Over the past year, one of the more amazing performers has been hardwood floor supplier Lumber Liquidators (LL). Shares have steadily climbed a whopping 185% over the past year and are up 55% year-to-date. However, we do not believe such robust performance is likely to continue.
Fundamentally, little is wrong with the company's recent performance. In fact, Lumber Liquidators is benefiting from a strong rebound in the U.S. housing market. Flooring is one of the more obvious features of a house, making it an obvious area to improve from almost all aspects of ownership, whether it be selling, buying or renting. With hardwood floors still in vogue, the firm is capitalizing on this demand, experiencing a torrid increase in sales and demand. In fact, for the first quarter, same-store sales jumped 15.2% year-over-year driving total sales growth of 22.5%. The company also benefited from lower input costs and higher average price per unit solid (ARPU), which resulted in a 300 basis point increase in gross margins. Higher sales also leveraged fixed costs, resulting in a 390 basis point increase in operating margins for the first quarter.
Since the housing market has shown few signs of deceleration, Lumber Liquidators raised its full-year forecast for sales to $913 million to $942 million, from $885 million to $920 million. The company also raised its earnings guidance range to $2.10-$2.35 (was $1.90-$2.15), without accounting for share repurchases. Considering the firm's aggressive use of excess free cash flow to repurchase shares, the given guidance range could be easily attainable. Free cash flow is up 18% compared to the prior year, but still totaled only a touch over $8 million.
Even though the company's future looks bright, we think the firm's valuation looks stretched. Assuming the company is able to earn $2.35 per share - the high end of its guidance range - Lumber Liquidator's current earnings multiple is approximately 35x 2013 earnings. This is higher than other floor sellers like Home Depot (HD), which trades at 21x next year's earnings, and Lowe's (LOW), which trades at 18x next year's earnings. While Lumber Liquidators is growing sales and earnings at a very attractive clip, we think the flooring market will remain incredibly competitive over the next several years. The company isn't only competing with Home Depot and Lowe's, but it also battles a considerable group of smaller players, Wal-Mart (WMT), and Amazon (AMZN). Both Wal-Mart and Amazon are willing to engage in destructive price wars for the sake of sales growth, and both could provide consumers with attractively priced alternatives to Lumber Liquidators. Strong customer service and installation outsourcing may help Lumber Liquidators fend off competitors, but we believe competition could intensify.
Ultimately, it is not difficult to see why shares of Lumber Liquidators are up substantially over the past year. The firm is experiencing a powerful tailwind from the U.S. housing recovery, and it continues to add new stores while sales surge at existing locations. However, we think shares look expensive on a discounted cash flow basis, and trade at a premium to peers. Although technicals and fundamentals look strong, the firm's valuation is far too rich for us to get excited about the company's return prospects, and we won't be adding shares to the portfolio of our Best Ideas Newsletter any time soon.