Illegal Products Could Spell Big Trouble At Lumber Liquidators

Jun. 20, 2013 2:33 PM ETLL Flooring Holdings, Inc. (LL)44 Comments
Xuhua Zhou profile picture
Xuhua Zhou
2.11K Followers

Lumber Liquidators (NYSE:LL) is one of the largest specialty retailers of hardwood flooring in the United States running a total of close to 300 retail stores in 46 states. Its product is found to contain illegal levels of formaldehyde -a known carcinogen.

Introduction

Lumber Liquidators reported net revenue of $813 million and $47 million in net income for the year 2012. At $82 a share, the stock trades at around 50x its 2012 earnings. This stock is the definition of a high flier: trading at over 50x fiscal year 2012 earnings, amazing for a building material retailer. The rationale for this huge multiple is twofold:

1) Huge gross and net margins, despite selling a commodity product

2) An aggressive growth plan to double the number of retail outlets

At the current level, Lumber Liquidators presents a compelling short opportunity for investors for reasons beyond its egregious valuation. This report shows that Lumber Liquidators lacks a proper product quality control system and its products may be hazardous to the unsuspecting consumers. Given the issues presented, Lumber Liquidators faces significant risks in executing its business plans. The margin expansion may reverse when additional quality control processes are put in place. Further, enormous risks are present for the Company may be required to recall its noncompliant products sold. Investors in Lumber Liquidators are likely unaware or unfamiliar with the significance of selling noncompliant composite wood products to consumers. The stock may experience significant decline if the Company were to be forced to recall its products. Moreover, sell-side estimate will become unreliable should consumers abandon Lumber Liquidators for health and safety concerns.

The Company's stock has been on a tear, rallying 300% over the last year, primarily on dramatic expansion of its gross and net margins. Management has often made reference to the significance of its acquisition of

This article was written by

Xuhua Zhou profile picture
2.11K Followers
I am currently an individual investor with focus on event-driven trading and long-short opportunities. I graduated Emory University in 2009 and is also a finance Phd dropout from UCLA Anderson.

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