A Furniture Maker Sets The Table For Growth

| About: Nova Lifestyle, (NVFY)

(Editors' Note: This article covers a small-cap stock. Please be aware of the risks associated with these stocks.)

Consumer confidence is wavering, as bitter political warfare in Washington, DC erodes job creation and the approval ratings of the nation's elected leaders. However, the recovery is proving resilient enough for consumers to continue opening their wallets for discretionary purchases, including home and office furnishings.

One small-cap stock is poised to benefit from this trend: Nova LifeStyle (STVS), based in Commerce, California.

Nova LifeStyle is a fast-growing designer and manufacturer of modern furniture, primarily sofas, dining room sets, cabinets, office furnishings, entertainment consoles, cupboards, and various accessories.

Nova's products are manufactured in the U.S., Europe and Asia and marketed under such brands as Diamond Sofa, Colorful World, Giorgio Mobili, NOVA QWIK, and Bright Swallow International.

With 700 full-time employees, Nova sells its brand-name products via franchise stores in the U.S. and internationally, as well as to about 60 unaffiliated retail stores and distributors in China.

The company also operates an online store in China, a country that's home to burgeoning e-commerce activity. Online offerings provide higher profit margins and also attract a younger demographic that's furnishing their "starter" homes.

Nova sells its products around the world but it's emphasizing emerging markets such as China, where a rising middle class is increasingly trying to emulate the "good life" of the West.

Economic recovery will fuel Nova's growth for the rest of the year and well into 2014. According to the Business and Institutional Furniture Manufacturer's Association, U.S. furniture production is projected to increase by 2.1 percent and 7.2 percent in 2013 and 2014, respectively.

To be sure, the U.S. Labor Department reported that the U.S. economy added just 148,000 jobs in September, indicating a loss of employment momentum that's dispiriting for American shoppers. But it's the nature of consumer sentiment to sometimes vacillate during a recovery, only to bounce back.

The Holiday Shopping Frenzy

On a year-to-date basis, the Consumer Discretionary Select Sector SPDR ETF (NYSEARCA:XLY) has returned 34.4 percent, compared to 25.7 percent for the S&P 500. Despite the recent hiccup in consumer sentiment, shoppers are still hitting the stores-activity that should pick-up during the perennial holiday shopping frenzy.

US consumer spending is a growth driver that comes to the fore every holiday season. The National Retail Federation projected in October that holiday sales will rise between 2.4 percent and 3.9 percent in 2013 compared to 2012. The holiday season can account for up to 40 percent of annual retail sales. This uptick in sales will drive growth for companies such as Nova.

The U.S. Commerce Department reported that orders for durable goods rose 3.7 percent in September, higher than the 0.2 percent gain in August. The government defines durable goods as items designed to last at least three years-and Nova's products certainly fall under this category.

Moreover, according to the recent data on residential construction from the U.S. Census Bureau, new building permits, housing starts and completions are on an upward trajectory.

Nova has a market cap of about $80 million, which makes it riskier than its large-cap brethren but which also means it offers greater upside potential. The stock sports a 12-month trailing price-to-earnings (P/E) ratio of 14.4, which is a distinct bargain compared to the trailing P/E of 37.8 for its industry of home furnishings and fixtures.

Nova is the result of a 2011 merger between Nova Furniture and Diamond Sofa. Diamond distributes furniture from Nova to retailers including Nebraska Furniture Mart, part of Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B).

Warren Buffett with Nova LifeStyle president Tawny Lam at the Marcum MicroCap Conference 2012 in New York City.

Nebraska Furniture Mart is now expanding in high opportunity areas in the U.S., particularly Texas where it is constructing a $1 billion retail space that should provide a significant boost to Nova's revenue.

In 2012, Nova raised $5.6 million in two private placements and secured $8 million in lines of credit, to fund the construction of a new Chinese factory that is producing inexpensive furniture for Ikea International Group in China.

In April 2013, Nova paid $6.5 million to acquire Bright Swallow International Group Ltd (Bright Swallow), a furniture company with manufacturing facilities in China and a global customer base. The economic rationale behind the deal was simple: products can be manufactured cheaply in China but then sold at a premium in developed countries.

Bright Swallow posted revenue of just over $13 million for its fiscal year 2012; its urban-oriented, contemporary line of furniture complement Nova's products. The merger has given Nova substantially greater global reach, but with low overhead. By incorporating Bright Swallow, the parent company Nova has reaped manufacturing, marketing and supply chain economies of scale.

In April, Nova announced that fiscal year 2012 revenue reached $66.3 million, a whopping year-over-year increase of 53.6 percent from fiscal year 2011 revenue of $43.2 million.

Nova's North America sales racked up a year-over-year increase of $11.3 million, while China sales increased by $6.8 million. Sales in the Middle Kingdom accounted for approximately 78.5 percent of the company's total growth last year. Earnings remained stable at $5.4 million, for earnings per share (EPS) of $0.29.

For the six months ending June 30, 2013, Nova reported revenue of $34.1 million, compared to $27.1 million in the same period a year ago. Earnings remained essentially flat, at $2.4 million for EPS of $0.13.

Nova is expanding its e-commerce presence in China, a move that's paying off as that country's wobbly economy regains a sound footing.

E-commerce is a fast-growing retail sector in the Middle Kingdom. According to the technology consultancy Forrester Research, annual online retail sales in China will reach $159.4 billion in 2015, compared to $48.8 billion in 2010.

Another tailwind for consumer stocks such as Nova is the Chinese government's policy of encouraging domestic consumption and transitioning away from the economy's historic reliance on exports.

As evidence of Nova's rise, the company in August filed a listing application with NASDAQ, the approval of which is pending.

Caveat Emptor

Take note: Nova is a small-cap stock and as such remains vulnerable to the inherent ups-and-downs of cyclical consumer industries such as furniture manufacturing.

Notably, Nova LifeStyle has a low float of only 8.1 million shares that could pave the way for future volatility. However, that's also an advantage, because stocks with small floats can make a major move on the upside.

The company faces giant competitors, such as U.S.-based HNI Corp (HNI), which boasts a market cap of $1.72 billion and is better able to survive any economic shocks or downturns. However, HNI also has a trailing P/E of 29.8, making it a far pricier proposition for investors with less room for growth.

And although China's wobbly economy has regained its footing in the second half of this year, it could still hit unforeseen bumps that would derail Nova's growth strategy for the rest of this year and into 2014.

All of that said, aggressive investors looking for a high-growth play on rising consumer discretionary income should grab a seat on Nova. The stock of this small-cap furniture maker is substantially undervalued compared to the company's growth prospects and it should leave investors sitting pretty.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.