Should Investors Be Buying This Beaten Down Stock?

| About: Lumber Liquidators (LL)

Summary

Recent settlement agreement approval is the first step towards helping rebuild brand value.

Management will have an incentive to put institutional measures in place to prevent this problem from happening in the future.

Continued movement on the Formaldehyde issue could help to restore investor confidence.

Lumber Liquidators (NYSE:LL) has been the recipient of many pieces of bad news over the past year. From investigations as to whether or not Lumber Liquidators flooring is violating emissions laws, to the large resignation of many senior staff members, 2015 was a tough year for Lumber Liquidators shareholders. As the company continues to try to work its way through the bad year that was 2015, the company finally appears to be on track towards helping to deal with the problems associated with the last year. A recently announced acceptance of a settlement between Lumber Liquidators and the Department of Justice should help to move the company forward, and is a step in the right direction towards Lumber Liquidators working its way out of the mess of the past few years.

The Agreement

A Federal judge signed off on an agreement yesterday that was originally struck in October between Lumber Liquidators and the US Department of Justice. This agreement helps to resolve charges regarding the illegal importation of wood and the alleged false statements made in connection with that action. The company is pleading guilty to four misdemeanors violations of the Lacey Act and a single felony charge of the entry of goods by means of false statements. This settlement notably does not deal with the other issue of the levels of Formaldehyde found in some of Lumber Liquidators wood, which is arguably the larger of the two issues.

Under the terms of the agreement, Lumber Liquidators agreed to pay $10 million in fines and agreed to a probationary period of five years. This probationary period will help to make sure that the company has the processes in place in order to not have a similar incident moving forward. Under the agreement, any additional illegal actions could result in substantial additional penalties and would likely be frowned upon by the court. This probationary period will incentivize Lumber Liquidators to put the mechanisms in place to prevent this issue in the future.

Lumber Liquidators does appear to be in a solid financial state at least in the interim. The company reported having $53.8 million in cash at the end of last quarter. Even with the $10 million in fine Lumber Liquidators should have enough cash on hand to be able to operate without a substantial risk for dilution. The company's net loss was $8.5 million last quarter, as a result of decreased sales and increased SG&A due to increased legal fees. While this settlement will take a dent out of Lumber Liquidators' cash pile, investors should be confident that it will have the cash needed in order to continue to move forward.

Why Should Investors Care?

One of the largest concerns about Lumber Liquidators is the total amount of liability that the company could be facing due to its wood importation and formaldehyde problems. This settlement is the first step towards moving past these issues and to hopefully rebuilding the brand image for Lumber Liquidators. As a result of the scandal, Lumber Liquidators has seen substantially decreased revenue and increased losses due to high legal fees. Lumber Liquidators will need to restore the confidence of its consumers and the first step towards doing that will be to deal with the legal issues that it is currently facing. This deal should also help to make investors confident that Lumber Liquidators will have the institutional mechanisms in place to help prevent future issues.

When examining the long term impact on the company, it is not likely to be very high. The company is still operating at a profit, and while the settlement does dip into Lumber Liquidators' cash reserves, it should help to remove the overhang from the stock. It should also help to lower some of Lumber Liquidators' substantial legal expenses from the scandal, as this will be one less case that the company will continue to have to worry about and will allow for its lawyers to focus on more pressing matters.

What Is Next For Lumber Liquidators?

The company needs to have some sort of movement regarding the Formaldehyde issue. The company is facing both litigation from the government and from private consumers. Any movement in favor of Lumber Liquidators in either of these cases should help to send shares higher. The company needs to try to find a way to reach a resolution to these cases, which will allow for the company to remove a substantial cash drain from its cash flow and will help the company to be able to recover. After these Formaldehyde cases are resolved I would expect for Lumber Liquidators to go about the expensive process of trying to rebuild its image. This could involve cheaper pricing to try to incentivize consumers to come back, and could even include some sort of media campaign in order to reintroduce the company to consumers. It is important that Lumber Liquidators begins to rebuild its tattered brand reputation. This will be a substantial challenge for management as management tries to prove itself worthy of leading the company forward after these tumultuous times.

Conclusion

While a settlement means that Lumber Liquidators will in some sense have to admit responsibility and be paying out money, this settlement was crucial for the company to be able to move forward. The company will have to continue to deal with its legal problems but should be able to restore investor and consumer confidence as it continues to reach agreements regarding its outstanding litigation. The approval of the plea agreement should also help to make investors confident that Lumber Liquidators will take the necessary steps in order to prevent itself from getting caught up in future importation issues and that the company will put the internal mechanisms in place in order to prevent this from happening again. Investors will also be looking to see how management is able to respond and begin to rebuild the Lumber Liquidators branding, and if the company is able to continue to reduce the substantial cash drain that the legal costs are eating into the company. Overall the approval of the plea agreement is good for Lumber Liquidators shareholders over the long term and is setting the company on the road to hopefully rebuilding its image.

Disclosure: I am/we are long LL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.