For Lumber Liquidators, The Storm Is Over

| About: Lumber Liquidators (LL)
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Summary

The company has set out its recovery plan going into 2017.

A new emphasis on compliance will reassure investors and customers.

A long position on this stock will be fruitful in the long run.

Investment Thesis

Lumber Liquidators seems to have undergone baptism by fire through a damaging lawsuit. Key changes including staff reshuffles will go a long way in reclaiming lost ground. A sufficient financial and customer base gives it a big advantage in its quest for better returns in 2017.

Lumber Liquidators (NYSE: LL) is a Virginia-based importer and distributor of hardwood flooring materials. It has grown over 23 years to be one of the largest hardwood retailers in the US with operations in more than 47 states, and Canada. Its range of products include laminate, vinyl plank, engineered hardwood, domestic hardwood, bamboo and cork.

Brief Industry View

The lumbering industry is largely dependent on several factors. One is availability of raw materials. Harvesting of hardwood is dependent on prevailing weather conditions which affect the quality of the product. In the US, there is a growing trend towards domestic species of wood.

Construction of new homes has led to a high demand for hardwood, which is the most popular flooring material due to its durability and quality. As home values continue to grow, the ripple effect is also felt across the lumbering industry which records higher demand and accrued revenues.

Being a market leader in laminate and hardwood flooring solutions, LL is in a tight spot to nurture positive customer and investor sentiment while still maintaining a grip on its market share.

In 2013 through to 2015, LL was embroiled in a number of court cases such as non-compliance to legal sourcing practices which violated the Lacey Act. The negative coverage led to LL losing around 20% of its stock value. In 2015, LL was put under investigation for allegedly importing Chinese flooring with unhealthy levels of carcinogenic formaldehyde. Widespread panic among consumers and negative media coverage saw a sharp drop in sales and a fallout in management of the company. To put into perspective, LL suffered a loss of $32.4 million, more than four times the previous year's loss of $7.8 million. Expenses rose 20% to $117.2 million, due to associated legal and professional penalties associated with the lawsuit.

In Q3 2016, gross margin climbed by 30 basis points to 31.4%, as a result of new products and reduced discounting in the solid lines. SG&A expense was $100.7 million against the previous year-ago quarter of $88.3 million. The higher figure was attributed to approximately $11.2 million associated with settling the class action suit and internal changes aimed at complying with industry regulations and legal policy. Heavier advertising further drove up costs by $3.5 million. Net sales increased 3.4% to $244.1 million despite a weaker range of products and reduced promotional emphasis.

In 2016, the company was still feeling the after-effects of the tumultuous legal woes of 2015. Despite the relief of not having to recall the untested Chinese laminate flooring, the financial outlook was dampened for the rest of the year as the company was barred from further selling of the laminated flooring that was still in stock. There was a slight uptick in quarterly sales in October, but this could not offset the expenses incurred in the legal settlements facing LL.

LL Price to Book is 1.9 against an industry average of 17.0. It has a debt to equity ratio of 0.1 against an average of 2.9. The stock has oscillated between lows of 10.01 to 20.10 within a 52-week range, with a market cap of $424.25M.

The earnings call reflected a company that is optimistic about recovery and reclaiming its lost luster. The structure and organization of LL will not suffer adverse effects, and appropriate changes are already in place to ensure quick recovery. There is focus on managing operations to maximize sales in the subsequent quarters.

There has been significant investment in compliance with sourcing processes and finance. Investments will be pursued side by side with optimizing the business model to steer back LL into a positive trajectory. In addition, LL is on a drive to build liquidity to navigate it out of the financial troubles inflicted by the court cases.

With legal claims already done with, LL has already shed its baggage and is ready for flight. With a share price of $15.56, I believe lumber is all set to record higher earnings beginning 2017. The bustling housing market will also set the stage for higher revenues for LL, translating to better paydays for investors. I therefore call a long position on this stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.