Lumber Liquidators: The Relationship Of March Sales To Q2 Sales

| About: Lumber Liquidators (LL)

Summary

Lumber Liquidators sales are likely to slowly rebound in the long-term. However, various examples point to how sales rebounds are often more protracted than investors expect.

March sales were higher than January and February sales (monthly average). However, March is historically one of the stronger months of the year for Lumber Liquidators.

March 2015 sales were still higher than January/February 2015 sales despite the 60 Minutes report.

Based on the historical relationship of March sales to Q2 sales, Q2 sales may end up in the $221 million to $238.5 million range.

Given Lumber Liquidators' purchase cycle, the effect of negative publicity in late February will almost definitely affect Q2 sales to a certain extent.

There were some comments during my last article about Lumber Liquidators (NYSE:LL) about how the damage from the negative headlines from the CDC report shouldn't last long and how March sales were actually stronger than January/February sales. A look at historical information though indicates that sales rebounds often take a long time (especially compared to investors' initial expectations) and that March 2016 sales were quite weak. If the historical relation of March sales to Q2 sales holds up, then Lumber Liquidators will miss Q2 revenue expectations.

Long Lasting Damage

Lumber Liquidators' sales will likely recover over the long-term (multiple years). However, there is plenty of evidence to show that consumers take a long time to come back. Lumber Liquidators' own sales reports should be strong proof of this as it reported substantial decreases in comparable store sales throughout 2015, especially after it reduced its aggressive post-crisis promotional pricing initiatives.

Chipotle's (NYSE:CMG) sales decline has also lingered for a while and KFC China's sales are still down somewhat nearly two years after a tainted meat scandal. In KFC China's case, it ended its relationship with the supplier very quickly, but Q2 2016 comparable store sales are still around 9% lower than Q2 2014. This is much improved from its -18% trough, but still indicates the difficulty in fully restoring sales. In Lumber Liquidators' case one could argue that the damage from flooring controversy is less than food safety/quality issues, but heavily publicized crises do take a considerable amount of time to recover from.

March Sales Compared To January/February

There was a comment on my previous article about how March 2016 sales were significantly higher than the monthly sales average for January/February 2016. This is true, but it appears that March sales have typically been significantly higher than the January/February average.

In 2014, March sales were 43% above the January/February average. In 2015, March sales were still 5% above the January/February average, despite the initial 60 Minutes report airing in early March. Despite January/February sales being normal and March sales being hit hard by the crisis, March 2015 sales still exceeded January/February sales. For 2016, March sales were 17% above the January/February average. This is an improvement compared to 2015, although there are a couple other factors to consider. The CDC report made headlines in late February, so one week of February 2016 sales would have been affected as well. Also, January/February 2016 sales were still somewhat depressed due to the fallout from the 60 Minutes report, so the March 2016 increase comes against a significantly lower January/February 2016 comparison.

$ Million

Jan/Feb Avg

March

% Increase

2014

$71.9

$102.5

43%

2015

$85.3

$89.4

5%

2016

$73.8

$86.0

17%

Click to enlarge

It should be noted that the 2014 increase of 43% is probably higher than historical averages though since Lumber Liquidators was affected by extreme winter weather in many locations that didn't fully abate until mid-March. That would push the January/February monthly average for 2014 down.

Some readers may also note that Lumber Liquidators January/February sales for 2016 were actually higher than 2014. I believe that is partially due to the extreme winter weather factor, combined with a 13% increase in the number of stores between 2014 and 2016.

Relationship Of March Sales To Q2 Sales

Generally it appears that March typically is one of the stronger months of the year for Lumber Liquidators. In 2014, Q2 sales ended up being $263.1 million compared to March's $102.5 million, which is a multiple of 2.57x. In 2015, Q2 sales ended up being $247.9 million compared to March's $89.4 million, which is a multiple of 2.77x. The Q2 to March multiple for 2015 is probably higher due to the damage from the 60 Minutes report diminishing from March to Q2 (early March was particularly affected by returns, as adjustments reached 27% of gross new orders for March 2 to March 10, compared to the 11% historical average). As well, Lumber Liquidators mentioned that it implemented aggressive promotional pricing to combat the 60 Minutes fallout. While it implemented the aggressive promotional pricing in March and continued it in Q2, I think Q2's sales were more likely to be boosted by that initiative than March's sales due to the lag time between order and invoicing. Partially as a result of the aggressive promotional pricing, Lumber Liquidators' adjusted gross margin (stripping out various charges) fell to 32.1% in Q2 2015.

$ Million

March

Q2

Multiple

2014

$102.5

$263.1

2.57

2015

$89.4

$247.9

2.77

Click to enlarge

Taking those multiples and applying it to March 2016's revenues results in an estimated sales number of $221 million on the low end to $238.5 million on the high end. My sales estimate of $233 million falls somewhat toward the higher end of this range as the damage from the negative headlines from the CDC report likely diminishes over time similar to the effect of the 60 Minute report last year. However, partially counteracting that is the assumption that Lumber Liquidators is trying to avoid the heavy promotional pricing from Q2 2015, and is aiming for 35% to 36% adjusted gross margins. If Lumber Liquidators ended up sacrificing margins again in Q2 2016 to attract more customers, I think my $233 million estimate would be too low, but then Lumber Liquidators' gross profits would be lower than my estimates as well.

$ Million

March

Q2 Low

Q2 High

2016

$86.0

$221.0

$238.5

Click to enlarge

Conclusion

The data points that we have indicate that March 2016 sales were fairly weak. Based on the historical relationship between Q2 and March, sales could end up between $221 million and $238.5 million for Q2 2016 if Lumber Liquidators' adjusted gross margin ends up around 35% to 36%.

There is certainly potential for error for this estimate given that we only have a limited set of data points, and there is often a bit of historical variance in how sales in one month relates to sales in the immediate previous and future periods. However I believe that neutrally looking at available data (even if incomplete) will give at least a marginally better estimate than looking at no data. This is especially true in cases like Lumber Liquidators, which inspires a lot of passion on both sides of the investment argument. The danger in this situation is that earnings and revenue expectations get driven by an individual's pre-existing view of Lumber Liquidators rather than data.

Lumber Liquidators is likely to rebuild its sales volumes over the long-term (gross margins are probably a more permanent issue), but available data points to the near-term being more likely challenging than not.

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Disclosure: I am/we are short 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.