La-Z-Boy Incorporated (LZB) reported its operating results for the fiscal quarter on Tuesday. The company grew its revenues by 6% to $280.1 million. The stock gained 8.8% during the regular hours, closing the day at $7.63. After the results were announced, the stock fell by 73 cents, completely giving up the initial gains. While the initial response was negative, the stock was able to recover, closing the night at $7.35. The net profit of $45.5 million was much more than what investors were expecting. However, that profit was primarily due to a deferred tax of benefit of $43.4 million.
As of the August 23 close, La-Z-Boy was trading at $7.35 with a 52-week range of $6.47 - $11.84. It has a market cap of $428.7 million. Trailing twelve month (ttm) P/E ratio is 17, and forward P/E ratio is 8.5. P/B, P/S, and P/CF ratios stand at 1.2, 0.4, and 15.5, respectively. The 3-year annualized revenue growth stands at -6.5%. Operating margin is 2.2%, and net profit margin is 2.0%. The company has a low debt-to-equity ratio of 0.1. La-Z-Boy does not yet have a dividend policy.
La-Z-Boy has a rating of 1.4 from the analysts. Out of 7 analysts covering the company, 4 have buy and 3 have hold ratings. Wall Street has diverse opinions on La-Z-Boy’s future. The bottom line is 23% growth, whereas the top-line growth estimate is 64% for the next 5 years. The average annualized EPS growth estimate for the next 5 years is 18%. What is the fair value of La-Z-Boy given the EPS growth estimates? In this article, the 11th in the series, I will show a step-by-step calculation of La-Z-Boy’s fair value using discounted earnings plus equity model.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E_{0} + E_{1}_{ }/(1+r) + E_{2}_{ }/(1+r)^{2} + E_{3}/(1+r)^{3} + E_{4}/(1+r)^{4} + E_{5}/(1+r)^{5}^{ }+ Disposal Value
V = E_{0} + E_{0}_{ }(1+g)/(1+r) + E_{0}(1+g)^{2}/(1+r)^{2} + … + E_{0}(1+g)^{5}/(1+r)^{5} + E_{0}(1+g)^{5}/[r(1+r)^{5}]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E_{0}(1+g)^{5}/[r(1+r)^{5}] = E_{5} / r
While this formula might look scary, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. I used an annualized EPS growth estimate of 18% for the next 5 years. You can set these parameters as you wish, according to your own diligence.
La-Z-Boy’s Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $0.45 along with the mean estimate of $0.97 for the next year.
E_{0}_{ }= EPS = ($0.45 + $0.97) / 2 = $0.71
Wall Street holds diversified opinions on La-Z-Boy’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. According to Morningstar, five-year annualized growth forecast is 18%. Book value per share is $6.96.
The rest is as follows:
Fair Value Estimator | ||
V0 | E_{0 } | $0.71 |
V1 | E_{0 }(1+g)/(1+r) | $0.75 |
V2 | E_{0}((1+g)/(1+r))^{2} | $0.80 |
V3 | E_{0}((1+g)/(1+r))^{3} | $0.85 |
V4 | E_{0}((1+g)/(1+r))^{4} | $0.91 |
V5 | E_{0}((1+g)/(1+r))^{5} | $0.96 |
D | E_{0}(1+g)^{5}/[r(1+r)^{5}] | $8.76 |
BV | Equals | $6.96 |
Fair Value Range | Lower Boundary | $13.75 |
Upper Boundary | $20.71 | |
Potential | 171.48% |
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for La-Z-Boy is between $13.75 and $20.71 per share. As of the Aug. 23 close, La-Z-Boy was trading at a price of $7.35, indicating that the stock is clearly undervalued. The stock is trading almost 50% lower than the lower boundary of its fair-value range. Thus, it has almost 100% upside potential based on 18% annualized EPS growth estimate.
O – Metrix Confirmation
If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:
O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5
Dividend Yield: Higher is better.
EPS Growth: Higher is better.
P/E Ratio: Lower is better.
The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.
What Is The O-Metrix Score?
- La-Z-Boy does not have a dividend policy. Therefore, the yield is 0.
- Growth estimate is the same as the discounted earnings model and is equal to 18%.
- Since we are at the middle of the year, taking the average of ttm [17] and forward [8.5] P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 12.75.
O-Metrix = [(18) / (12.75] * 5 = 7.06
Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. La-Z-Boy’s O-Metrix score of 7.06 is in the higher-than-average fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $7.53, the company is trading within the B-Grade, above-average-return zone.
Summary
La-Z-Boy has no debt problems, but it has a high Beta of 2.39. That is probably why the stock lost almost 28% in the last quarter. It is trading 35.56% lower than its 52-week high. If it was not for the Tuesday’s spike, the stock would be trading at more than 42% lower than its 52-week high. Nevertheless, based on my FED+ model it has a fair-value range of $13.75 and $20.71. Analysts mean target price of $13.46 is at the lower end of my fair-value estimate. With a high beta of 2.39, La-Z-Boy is a high-risk and high-reward stock to invest in. It has a pretty high short float of 9% and short ratio of 6.46. In case of a short squeeze, the stock can make double-digit returns in a single day. Besides, the current price offers a good entry point. Thus, it can be added to the speculative portion of a portfolio.