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Q1-2013 - Financial Performance:

Today Lumber Liquidators (LL) released an outstanding quarter as income nearly doubled (up 92.5%) to $.57 a share up from $.29 during Q1 last year. Net sales for the company increased $42.4 million or 22.5% to $230.4 million. This number handily beat both analyst estimates of $215.4 million in net sales and $.42 cents a share in earnings. - Thomson Reuters

Three Months Ended March 31

2013

2012

Net sales

$ 230,419

$ 188,034

Percentage increase

22.50%

17.80%

Number of stores open at end of period

293

267

Number of stores opened in period

5

4

Percentage Increase

Average sale

7.30%

-0.40%

Average retail price per unit sold

6.50%

-1.80%

Comparable Stores:

Net sales

15.20%

7.50%

Customers invoiced

7.30%

8%

Net sales of stores operating for 13 to 36 months

18.40%

20%

Net sales of stores operating for more than 36 months

14.90%

4%

Net sales in markets with all stores comparable (no cannibalization)

17.70%

9.3

Net sales in cannibalized markets

40.90%

32.6

Source: 10-Q

Key Takeaways From Q1:

  1. Comparable store net sales increased 15.2%
  2. Gross margin was up 310 basis points to 40.4% compared to 37.3% last year
  3. Operating margin improved to 11% up from 7.1% in 2012
  4. Opened 5 new stores in Q1
  5. Raised full year guidance on net sales to $913-942 million up from $885-920 million
  6. EPS guidance increased to $2.10 to $2.35 versus previous estimates of $1.90 to $2.15

Lumber Liquidators has been on a tear recently, with the stock up roughly 45% YTD, and with all numbers in check, it shows little to no sign of slowing its momentum. This large flooring retailer might be just the company you need to help you remodel your portfolio, but first you should understand what is driving this growth.

Overview: Lumber Liquidators is the largest specialty retailer of hardwood flooring in the U.S. The company operates over 290 brick and mortar locations in 46 States with 9 locations in Canada. The company also offers call centers, website ordering and catalogs to consumers everywhere. LL claims to ship anywhere and offers installation services through The Home Service Store, less than 10% of customers utilized this service in 2012. LL negotiates with the mills directly to buy over an entire years' worth of production which allows savings to be passed onto the buyers. In 2012 LL sourced roughly half of its product from outside the United States with the largest of that (43%) coming from Asia. Sales are generated in three main categories including Hardwoods, Laminates and Moldings & Accessories. These categories accounted for 47%, 36% and 17% of revenue respectively in 2012. Lumber Liquidators flagship brand of hardwood is its Bellawood line.

The company sells its product mainly to existing homeowners which represent 90% of sales with the remaining coming from small business contractors. The company is shifting its product mix to offering higher margin products and offering more choices for consumers and DIYers (Do-It-Yourselfers).

The following chart shows this sales transformation of new product lines.

2012

2011

2010

Product Lines:

Percentage of Net Sales:

Solid and Engineered Hardwood

47%

50%

54%

Laminates

22%

23%

21%

Bamboo, Cork and Resilient

14%

11%

10%

Moldings and Accessories

16%

15%

14%

Other

1%

1%

1%

Total

100%

100%

100%

Source: 10-Q

Unique Store Model: Show room format is typically 1,000 to 1,200 sft in a 6,000 - 7,000 sft location. Stores are typically located in non-traditional retail spaces with high visibility to major roadways (Highways), and inconveniently placed to provide for low cost of occupancy. New stores are typically profitable months within opening and generally return initial cash investment within the first year. Store layout is also very flexible adaptable with low capital expenditures and no special needs for showrooms which allows for shorter lead times from site selection to opening. Lumber Liquidators is releasing a new store layout known as the store of the future which is discussed later in this report.

Unique Market Position - Low Competition / Highly Fragmented Market:

Being the largest specialty retailer in North America, Lumber Liquidators has a unique position. The company operates in a very fragmented market with large competitors Home Depot (HD), Lowes (LOW) and itself representing only 37% of the market. Currently LL believes it captures around 10% of the hardwood market and 9% of the laminate market.

Strategy: LL has 5 Key Strategic Initiatives

  1. Focus on Growing Revenue
  2. Improve Sourcing
  3. Optimizing Supply Chain
  4. Driving Traffic through advertising reach and frequency
  5. Develop Employees to provide an exceptional customer experience

3 Main Growth Strategies: In a highly fragmented market LL has grown through capture of market share by focusing on these 3 specific strategies to do so:

  1. Improve Market Breadth and Probability - Significant opportunity to expand store base in both new and existing markets, domestic and international. LL Expects store base growth will drive market productivity and operational efficiencies. The company is looking to expand internationally and has 9 stores currently in Canada.
  2. Commitment to Merchandise Inventories - LL believes commitment to Merchandise Inventories offers advantage to smaller competitors and will thus drive market share. Their strong commitment to keeping top selling products in stock will help maintain net sales growth. Strong initiatives in logistics and merchandise planning will help drive profitability.
  3. Leverage Brand Marketing Across Multiple Channels- Use of advertising and marketing activities to drive customer knowledge of hardwood floors and thus drive purchases. Once customers are acquainted with the product the company uses its multiple channels to drive repeat traffic. As the company grows the targeting and branding activities will become more efficient and targeted, allowing for a reduced customer acquisition costs.

Value Proposition: (Begins with Direct Sourcing)

The company continually listens to customer's wants and needs and improves the product mix to fill them. They focus on 5 main value propositions which separate them from their competitors.

  1. Price - Lowest Price in marketplace, provide price points for everyone
  2. Selection - Broad assortment of 25 wood species and over 340 varieties (styles, stains)
  3. Quality - Products are best in their category, invest in quality control and assurance from vendor mill to sales floor
  4. Availability - Entire assortment available in no more than 2 weeks, best sellers are always in stock, in stores
  5. People - Highly skilled flooring experts, world class motivated sales force, effective support infrastructure focused on continuous improvement

The sentiment of management's discussion really highlighted these key propositions and providing continuous improvement to leverage the value props of the company through advertising.

Financial Performance Full Year 2012:

Goal - "Multi- Year Growth in Sales and Operating Margin Expansion"

Results: For 2012 the company saw a net sales increase to $813.3, up 19.3% from $681.58 million in 2011, with comparable store net sales of 11.4% and a gross margin increase of 270 basis points to 38% operating margin expansion of 340 basis points to 9.6%, and net income growth of over 79%. The company expects the margin expansion to increase into 2013 but at a slower rate as the company shifts to increasing advertising spend and opening new stores. During this period the company opened 25 new stores, 17 in existing U.S. markets, 6 in new U.S. markets and 2 in Canada. This compared to 40 and 37 new stores in the previous two years shows that the company is focusing more on improving its existing network and store format to push growth.

In 2012 the company increased the total number of customers invoiced by 16.4% over 2011 figures and by over 8.6% in comparable stores, showing its ability to drive new customers to new and existing stores through its advertising reach.

Other Highlights:

Store of The Future - In the company's Q3-2012 conference call they discussed its new store of the future initiative which they said would roll out for new and existing stores in late 2012 and 2013. The new layout will aim to optimize the layout and presentation of all products to the customer. It appears that the focus is to be the one stop shop for customers to make sure they have the right materials from everything to the floor, tools to tear out old floor, install new floor, and accessories and items to maintain and clean the new floor. The showroom will be about 50% larger than the current store showrooms. This approach is aimed at the DIYers.

Through market research the company believes that the U.S. market can support at least 600 locations or over double the current level of 290 stores. The company is looking at opening around 25-35 new stores throughout 2013, all with this new format. It is also looking to remodel roughly 20-25 stores to the new format, bringing the total to around 45-60 or 15% of the companies store base.

Q1-Update:

"We opened our first locations in our "store of the future" format which feature an expanded showroom. Though the results are early, across the five new store openings, four relocations of existing stores and two major remodels completed during the first quarter with the new format, we are pleased with the performance to date." - CEO Robert Lynch

Investment Thesis

The company has seen very nice compounded annual growth in net sales of 13.5% over the past 6 years, growing rapidly even during the recession. This can be attributed to the company's unique business model and capturing of fragmented market share. While new store growth slowed heavily from the 40 new stores in 2011 to 25 in 2012, the company looks to be picking up the pace in 2013 to around 25-35 new locations, now that it has a grasp of its new format performance. It is clear that the company has switched focus to optimizing current locations and offering new product mixes and advertising to capture market share. I view the company's advertising strategy and new store of the future format to be a positive approach for the company. With such a large fragmented industry it will be much easier for the company to capture market share by focusing on improving the value proposition and offering new high quality, cheap products to customers. As of late, Lumber Liquidators only captures 10% of the Hardwood flooring market and 9% of the laminate market, providing a significant opportunity for growth.

The Gross margin expansion story doesn't hurt either with benefits predicted to continue into next quarter. The company is making investments in quality control and strengthening relationships with vendors which will only add to the gross margin story on top of its operating leverage. Look for continues improvements in gross margins and net income in the upcoming quarter, with new stores to be above 300.

Recent consumer trends have also suggested that consumers increasingly prefer the look and durability of hardwood compared with carpet or laminate, as well as increase the value of the home, which all bodes well for LL in the long term (Hardwood Trends). The stock is trading at a current trailing P/E of 44 which is easy to understand with expected growth of 28% in 2013 and 20% in 2014. This means LL is trading at a very realistic 2 year Price to Earnings Growth (PEG) of 1.83. - Yahoo Finance

Source: This Flooring Retailer Could Help You Remodel Your Portfolio