After Lumber Liquidators (NYSE:LL) posted its most recent quarter I took to my laptop to declare the stock, then trading under $50, still wasn't cheap enough to buy. The reason was simple; nothing had changed. LL was still suffering horrendous comp sales numbers, top line growth had all but disappeared and margins were moving in the wrong direction. In short, there really wasn't much to like. The interesting thing that has happened since the stock was crushed after earnings is that we now see shares trading for more than $65 on no news. That's right; the stock has moved up an eye-popping 33% since reporting yet another horrible quarter without any kind of reason. So what gives?
I think what gives is that we are in the same cycle we've been in for the last couple of years now with LL. I don't want people to think I'm overly bearish just for the sake of it; I have reasons. Why would a stock that has seen several dismal quarters in a row suddenly move up by a third? That makes no sense. But it's a story we've seen play out with LL a few times now; the stock just goes up and nobody knows why. Then, one day, terrible earnings come out and longs get crushed. Is this time different? Uhh, nope.
LL was an unbelievable growth story as a great strategy combined with the right products and strong consumer demand sent shares from the low teens to $120 in a few quarters. However, at that point expectations were laughably high and LL inevitably found itself missing those impossible expectations and the stock suffered mightily for it. We certainly aren't in bubble territory like we were at $120 but at $65, LL is still way too expensive.
The problems that have cut the stock in half from its highs are still around. Consumer spending on big ticket items like flooring is still muted. The housing market rebound that sent millions of consumers into home improvement mode and artificially inflated LL's demand temporarily is long, long gone. This is evident in LL's margins, which I discussed in the linked article, as margins continue to fall due to discounting. When LL was shooting to the moon its margins moved up every quarter and posted very strong gains. Moves up in the 200+ basis point range were not uncommon during the boom times. But, for the reasons I just mentioned LL doesn't have the flood of demand it once did and thus, it has resumed discounting to move product. This means margins are coming down and while discounting masks falling demand by artificially boosting revenue, margins don't lie; LL has a demand problem just like it has had for the past year or more.
None of this has changed since the end of October and yet, the stock is one-third more valuable than it was. Incredibly, analysts have begun moving their EPS estimates for next year up. Why? What justification do they have for this? These are the same people who pumped LL's growth into the stratosphere on the way to $120 only for the stock to be cut in half and then some. It's the same thing we've seen before and I'm afraid investors are being duped yet again.
I think investors will be sorely disappointed by LL's year-end report due in early February. I think we're going to see another disappointing quarter with more discounting, lower margins and terrible comp sales yet again. We have absolutely no reason to think that the fourth quarter will be strong for LL after its seasonally stronger quarters in 2014 have been terrible. Nothing has changed with LL except the price.
Analysts are blindly forecasting 11%+ sales growth for next year; LL is only growing the top line this year because of new stores. Otherwise, the -5% comp sales would have dragged total revenue down. Would analysts have us believe LL will somehow reverse the string of awful comps and add another 7% of revenue growth on top of that? If you believe that will happen, please, buy the stock; but I don't. The industry trends that drove LL to $120 have long disappeared and LL is just another retailer again.
Even if you believe analysts' estimates for EPS of $3 next year (which I don't), LL is still trading for 22 times forward earnings. Why does this company deserve that multiple? Why does a company that is less productive (negative comp sales and lower margins) get a premium multiple? This is the same thing that happened on the way up with LL trading for 40 times earnings as it was boosted by analysts pumping the stock but although the earnings multiple is much lower this time, it's nearly as ludicrous.
The bottom line on LL is that demand will continue to prove the stock to be too expensive. For whatever reason, investors love to bid this thing up in between quarters. The problem is the day of reckoning always comes every three months and this time around, I don't think it will be any different. Look for LL to continue to post disappointing comp sales and most telling of all, margins. Margins will be the tell that shows LL has turned the corner because as long as it needs to discount to move product, the stock should continue to fall. LL's business model doesn't support a $65 stock price unless margins are ever-expanding so that's what you should be watching when the company reports in February. Until then, I'll make the prediction that LL shares will be trading under $65 after the company reports fourth quarter earnings because nothing has changed.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.