Turning to a short idea, what’s the bear case for Haverty Furniture [HVT]?
WH: Haverty is a furniture retailer in the Southeast with what we consider to be a pretty undifferentiated offer. It’s like many other local furniture stores out there, except instead of having a few stores they have around 120. The company’s historical margins and returns on equity have never been particularly strong. During the height of the housing boom when furniture was selling quite nicely, its net income margin got as high as 3.5%, versus around 8% for bestin-class companies in the sector like Ethan Allen and Williams-Sonoma.
For the last four or five years the company produced strong negative comps, with sales per square foot falling from $200 to around $120 today. That’s not good news for a retailer with relatively high fixed costs, and over the past 12 months Haverty had a $15 million operating loss. While other kinds of retail sales showed some signs of life in the first quarter, furniture sales were terrible and appear to be equally bad this quarter.
The primary reason we’re short Haverty is not because it’s a low-quality business, which it is, or that macro furniture sales are bad, which they are, but because the company today trades at 15x mid-cycle earnings when there are loads of retailers out there at less than 5x midcycle earnings. It makes no sense to us why it would be so highly valued.
We thought you didn’t like it when you didn’t know why something was mispriced.
WH: One notion that has been out there for a long time is that the company owns a third of its store base, which puts a sort of a real estate floor on the stock. While that might have made some sense three years ago, the bid on real estate like this has fallen way off and their practical ability to realize any significant value is limited.
I guess people have also been somewhat pleased by the company’s ability to cut costs and that its trailing 12-month EBITDA is still positive. But that hardly seems like a justification for the shares to trade at 15x mid-cycle earnings when a company like Williams-Sonoma trades at 3x mid-cycle earnings. The valuation premium may be even higher than that: Haverty’s peak earnings early this decade were around $1 per share, so it’s probably even generous to call 70 cents per share mid-cycle earnings.
What do you think the shares, now trading at $10.50, are worth?
WH: If the stock traded at 7.5x mid-cycle earnings – still a valuation premium we couldn’t justify – the shares would be cut in half. Even though the numbers have already been bad, we expect lousy results in the next quarter or two to start to get noticed.
We’ve seen selling over the last two quarters by Haverty’s largest shareholder, the Third Avenue Value mutual fund. If that continues, we don’t expect much enthusiasm by people to step up and buy ahead of that.