Several Reasons to Be Bullish on Lumber Liquidators!

Ashit is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The housing sector is on a recovery path in the U.S. with all the major lead indicators exhibiting growth. The median home sales price have increased 33% since July 2010, and housing inventory is at an all time low. In addition, the labor market data is also upbeat and the consumer confidence index is at a five-year high.

Such data points are particularly good for sectors that rely on consumer discretionary spending. Home product retailer Lumber Liquidators Holdings (NYSE: LL) is certainly expected to benefit from the rebound in the housing sector.

During the first quarter, despite the fall in consumer discretionary spending due to a hike in payroll taxes and a delay in tax refunds, Lumber Liquidators reported an increase in like for like store sales by 15.2%.

Because a large percentage of the company’s costs are fixed, higher sales resulted in an improvement in gross margin by 310 basis points to 40.4%. Furthermore, cost pressures reduced considerably, predominantly due to direct sourcing from mills.

The company benefited from fewer comparable stores operating in existing markets leading to low cannibalization. As of December 31, the company was operating 18 comparable stores, down from 24 stores December 31, 2011 and 23 stores on December 31, 2010.

Introducing "Store of the Future"

Lumber Liquidators introduced "Store of the Future," which is a new concept with enhanced shopping experience. The new store concept works on a higher carpet area and more assortments in flooring options and accessories. This is expected to result in increased productivity and generate a higher operating efficiency.

During the first quarter of fiscal 2014, the company launched 5 new stores under the "Store of the Future" concept. Going forward, the company plans to launch  25 to 35 stores under the new concept  and convert 20 to 25 existing stores to the new format.

Moreover, the improving consumer sentiment and the gradual increase in discretionary spending will lead to growing preference for the premium products offered by Lumber Liquidators.

I believe higher sales of premium offerings should bolster its margin in the future. Lumber Liquidators introduced more than 50 new floors during 2012, primarily in the premium segment. Since the premium segments operates on relatively higher margins the gross margin profile will certainly improve moving ahead.

Initiative that will bolster company growth

Lumber Liquidators is making serious efforts in propping up its advertising reach in order to tap more casual customers, in addition to its traditional do-it-yourself customers. The company is expected to offset the increase in advertisement expenses by growth in store base. This will allow the company a deeper market penetration and enter new unexplored consumer segments.

To further bolster its sales the company conducts several Lumber Liquidators university programs, which enrich its employees with in-depth training on products and innovative selling techniques. Such efforts should augur well with the company’s strategy of targeting casual customers.

Lumber Liquidators has established a long-term relationship with well-known home improvement celebrities such as Bob Vila and Ty Pennington. The company also works with shows such as “Dream Home Sweepstakes,” which uses company’s products and enable potential customers to witness the flooring appearance after installation.

The company has also developed iPhone and iPad apps “the floor finder,” which grants potential consumers direct access to nearly 200 digital samples in addition to a large variety of tools specifically designed to facilitate flooring purchase decisions.

It must be noted, Lumber Liquidator purchases directly from mills with no middleman involved in its supply chain, which allows the company to operate on relatively higher margins. In addition, the company is actively involved in expanding its supplier base beyond China and Brazil to several other parts of Asia and Latin America. As a result, Lumber liquidators is immune to any increase in domestic prices.

Competitive landscape

Lumber Liquidators competes against retailers such as Home Depot (NYSE: HD) and Lowe's (NYSE: LOW). However, the company focuses on a niche segment, which enables it to offer differentiated value proposition. Home Depot is the biggest threat to Lumber Liquidators with a revenue market share of 6% in building materials.

Home Depot generates the highest percentage of its revenues through its Hardware & Seasonal segment at around 27%, which is followed by Plumbing, Electrical & Kitchen at around 26.8%. This is followed by Building Materials and Painting & Flooring at around 18.8% and 17% respectively. 

The company reported reasonable growth during the first quarter primarily due to a recovery in the housing sector, which is driving demand for home improvement products.

Its performance should be encouraging for investors, as the company posted strong numbers in spite of poor weather conditions. On the grounds of its recent performance, the company raised its sales guidance to approximately 2.8% year-over-year. In addition, it expects the like for like store sales to grow at around 4%.

Similarly, Lowe's also competes with Lumber Liquidators. Lowe's generates its maximum revenue through Plumbing, Electrical & Kitchen at around 32%. This is followed by Hardware & Seasonal and Building Materials at around 29% and 18% respectively.

During the first quarter, the company witnessed a decline in sales due to cold and wet weather conditions. Recently, the company made a bid to acquire 60 stores of Orchard Supply Hardware for $205 million in cash. The company believes that this acquisition will enable it in competing with Home Depot and Lumber Liquidators on a par level

Contrary to its peers, Lowe's has struggled particularly to benefit from the recovery in the housing market, as the first quarter results were nothing less than disappointing. However, if the acquisition goes through, Lowe's will benefit from an extended reach with 60 added standalone stores to its business. This acquisition can certainly bolster its earnings in the future.

Long call

Below is a quick review on why I think Lumber Liquidators is a buy:

  • Recovery in housing industry cycle
  • Improvement in sales of new U.S. homes
  • Market leadership
  • Improvement in operational efficiency
  • New advertising initiatives
  • Increase in contribution from high margin products
  • Larger number of stores
  • Near zero interest rates resulting in easy credit availability.

Investors with a long-term horizon should hold on to this stock. I expect a correction in the share price of the company with a 9.70% annual return during the next two year.

I hold this view particularly as the company is presently trading at around 34-38 times one-year forward earnings (per earnings guidance issued by the company).

However, it is essential to note that recovery in the economy will lead to higher revenue for the company in the coming years. This, coupled with superior operational efficiency, can lead to a revenue and EPS growth of 22% and 30% respectively over the next two years.

Therefore, by 2015 we can expect the company to deliver an EPS of $3.25. Considering the PE multiple of 30 (higher than the industry due to its competitive advantage), Lumber Liquidator's shares are expected to trade at around $98 by 2016. Hence I suggest investors to hold on to its stock. 

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Ashit Gulati has no position in any stocks mentioned. The Motley Fool recommends Home Depot, Lowe's, and Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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