Lumber Liquidators (NYSE:LL) experienced a roughly 7% sell-off since my last article was published highlighting the existence of illegal and noncompliant toxic product in its inventory. Despite having offered to send the company my noncompliant sample and the relevant lab reports, I have yet to correspond with anyone from Lumber Liquidators. Instead, Lumber Liquidators initiated an End of Quarter CLEARANCE sale for all its flooring products per a marketing email received this Sunday. The company chose not to follow up on credible questions raised about its product safety and instead launched a marketing sales campaign to get rid of existing inventory faster. It could be that Lumber Liquidators management needs to make analyst projections for the second quarter or it may be trying to unload all noncompliant inventories before the California Air Resource Board starts to crack down on the issue. Regardless of the rationale, it is hardly a responsible decision on the part of Lumber Liquidators.
Rebuttal from Analyst at Piper Jaffray
It seems always to be the case when an insightful negative piece of analysis gets read by market participants, certain Wall Street cheerleading brokerage firms would come out and reiterate their bullish sentiment on the stock. They summarily dismiss serious questions raised in the analysis and respond to every question with a simple and uniform answer - we spoke with the management; everything is fine. After raising the price target from $90 per share to $97 per share on Monday of last week, Piper Jaffray analyst Peter Keith issued another commentary on Friday responding to the evidence I presented in my Thursday article. Mr. Keith summarily dismissed the issue I raised by stating:
"After completing our own research and speaking with members of LL management team, we believe many of the claims made in the report are misleading."
Before discussing in detail the lack of merits presented in the referenced commentary, I would like to note that reading this comment was a déjà vu moment for me. Almost exactly five months ago on January 23rd, 2013, I published an article on Joy Global (NYSE:JOY) discussing the ramifications of the revealed misdeeds at Caterpillar (NYSE:CAT) and raised serious questions about Joy Global's acquisition of IMM. The concerns raised in the article were essentially proven true after Anonymous Analytics released a detailed 46-page report showing with documents the financial irregularities that were present at the time of IMM's acquisition by JOY. Another Piper Jaffray analyst posted a response to the concerns raised in my article on the same day dismissing all questions raised in the article. The analyst reiterated his buy rating with an $84 price target and advised its clients the temporary dip in JOY's share price was a buying opportunity.
Clients who heeded Piper's advice lost almost 25% while S&P 500 Index gained 6.5%. JOY is a member of S&P 500 Index.
Fast forward five months, Piper analyst again stated the following:
"Today's sell-off in LL shares as a result of a short report posted on Seeking Alpha presents investors with an attractive buying opportunity."
Investors who plan on heeding Piper's advice and buy into LL's stock on the dip should be aware of its prior track record given the eerie similarity of the setup between JOY and LL.
Piper's defense came in three folds:
- Quality Control is taken very seriously at LL with the management stating all of its products are CARB Phase 2 compliant. Then, the analyst noted the CARB regulations are not yet adopted nationally. Even if it were to be adopted, LL will be overly compliant. Products are extensively tested by 3rd party with random sampling. Additionally, LL also spot tests on products at its facility in China.
- Due to the amount of products I tested, the results suffer from sampling error hence the result may not be valid.
- The negative review issue I noted on Reseller Reviews is a result of cherry picking data to put a negative spin on the company. Piper believes it is much more helpful to also consider reviews found on Google Shopping with over 2400 largely positive reviews because sample size is 28x larger.
Before the product quality issue can be addressed, it is imperative for investors to understand which review website holds more value. In my humble opinion, Piper's claim that Google's review is more relevant is one of the most preposterous opinions rendered by a professional who is supposed to possess extensive knowledge to analyze the consumer space. The Google reviews are notoriously known to be subject to easy manipulation. The issue got so severe that Google itself had to issue a warning to SEO and businesses to avoid fake reviews. In the case of Lumber Liquidators, the reviews on Google Shopping are especially suspicious. Investors should take time to scroll down a number of pages and actually read the reviews. Most of the reviews came from Online Shopper (I do not think many consumers who purchase LL products do so exclusively online). And almost 96% of the reviews or 3168 of them came from a single source, Bizrate. Of the 11 opinions sourced from Epinions, 8 of the 11 reviewers gave LL 1 out 5. Reseller Ratings is noted in my prior article which is also almost exclusively negative. The reviewers through Epinions and Reseller Ratings are all individuals with names yet the ones from Bizrate are uniformly online shopper. Amazingly, the equity research analyst at Piper believes those online shopper reviews should be relied upon by investors to determine the quality of LL's products and the level of its consumer satisfaction.
Needless to say, it is my strongest belief that somebody has been rigging Google reviews and an email has been sent to Google to request an investigation on the matter due to the apparent data discrepancy. It is my view that Google has a strong interest in ensuring the integrity of its review product and we may see a slightly different Google review on LL in the next few weeks should anything unusual gets discovered.
Furthermore, it is puzzling to me how Piper can state all of LL's products are compliant with CARB Phase 2 when my lab report clearly demonstrates egregious noncompliance. The noncompliant flooring product that was tested came straight from a box purchase at Lumber Liquidators and that box is clearly non-compliant as demonstrated by the presented lab report. The statement is patently false. Additionally, while the sample size is small, they are selected randomly. Precisely because of that, there is a greater potential variation of the extent to which LL has been selling noncompliant products. If anything, investors should be concerned more by my ability to identify one egregious violator after testing merely three products sourced from China. Finally, that very tested box was sold to me as a consumer in the state of California. It is a clear violation of the relevant laws and regulations governing formaldehyde emission standards in the state of California. Even if we take a step back from a regulatory perspective, that box of flooring is supposed to go into somebody's home and will be emitting excessive levels of formaldehyde heightening that entire family's risk to a slew of incurable diseases such as leukemia for years to come. It is simply wrong regardless of how one may look at the situation.
After publishing the article on Thursday, I have been expecting to be contacted by someone from Lumber Liquidators to address the situation and supply them with the evidence and sample I tested. Unfortunately, I have yet to hear from anybody. Obviously well-aware of the situation and my concerns, LL's management thus far has chosen a path of inaction hoping the issue will simply blow over. From the commentary published by Piper Jaffray, it appears the management stated to the analyst that all their products are CARB Phase 2 compliant without addressing how I was able to purchase a sample that emits over two times the CARB phase 1 limit. Instead of using its proper channel, a press release, to communicate with its shareholders, LL has chosen to hide behind a speaker. Is it because the management wants to shield any potential liability and therefore does not want to make any statements they know to be false? Maybe, maybe not. But it does not strike me as the management genuinely intends to deal with the issue in a proper fashion.
In light of the lack of proper response from Lumber Liquidators, I believe further activist activities may be warranted to ensure the public interest can be preserved in this matter. I plan to spend a portion of my profits from shoring LL to engage a public relations firm to raise the general consumer awareness on the formaldehyde issues in flooring products. It is not limited to Lumber Liquidators but also other flooring retailers. Further, a plan is developed to initiate active conversations with members of Congress who have demonstrated interest in the formaldehyde issue. Public letters can be found here, here and here. Finally, as a LL customer, I may plan to file a class-action lawsuit against Lumber Liquidators so other similarly situated can be properly compensated for the harm caused by the potentially unscrupulous products.
In conclusion, I remain steadfastly short Lumber Liquidators with the belief that Lumber Liquidators' future will be clouded by its past. Even with an improving housing market and growing demand for home renovation, consumers will become aware that the risks of purchasing cheap products go beyond the mere lack of durability. Finally, at $76 a share, Lumber Liquidators still trades at an outsized valuation despite the substantial risks present in its business model and its future.