A rebounding economy is good for most industries. And when you have the strengthening economy, coupled with the rebounding of the housing market that should help further increase furniture sales. La-Z-Boy (LZB) is one of the market's biggest, pure-plays, on the furniture market.
However, La-Z-Boy is down nearly 20% year to date, against an S&P 500 that's essentially flat. This comes as the furniture company missed fiscal 3Q EPS estimates by over 10%. Of course, the weather played its part. Something investors were not pleased with, especially after the company had beat expectations by nearly 20% in each of the prior two quarters.
However, the fundamentals of the business remains strong. The majority of La-Z-Boy's weak fiscal 3Q was likely weather related, and the pullback appears to be providing investors with an attractive entry point.
Despite the weak January and fiscal 3Q performance, I think the company could be set up to outperform analysts' expectations for fiscal 4Q. The weather not only hurt sales in the retail segment, but also delayed deliveries to stores. There's still some backlog on the books there. That's not just because of the delivery delays, but also delays in manufacturing at its facilities. We saw same store sales down 1.5% in January, after being up 9.5% in November.
Suggesting that going into the holiday season the company was seeing positive momentum, but the weather eventually put a damper on the top-line. Nonetheless, for fiscal 3Q 2014 sales were up 0.4% Y/Y, with operating income and earnings up slightly. Operating margins also expanded, up to 7.3%, from 6.7% in 3Q 2013.
Store revamp is a revenue driver going forward
La-Z-Boy has a network of over 900 distribution outlets. And while there's a big opportunity to continue expanding across the North American market, one of the potentially overlooked opportunities is store revamping.
La-Z-Boy has three furniture gallery formats. The first is its newest concept, introduced in 2011, with only 25 stores in the market place. This format is the best performing of the three, generating over $4.5 million in annual revenue per store on average.
Its second format, introduced in 2000, still generates over $4 million in annual revenues on average. There are about 230 of those in operation. However, the biggest opportunity is in its oldest store format, which is over 15 years old. Many of these stores need to be remodeled or closed. They generate the lowest average revenue per store, at about $3 million.
The goal is to have this older format cycled out within the next three years. Again, the latest format stores are generating sales per store that's nearly 50% higher than the oldest format stores. There's a big opportunity to boost overall revenue per store.
The ultimate goal is to hit its 4-4-5 goal, which includes having 400 stores in North America averaging $4 million in revenue within the next five years. And with same store sales already on the rise, that looks to be quite achievable.
Its vast retail presence presents a growth opportunity
The retail business hasn't been the best. I'd expect the retail segment to see a level of rebounding as we head into spring. A large number of its stores are located in the Midwest and Northern part of the U.S., both of which have been hit hard by the severe weather.
January performance saw a large discrepancy from past quarters, one of the largest discrepancies the company has seen in some time. Midwest and Northern area sales were down as much as 20%, while others were up 15%. I'd look for the company to start making a push to open stores in warmer climates this year and next. This should help boost overall sales, but also smooth out seasonal patterns.
Beyond just warmer climate markets, the company will still be targeting underpenetrated markets. It just introduced a new build out program for the next five years, which also includes a target of increasing its ownership of La-Z-Boy Furniture Galleries stores to 40%, up from 32% currently.
During fiscal 3Q, La-Z-Boy brought up two stores from dealers. As they look to bring more stores within their own operating umbrella, costs will likely see a near term spike, associated with starting up -- i.e. training, branding and IT costs -- but longer-term, these stores will increase profitability in the retail segment.
On the other hand, there are still dealers that are looking to make deals and expand their footprint, however, the overall operating environment has delayed that. With signs of a strengthening furniture market, I'd look for these dealers to capitalize on some of the advantageous real estate deals still available in the market.
Margin improvement and other segments will further supplement
La-Z-Boy's more efficient manufacturing process should continue helping improve margins. During 3Q, the wholesale upholstery segment saw operating margins improve 100 basis points to 11.3% year over year. I'd also expect overall profitability to get a nice boost as sales rebound, thanks to the company's fixed cost structure.
Another key top line driver for the company is its Urban Attitudes collection, which the company just rolled out to its stores. I see this collection as a big positive, especially with the trend that housing is seeing. Urban Attitudes focuses on younger consumers, and those living in smaller spaces -- i.e. condos and apartments.
There is also an opportunity to also turnaround its case goods segment faster than expected. This segment has been pressured the most, and has been the slowest to recover. That's because these products are heavily tied to housing. The planned case goods product refresh should do wonders for this segment. The move likely won't be completed until 2015, at which time, all the new product should be rolled out onto retail floors.
Using a long-term free cash flow growth rate of 3.5%, coupled with a 10% discount rate, suggests that fair value is around $30. A historical 20x price to earnings multiple, and fiscal 2015 EPS expectations of $1.52, puts the price target for La-Z-Boy at over $30. The company is still a workhorse for investors, sporting negligible debt, a 7% FCF yield and healthy 12% return on investment.
The most encouraging aspect to the setback in fiscal 3Q, was that the business has not fundamentally changed. One of the few areas of strength in the retail market is appliances and furniture. It's one of the few areas that e-commerce, and the likes of Amazon, have yet to disrupt. Thus, its plans to revamp its retail strategy could prove to be very beneficial for La-Z-Boy. Assuming La-Z-Boy can continue driving its sales with store revamps, while also boosting margins via manufacturing initiatives, the company should be set up to beat market expectations and offer investors market beating returns.