 10-K, this line item jumped to $76.6 million, a nearly 90% increase above the average spending.
With these figures in mind, we are now equipped to do some magic on those FCF numbers. Let's take the meager $2.42 million of FCF and add back $36 million related to capex and, let's say, $40 million related to unusual inventory purchasing. We would then end up with $84 million of FCF. And given that the FCF for the trailing twelve months is $85.4 million, my "blip theory" seems to hold some water.
Adjusting numbers is a fun exercise, but numbers are what they are. And because we know that the company plans to keep the capex in the range of $75 to $80 million in 2023, we should temper our expectations for FCF in the coming year. This spending is related to improvements in the retail stores, new store openings, and upgrades in the manufacturing facilities. Assuming the supply chain constraints normalize and capex returns to the average, the revenue and margins improvement should allow FCF to expand in the coming years. One way margins are improving is through the acquisition of more and more independently owned La-Z-Boy stores. Increasing the number of company-owned stores allows La-Z-Boy to combine the profit of both their wholesale and retail sales. Is this strategy panning out? Figure 2 below seems to confirm it is. Net margin is now at an all-time high of 7.03%, the same being true for operating margin.
Fig. 2: LZB Profitability and Efficiency (Author)
The Industry Peers
In the Furnishings, Fixtures & Appliances industry, I looked at the more relevant furniture peers. Although LZB does not score the best in terms of Margins, Return on Invested Capital ((ROIC)), Debt/Equity, and Growth, it is however, the most consistent of the bunch, consistently being among the top three for every indicator except gross margin (Figure 3 - highest three indicators highlighted green). Ethan Allen ( ETD ) scores the highest in most of these indicators, but it substantially lags behind in growth. Lovesac's five-year growth and gross margin are impressive, and the company deserves its own dedicated analysis. As a newer and growing company, positive FCF has been an unpredictable guest in the Statement of Cash Flows. When it comes to hard cash at the end of the day, the longer history of LZB gives the company an advantage for the strict cashflow investors. There is really nothing to fault in LZB's profitability and growth. The bearings of the business seem well-greased and with plenty of time to run.
Outlook
One of the catalysts for growth up La-Z-Boy's sleeve is Joybird, a 2019 acquisition whose sales happen almost exclusively online, in keeping with the shopping trends taking root in front of our eyes. The company currently reports Joybird's sales under Corporate and Other, and although revenue from this segment has decreased in the first quarter and first nine months of the 2023 fiscal year, growth in this segment was 62% in 2022. This recent underperformance is understandable if we think of the doom and gloom brought upon us by inflation, and the impending recession that all the card readers out there say will be the worst ever. We will have to wait and see because I do not have a clue about what the future will bring. History supports the idea that recessions come and go and, for that reason, I do think Joybird and the increased online presence is a plus in the long run. Low overhead means higher margins and hopefully higher returns for shareholders.
As a result of the Joybird acquisition, we have seen a slight increase in goodwill on the balance sheet, but interest-bearing debt is still non-existent. Whatever cataclysmic recession happens to strike us, LZB should not go down because of interest rates, or at least not before most other companies do. In case the mother of all crashes does not materialize, revenue for next year is still expected to fall about 15% but the next five years should see a growth of 7.8% per year. Because analysts are always right - ahem - I take this as a reference but do not hang all my hopes on it. If we are going to buy furniture in the future, chances are LZB is well-positioned to do just as well or better than its peers. And with plenty of room to borrow, I would not be surprised if other acquisitions happen down the line.
I Want To Make Money. Does The Math Work Out?
My "shotgun approach" to valuation aims at not being dead wrong about the downside, more than being right about the potential gains. I do have a number in mind that I think is more appropriate, but because there are as many valuations as analysts doing them, that "right number" should come to every investor as the result of their own work. More detail on my crude approach can be found in my previous article, Simpson Manufacturing: A Midcap Hammering Away In The Industrial Sector .
LZB is trading at a PE of 7.13 (the second red arrow in Figure 4). The 95% confidence interval using data for the last 10 years is between 15.99 and 16.95 (Figure 4). From this perspective, the stock seems undervalued. Statistically speaking, and although we have seen even lower PE ratios, if we were to randomly buy the stock, the probability of getting it at this PE level would be just 5.99% (third red arrow in Figure 4). This PE level is unusually low. The analysts included in my data provider estimate the EPS for this year to be $3.18. I am assuming $3.04. Over the last 10 years, LZB's net income has seen an EPS CAGR of about 14%. I am taking the $3.04 and growing it at half that rate for the next 10 years (fourth red arrow). This would mean earnings of $5.14 per share 10 years in the future. I then apply an exit multiple of 12, which is lower than the last 10-year average, and discount these to today's value at the cost of equity for the company: 8.96% (4.88% Equity Risk Premium times the company's beta added to the current Risk-free Rate). This gives me a fair price of $47.46 per share, substantially above the current share price. On the right side of Figure 4, I do exactly the same exercise, looking only 5 years into the future, assuming no growth and exiting at an even lower multiple. With those assumptions, I get a fair price that is basically today's share price. The message is, I do not see much downside if I invest in the company today.
Fig.4: LZB Fair Value (Author)
I did a somewhat similar exercise where I look at FCF and use the more traditional DCF approach. To make it more visual, Figure 5 below shows my expected revenue, net income, EBITDA, and FCF. To play along with the doom and gloom that seem to have taken the market, I am applying a negative growth rate of 3% for the first 5 years, followed by a 7% growth in the next five. We can see that these assumptions will make the revenue in 2032 just about 16.5% higher than the trailing twelve-month revenue. Because I do not think that reality is a mathematical model, I add a statistical correction in 2025 and 2028. For reference, I end up with a terminal value that is about 55% of the undiscounted value for the company. When I compute the internal rate of return for these cashflows, I find an interesting 12.9%. At this point, I want to reiterate what I have said two paragraphs above. This is a crude approach and I do not claim to know what the real revenue and FCF figures will be. I do not think anyone does. I am mainly weighing the risk and reward of a potential investment given conservative assumptions, perhaps exceedingly so. The risk seems limited and the reward is likely above the market average.
Fig. 5: LZB Revenue and FCF Projections (Author)
Recline, Relax, And Wait
I am long LZB and my plan for the future is to do nothing. I think the potential upside is very interesting and, even if the share price does not move in the near future, the current return of 3.96%, including dividend and share repurchases, is good enough to feed my already long-lasting patience. In retrospect, the US Government and Federal Reserve's immediate intervention to mitigate the consequences of the pandemic in 2020 very much looks like a diabetic who got a sugar rush and immediately got his dose of insulin. The money that flooded everyone's pockets seems to be gone now, and inflation has put an end to the optimism that reigned when the market was booming. The market sentiment turns on a dime, which is why I usually do not care for the trends of the moment. The optimism will eventually return, the housing market will pick up again and people will buy furniture to fill their new homes. It's just a matter of time. With more than two decades of consistent profitability, I have little doubt that the future can be just as bright as the past. The numbers seem to support my thesis.
For further details see:
La-Z-Boy: Resting On Limited Downside