2023-06-27 15:30:50 ET
Summary
- Lovesac's "Designed For Life" approach and unique product offerings position it to disrupt the furniture industry and expand market share.
- The company's customer-centric business model contributes to higher net sales as economic conditions improve.
- The focus on efficiency in showroom operations and leveraging a normalized supply chain with decreasing freight costs will stabilize gross margin and increase bottom-line contribution.
- Institutional investors recognizing Lovesac's potential and short sellers recovering could potentially drive the share price higher.
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Investment Thesis
Lovesac ( LOVE ), a U.S. technology-driven retailer specializing in innovative modular foam-filled furniture, is currently trading at a discount to its estimated intrinsic value. With a conservative price target between $18.14 and $40.50 , I believe the company presents a compelling opportunity that presents little downside for those who are willing to stomach short-term fluctuation. Since its IPO in 2018, Lovesac has demonstrated its ability to outperform the industry by maintaining above-average gross margins, establishing a strong financial foundation, and fostering a loyal customer base with a high lifetime value. In contrast to many larger competitors who are struggling with stagnant or negative revenue growth, the company has consistently delivered impressive results. With its share price currently trading at a forward P/E of 11.59x and a P/S of 0.52x, I think Lovesac presents an attractive investment proposition with the potential for substantial returns.
Company Overview
Lovesac, established in 1995 by its current CEO Shawn Nelson, has quickly emerged as a prominent player in the furniture industry, renowned for its forward-thinking "Designed for Life" approach. This philosophy centers on the creation of durable products that can withstand the test of time and seamlessly adapt to customers' evolving lifestyles. Lovesac's diverse product portfolio includes their signature modular couches called Sactionals, high-end bean bag chairs known as Sacs, and a range of complementary home accessories specifically designed for their Sactionals and Sacs. Leveraging an omni-channel platform, the company effectively engages customers through a variety of sales channels, including showrooms, e-commerce, and strategically positioned touchpoints like pop-up shops and shop-in-shops.
Here is the full breakdown of net sales for the company’s products by fiscal year:
$ in thousands | FY 2018 | FY 2019 | FY 2020 | FY 2021 | FY 2022 | FY 2023 |
Sactionals | 72,563 | 120,205 | 188,437 | 271,019 | 436,588 | 584,815 |
% of Total Sales | 71% | 72% | 81% | 84% | 88% | 90% |
Sacs | 26,855 | 41,175 | 39,641 | 44,975 | 52,478 | 55,145 |
% of Total Sales | 26% | 25% | 17% | 14% | 11% | 8% |
Accessories | 2,393 | 4,501 | 5,300 | 4,745 | 9,173 | 11,585 |
% of Total Sales | 2% | 3% | 2% | 1% | 2% | 2% |
Total Net Sales | 101,810 | 165,881 | 233,377 | 320,738 | 498,239 | 651,545 |
Lovesac's Sactionals (ICR Conference 2023 Presentation) Lovesac's Bean Bag Website
- Sactionals: A patented modular furniture system consisting of only two standardized pieces, "seats" and "sides," and a wide selection of removable, washable, and changeable covers. This system allows customers to create various sectional couch configurations with minimal effort and offers attractive recurring revenue opportunities.
- Sacs: A line of highly durable, comfortable foam-filled bean bag chairs available in 6 different sizes, capable of seating 3+ people on the largest model.
- Accessories: An array of Sactional-specific add-ons, such as drink holders, decorative pillows, fitted seat tables, and Sactionals Power Hub, thus providing their customers with the flexibility to customize their furnishings with decorative and practical add-ons.
In short, Lovesac's Sactionals have experienced remarkable success, with sales growing at an impressive compound annual growth rate ((CAGR)) of 51.80%, while Sacs, their premium bean bag chairs, also contribute to the overall revenue growth, though their growth rate is comparatively slower. The revenue generated from Accessories has been compounding at a noteworthy rate of 37.08%, showcasing management's commitment to providing upgraded product lines that complement their Sactionals. In my opinion, this strategy has successfully fostered a loyal customer base that values staying up-to-date with the latest offerings.
ICR Conference 2023 Presentation
Continuing their pursuit of growth, management remains proactive in launching innovative products. One example is the introduction of StealTech, a technology-enhanced feature embedded within Sactionals that incorporates speakers and integrated wireless charging to provide customers with the 4-D experience. Another recent addition is the Angled Side, which enhances the aesthetics and comfort of Sactionals, presenting significant upside potential for customers who wish to further enhance their comfortability.
Here’s the full breakdown of net sales for the company’s sales channels by FY:
$ in thousands | FY 2018 | FY 2019 | FY 2020 | FY 2021 | FY 2022 | FY 2023 |
Showrooms | 77,837 | 113,105 | 148,004 | 146,150 | 298,989 | 398,550 |
% of Total Sales | 76% | 68% | 63% | 46% | 60% | 61% |
E-Commerce | 18,859 | 33,024 | 55,781 | 151,065 | 150,622 | 176,519 |
% of Total Sales | 19% | 20% | 24% | 47% | 30% | 27% |
Touchpoints | 5,114 | 19,752 | 29,592 | 23,523 | 48,628 | 76,476 |
% of Total Sales | 5% | 12% | 13% | 7% | 10% | 12% |
Total Net Sales | 101,810 | 165,881 | 233,377 | 320,738 | 498,239 | 651,545 |
By strategically harnessing its omni-channel platform, the company has achieved remarkable success in marketing and selling its products across all channels. The company's showroom net sales have experienced a robust CAGR of 38.63%, while e-commerce net sales have soared at an impressive CAGR of 56.41%. Furthermore, sales through other touchpoints, including partnerships with retail giants such as Best Buy and Costco, have seen exceptional growth, experiencing a CAGR of 71.77%. While the COVID-19 pandemic impacted showroom sales in FY 2021, Lovesac swiftly adapted and capitalized on the surge in e-commerce demand. As a result, their e-commerce sales tripled during this period, compensating for the temporary decline in showroom sales.
Despite the deceleration of e-commerce sales growth, net sales from showrooms and other touchpoints continue to experience significant expansion as the company continues to broaden its showroom network and establish new touchpoints. By leveraging their omni-channel approach, Lovesac has successfully navigated the challenges posed by the pandemic, capitalized on the exponential growth of e-commerce, and continued to expand their physical presence, thus allowing management to position themselves for sustainable success in the furniture market.
Industry and Macro Overview
Grand View Research Spherical Insights
The U.S. and International Furniture Markets are projected to exhibit a steady CAGR between 4% to 5.25% until 2030, as indicated by reputable sources such as Spherical Insights , Grand View Research , and Statista . This growth is primarily driven by the upcoming wave of millennials who are expected to start families and purchase their first homes over the next three to five years. Among furniture categories, the “sofa and couch” segment is expected to witness higher growth, particularly for products offering advanced technology and aesthetically pleasing features that are appealing among the younger generations. By consistently introducing innovative products and expanding its sustainable offerings, I believe that Lovesac is poised to capitalize on the anticipated growing furniture market and gain more market share over the coming years.
Despite recent macroeconomic trends that have affected the furniture industry, including rising inflation and higher interest rates which have caused consumers to be more cost-conscious, Lovesac has demonstrated its ability to outperform the market. According to the most recent earnings call , management has shown how their unique business model and product designs have allowed them to grow net sales by 9.1% and “outperform the category, which was down 20% in the first quarter .”
While competitors such as RH ( RH ) and Arhaus ( ARHS ) are issuing guidance with minimal or negative growth, Lovesac remains confident in its full-year guidance, projecting net sales between $700 to $740 million, representing an increase of 7.44% to 13.58%. In my opinion, management’s ability to gain market share from their competitors positions them favorably as they continue to navigate through the industry backdrop. Although consumer confidence and the macroeconomic situation have impacted the industry in the short-term, Lovesac's solid performance and strategic positioning suggest strong growth potential once these conditions improve.
Most Recent Quarterly Highlights
According to Lovesac's Q1 FY 2024 release , the company experienced a 9.1% increase in overall net sales, rising from $129.4 million to $141.2 million compared to the previous year. This growth was primarily driven by a significant 28.7% increase in e-commerce sales, partially offset by a more modest 2.9% increase in showroom sales. It is worth noting that comparable showroom sales, which reflect point-of-sale transactions rather than products shipped to customers, grew by 8.4% and will have a greater impact on Q2 numbers. Despite experiencing a slower growth rate compared to previous periods, Lovesac's net sales demonstrated more resilience than I initially anticipated. This is particularly notable considering the challenging economic backdrop and the significant slowdown in furniture spending that many of Lovesac's peers are currently facing after two years of robust growth.
Although the company faced challenges in the form of higher SG&A expenses, attributed to higher rent costs and wage inflation, and reported an operating loss of $5.9 million for the first quarter of fiscal 2024, inventory saw a slight decrease. This resulted in a positive free cash flow of $2.11 million, a notable improvement from the negative free cash flow of $27.68 million reported a year ago. I believe this minor increase in cash balance will allow Lovesac to strengthen its balance sheet and capture more growth through aggressive marketing once demand returns.
Key Drivers and Catalysts
ICR Conference 2023 Presentation
Large TAM To Be Unlocked: According to Lovesac's presentation at the ICR Conference 2023 , the company currently holds a market share of only 1% in the overall furniture segment. Despite the significant growth Lovesac has achieved since 2018, this figure suggests that there is still ample room for further expansion. Additionally, the potential for international expansion has yet to be fully realized, adding to the company's growth opportunities. While the long-term trend for the furniture industry remains positive, Lovesac is positioned to outpace the industry average and capture larger market share over the next few years. With its innovative product offerings, strong brand positioning, and proven ability to drive sales, I believe Lovesac is well-equipped to capitalize on the increasing demand for its unique, high-quality furniture.
ICR Conference 2023 Presentation
Disruptive Business Model & Unique Product Offerings: Unlike the traditional approach of offering a wide range of standard products through distributors, Lovesac has implemented a highly efficient inventory management system. This allows the company to ship products within a short timeframe, improving working capital and reducing costs. In my opinion, the direct-to-consumer approach employed by Lovesac also provides several advantages since the company can maintain exclusive proprietary data to develop highly targeted and effective marketing campaigns tailored to customer needs. I believe this direct relationship with customers has and will continue enabling Lovesac to deliver a personalized experience and ensure customer satisfaction.
ICR Conference 2023 Presentation
More importantly, one of Lovesac's standout products is the customizable Sactionals. These modular couches can be reconfigured and interchanged according to individual preferences. Notably, Sactionals are designed to be durable and have a long lifespan, making them an attractive choice for millennials who are experiencing growing family sizes. Unlike the limitations of traditional furniture stores, Lovesac empowers customers to create exactly what they need, with the ability to add additional components such as StealTech or other features as desired. As a result, I believe the company's ability to meet customer demands with speed, personalization, and longevity positions it as a disruptive frontrunner in the market.
Lovesac's Presentations Since 2018 Lovesac's Presentations Since 2018
Expanding Retail Footprint & Effective Showroom Usage: The company's showroom locations have grown from 66 in FY 2018 to over 211 in the first quarter of FY 2024. Moreover, management has set ambitious goals, aiming to surpass 400 showrooms within the next five years. An impressive aspect of Lovesac's showroom strategy is its efficient use of space. With minimal on-site inventory, the company has optimized its showrooms, allowing for a smaller footprint while still delivering an exceptional customer experience. This efficient utilization of space enables Lovesac's average showrooms to achieve a full payback within just two years. Another key metric that highlights Lovesac's success is its retail sales per selling square foot, which has experienced substantial growth, increasing from $1,262 to over $3,000. In comparison, Arhaus has a retail sales per selling square foot of only $600, as noted in the ICR Conference mentioned earlier. Lovesac's ability to generate significantly higher sales per square foot further reinforces the company's effective showroom execution. By continuing to expand its showroom network and enhancing space utilization efficiency, I believe Lovesac is well-positioned to drive notable sales growth and achieve faster payback periods.
Customer Lifetime Value Versus Customer Acquisition Cost: Lovesac's value proposition to customers continues to evolve, attracting both new and existing customers with their innovative products and the "Designed for Life" philosophy. Lovesac's CLV has shown a positive trend, indicating that customers are displaying higher levels of loyalty, repeat purchases, and larger order sizes. While the customer acquisition cost ((CAC)) metric has also increased over time, mostly due to intensified market competition or fluctuations in the advertising landscape, the escalating CLV suggests that Lovesac's advertising campaigns remain effective in attracting new customers despite the rising advertising costs. Lovesac's ability to generate long-term value from its customer base is a testament to its successful marketing campaigns and the strong customer relationships it has cultivated over the years. By continuously improving its value proposition and customer experience, Lovesac is positioned to enhance customer loyalty, drive repeat purchases, and maximize the lifetime value of each customer in my opinion.
Financial Metrics (LTM) | Gross Margin | EBIT Margin | Net income Margin |
Ethan Allen Interior Inc. (ETD) | 59.85% | 17.41% | 13.42% |
Bassett Furniture Industries (BSET) | 52.19% | 5.47% | 4.73% |
Haverty Furniture Companies (HVT) | 57.72% | 10.32% | 7.98% |
Flexsteel Industries (FLXS) | 14.20% | 1.49% | 0.91% |
La-Z-Boy Incorporated (LZB) | 41.28% | 9.96% | 7.03% |
Hooker Furnishings Corporation (HOFT) | 20.83% | 2.95% | 3.37% |
Arhaus, Inc. (ARHS) | 48.81% | 16.10% | 12.02% |
RH (RH) | 49.25% | 18.36% | 10.97% |
High | 59.85% | 18.36% | 13.42% |
Low | 14.20% | 1.49% | 0.91% |
Mean | 43.02% | 10.26% | 7.55% |
Median | 49.03% | 10.14% | 7.50% |
The Lovesac Company | 52.13% | 4.60% | 3.33% |
Operational Leverage: Lovesac's operational leverage presents a significant opportunity for the company to expand its EBIT and net margins as it continues to mature. Although the company already maintains a competitive gross margin compared to its competitors, there is room for further improvement in profitability. Many competitors with gross margins above 48% have successfully achieved EBIT margins closer to 10% or 15%. Over the next 5 to 10 years, as Lovesac's marketing campaigns slow down, the company is expected to leverage its bottom-line capabilities and achieve higher profits. This transition to a more mature stage will likely lead to an expansion of both EBIT and net margins, potentially doubling from current levels. In the short term, the company's gross margin is expected to benefit from a decrease in inbound freight costs by 200 basis points, as mentioned by management in the most recent earnings call. As freight costs normalize and inflationary pressures ease, Lovesac's gross margin is expected to expand and return to historical levels, typically ranging between 53.5% and 54%. By capitalizing on operational leverage and optimizing its cost structure, Lovesac has the potential to significantly enhance its profitability and deliver strong financial performance over the long term.
Capital Structure and Liquidity Analysis
With a robust cash equivalent balance of $45.1 million and access to an undrawn credit facility of $36.0 million, Lovesac is well-equipped to navigate through the current economic downturn and reinforce its position in the market. The company boasts a debt-free balance sheet, except for operating leases, which can be considered a form of capital requirement instead of pure debt. As a result, the its cash reserves, combined with the available credit facility, provide ample liquidity to support ongoing operations, invest in growth initiatives, and seize strategic opportunities. As for operating lease, below is the attachment of their most updated lease schedule, assuming no further additional lease in the future:
Lovesac's first quarter FY 2024 10-Q
The lease expense is typically included in the SG&A expense, which has been around $41.1 and $31.68 million for FY 2023 and 2022, respectively. By using an estimated gross profit of $369.49 million for FY 2024 (my base case scenario assumption below) and a full-year operating lease expense of $30.97 million (company's estimate in its FY 2024 First Quarter 10-Q), the current lease coverage ratio stands at approximately 11.93x which is a very healthy level. Still, it is worth noting that the overall cash balance has been decreasing in recent years due to the rising inventory level, which negatively affects working capital. Due to seasonality of Lovesac’s business, investors may prudently anticipate a burn in cash levels over the upcoming quarters as inventory levels rise in preparation for the fourth quarter. However, the spurt in inventory level is expected to normalize going forward or may even decrease since freight cost has significantly dropped and stabilized as supply chains continue to improve.
Financial Valuation
For the financial valuation of Lovesac, I will solely focus on developing three case scenarios using the discounted cash flow with a considerable amount of conservatism in mind. Since Lovesac has exhibited exceptional growth and operates under a unique business model, it may not be appropriate to compare it to other furniture companies with traditional business models that currently exhibit negative sales growth since using a comparable analysis will undermine the true intrinsic value of Lovesac.
In the bear-case scenario, I will assume that Lovesac's revenue and EBITDA will grow below management's expectations of $700.00 and $56.00 million, respectively. While revenue is expected to pick up at a faster pace in FY 2025 and FY 2026 as the U.S. economic conditions improve, I assume that it will grow below its historical pace and other analysts' expectation. The EBIT margin will temporarily decline due to a decrease in gross margin, which will gradually improve over time. Although the company is expected to achieve a more optimal level of operational leverage as it matures, the EBIT margin in this scenario will still be below the industry average.
Author's Representation Capital IQ
Based on the data from CapitalIQ, Lovesac's share price has exhibited a wide range of trading levels, influenced by factors such as the company's improved profitability and the prevailing zero interest rate environment. Looking ahead, it is reasonable to expect that the stock will trade within a range of 7.0 - 8.0x EV/EBITDA multiples, which is below the historical average of 12.78x but closer to the industry average. This approach allows for a significant margin of safety in valuation. Still, it is worth noting that Lovesac's current trading multiple is relatively low compared to its historical average, primarily due to general concerns about a potential recession. As a result, the stock may experience a decline in price within a range of $18.14 to $20.97 , assuming a weighted average cost of capital of 11%.
For the base-case scenario, I will take into consideration a more conservative gross margin and ignore the potential expansion due to the reduction in freight cost. Revenue will be growing at a more reasonable rate but still operating slightly below other analysts’ expectations, which eventually slows down as the company reaches maturity. The expansion in EBIT and EBITDA margins will contribute significantly to the bottom line as advertising effort slows down and shows more efficiency, but it is still important to note that it is still operating below the industry average.
Based on the sensitivity analysis, the stock’s valuation could range anywhere from $26.40 to $30.08 . It is important to consider that this analysis provides a conservative estimate, aiming to prioritize caution and minimize potential downside risk for investors. While the share price may not appear significantly undervalued based on this analysis, I believe the conservative approach ensures that investors are provided with a high level of prudence and safeguards against potential downturns.
In my best-case scenario, revenue is expected to align with management's and analysts' expectations, accompanied by a recovery in gross margin to historical levels. This scenario takes into consideration the improvement in operating efficiency and the amount of leverage internal operations can utilize to reduce SG&A and marketing expenses as a percentage of revenue. This scenario assumes a significant increase in operating margin, potentially expanding from 5.99% to 9.25%. However, I believe it is important for investors to approach this bullish scenario with caution and conduct further analysis as it is based on my optimistic assumptions, which may not materialize due to intense competition and horrible economic conditions.
As a result, our target share price for the bullish scenario will be closer to $35.84 and $40.50 , thus making it seem quite undervalued based on our current share price of $26.69. As market sentiment improves and concerns about a recession diminish, it is plausible that Lovesac's share price may exceed the projected multiples and deliver satisfactory investment returns.
Trading Activity
Within the past year and a half, the company's CEO, Nelson David, has consistently taken advantage of his share-based compensation by selling shares in the market . Although his overall share count has continued to increase over time, I believe that it would instill more confidence in investors and deter short sellers if he were to demonstrate more belief in the company's future by purchasing shares in the open market.
On the other hand, there has been a significant surge in institutional buying during the first quarter of 2023. As more institutional investors recognize the true underlying value of the company and accumulate shares from short sellers, it draws the attention of larger investors. In my opinion, this influx of institutional interest has the potential to drive up the overall share price, as these big investors possess substantial purchasing power and can further contribute to the company's positive momentum.
As evident from the two charts provided , there has been a notable increase in short interest and the percentage of float being shorted in recent months. This can be attributed to a growing anticipation of a significant economic slowdown and a decline in the company's overall net sales, coupled with its negative free cash flow generation. Some of this increase may also be attributed to the revaluation of the stock price to align with industry averages. However, Lovesac has defied the expectations of short sellers by demonstrating continued growth in net sales over the past few quarters, even amidst challenging industry conditions. Once condition improves, I expect short sellers to start recovering their shares and drive the stock price higher from today’s price.
Risks
Cyclical industry: Lovesac currently operates exclusively in the United States, which makes the company vulnerable to the pending U.S. economic downturns. Furthermore, the current economic landscape, characterized by elevated inflation and rising interest rates, adds to the challenges faced by the company. If these economic conditions persist, they can hinder the growth of consumers' disposable income, potentially leading to a further decrease in furniture purchases. Due to the cyclical nature of the furniture industry, I think the company may follow the rest of its peers and start reporting negative sales growth.
Operating in a highly competitive field with limited product range: Lovesac faces severe competition from established furniture retailers such as Wayfair, Haverty Furniture, and La-Z-Boy, which have established brand recognition, wider product offerings, and greater resources. The company, on the other hand, is highly dependent on selling its Sactionals, which currently represents more than 90% of its total sales. While Sactionals have been a successful and innovative product for the company, this narrow product range leaves Lovesac vulnerable to changes in consumer preferences.
Low free cash flow conversion: While the company has been able to generate positive net income in recent years, its free cash flow conversion has been relatively low. For instance, although the company generated $45.90 and $28.24 million for FY 2022 and FY 2023, its free cash flow was closer to $18.13 and -$46.62 million, respectively. This is primarily attributed to the increase in inventory levels, driven by supply chain disruptions and high freight costs. If the company is unable to effectively manage its inventory levels and align them with demand, it could face challenges in generating positive free cash flow and maintaining sufficient liquidity.
Summary
In conclusion, I am issuing a Buy rating for Lovesac's stock with a conservative price target ranging from $18.14 to $40.50 over the next 3-5 years. Lovesac's commitment to its "Designed For Life" approach, coupled with its unique product offerings and customer-centric business model, positions the company to disrupt the furniture industry, expand its market share, and drive higher net sales as economic conditions improve. Altogether, these catalysts will be able build a more sustainable company that focuses on creating long-term shareholder value.
As Lovesac continues to mature, it will be able to enhance the efficiency of its showroom operations, stabilize gross margin, and increase its bottom-line contribution through operational leverage. Institutional investors are likely to recognize the company's potential, and as short sellers recover, the share price has the potential to exceed previous forecasts. However, it is important to consider that Lovesac is still a relatively young company with a limited operating history, having only recently achieved profitability. Investors should conduct thorough due diligence and only invest capital they can afford to lose in this business.
For further details see:
Lovesac: An Exceptional Technology-Driven Business With Strong Growth Opportunities