Ethan Allen Still Looks Overvalued

Aug.12.09 | About: Ethan Allen (ETH)

Ethan Allen (NYSE:ETH) reported Q4 09 Rev of $138.7 million and EPS (ex-one-time items) of negative $0.23, which was more or less in-line with its July 21st pre-announcement. Conference Call is Wednesday at 11AM EST.

Key takeaways:

1. Not only did Q4 09 revenue decline 41.2% year-over-year, but revenue declined 1.1% sequentially. Moreover, comparable store sales deteriorated relative to Q3 (Q4 comp store sales declined 43.5% y/y versus 41.8% in Q3). Thus, it appears the Company received no benefit from the stabilization in home sales. Considering new home buyers also received an $8,000 rebate from the government, we would have expected home furnishing retailers to at least show a marginal benefit.

2. Inventory declined 16% in FY 09, but remained elevated relative to revenue and cost of sales. Until the Company reduces inventory commensurate with the drop-off in demand, we believe gross margin will continue to be pressured (gross margin declined 550 bps y/y in Q4).

3. Receivables increased slightly despite the significant drop-off in sales. In the last quarter, the Company stated that it was financing weaker customers.

4. The Company's believes its recent restructuring initiatives are expected to cut $120 million in operating costs and $30 million in manufacturing costs, most of which will be realized in FY 10.

What to listen for on the Call:

- We will look for an update on whether or not the Company continued to finance weak customers and, if so, whether the company increased its allowance for debts to compensate for the extra risk.

- We will look for additional details on the two press releases issued since pre-announcing on 7/21. In particular, we would like to see if the Company addresses the revenue impact of the reinvention of its American-made case goods division to a custom operation. It is our hunch that some of the cost savings outlined are merely reflecting a shift from a higher volume business to a lower volume custom business with lower revenue potential. Thus, the Company may not be able to have the capacity to grow revenue if the economy recovers, and if that is the case, some of the earnings leverage being priced into current valuation may no longer be attainable.

Bottom Up's FY 10 Estimates Revised

Once again, we'll start with revenue. Previously, we expected $600 million in FY 10. However, the sequential deterioration and potential implications of the shift in business model suggest that revenue could come in materially lower. Until we have more clarity, however, we will leave our estimate as is.

Operating costs are expected to be reduced by ~$150 million annually in FY 10. We estimate the Company realized about $55 million of the benefit in FY 09. Thus, we lower costs by the remaining $95 million to $585 million.

Operating profit is equal to $15 million, less non-operating expenses (net) of $7.5 million and a tax rate of 37%, which leads to net profit of $4.7 million, or $0.16 per share.

Valuation

ETH is currently trading at 86 times our estimate of FY 10 earnings and 100 times the Street's FY 10 consensus estimate. For FY 11, the Street is anticipating earnings of $0.60, so investors looking past the upcoming year are still paying ~24 times earnings. We believe a company in this position should be trading at closer to its historical multiple of about 15 times earnings. Applying the Streets FY 11 estimate to its historical multiple would imply a valuation of $9.00.

We will update our thesis if anything material is disclosed on the Conference call or in the 10K filing.

Disclosure: Short ETH