Stanley Furniture Q4 Update - Operational Issues Continue, Turnaround Is Uncertain And Will Take Time

| About: Stanley Furniture (STLY)

Summary

This troubled furniture manufacturer is still nowhere near having stable operations and the ability to break even.

The company continues to struggle with the manufacturing process in Vietnam. This might have a severe long-term impact on the roll-out of the new brand and its value.

The management offered little to assuage the fears, although the activist group increased their ownership and got another person onto the board of STLY.

This is though not enough to show that at the current prices the stock presents an opportunity to participate in the turnaround.

My initial thesis of Stanley Furniture (STLY) can be seen here. The previous quarterly update can be seen here.

I believed that investors should avoid this company due to the following points:

  • STLY has recently announced a cash dividend, which distributed a large portion of the shareholder value that the stock was worth buying for.

  • Now the company faces uncertain future as its business is struggling to break even and is still supported by a governmental subsidy, which is currently under review.

  • The valuation is not offering enough downside protection to these uncertainties and therefore it is best to avoid STLY until at least the subsidy issue is resolved.

  • That being said there is a group of activists revolving around the management, which could try to change the status-quo, possibly through exploring a sale of the business.

I believe that the thesis continues to hold as the Q4 results showcased that the operational loss widened and that they continued to struggle with the ramp-up of new production which could significantly hurt the brand value.

Share price reaction

Q4price.png

As you can see the share price was not significantly impacted by the results on the 23rd of February. Despite the prolonged negative results, the price action might be reasonable as investors were likely not expecting much.

The reason behind the negative results was almost identical to that of Q3 (when the share price plummeted). The revenue has dropped due to issues related to capacity and manufacturing constraints in Vietnam, the gross margin was also impacted by this and by discounting of products that were not tied to the Vietnam production. This led to a loss, build up of inventory and increasingly negative operational cash flow.

The management was not entirely clear about when will the Vietnam issue fully subside, but said that in 2017 STLY should see growth. While the short-term rebound might occur, I believe that the longer the production issue is going to be present the harder it is going to be for STLY to promote its new product line, the brand value of which might now be severely impaired. This could then hurt the long-term prospects of the business.

That being said the Hale-Talanta activist group had reached an agreement with the management and appointed Mr. Hale onto the board of directors. The shareholder group also increased their stake in the business which is positive. Another positive point is that the sunset review of the CSDOA subsidy which significantly improved STLY’s operations in past was kept in place which could help the losses going forward.

Although these points are certainly not enough to justify buying STLY at these prices as the valuation is not showcasing much margin of safety given the fact that NCAV value is now mostly consisting of inventory after the two special cash dividends.

Continuous Loss & Production Issues

As mentioned, the manufacturing issue continued to weigh on the revenue stream which ended up decreasing 22% for the year compared to FY2015. This issue also hit gross margin which ended up 5% lower. The margin was also impacted by discounting which certainly does not help the operations going forward. These negative factors then brought the company to a $5 million loss even including the anti-dumping subsidy (CSDOA) which was $1.1 million for that year which as mentioned will keep on supporting the business going forward.

The management mentioned that they are going to continue sourcing products from Starwood (the Vietnamese manufacturer) but that in the meantime they will rely on other third-party vendors to fill the gap that the issue caused. They said that by Q2 of FY2017 the company should start seeing improved operational results.

Another positive fact is that the company reached a new agreement with the Hale-Talanta activist group which allowed them to increase their stake (despite the rights agreement adopted by STLY prior to that) and appoint Mr. Steven Hale to the board of directors. The group did not mention what they want to do regarding STLY's operations but the fact that they have bought more of the stock could be a sign that they believe there is some value here.

Valuation & Cash Flow

What one could think of as an additional positive point is the current situation regarding the company’s balance sheet as you can see below that the NCAV value is now above the market capitalization.

Q4ncav.png

I believe though that this is not likely to showcase meaningful margin of safety as most of the value currently resides in inventory which has been piling up in the past few quarters (in Q4 it increased by $1.61 million to $22.9 million). I do not believe that this is liquid as one could expect due to the manufacturing issues and due to the possible impact of this on the brand.

One should also point out that the operational cash flow significantly declined in Q4 by roughly $1.5 million to -$2.5 million. I believe that the company might start to struggle to sustain their liquidity if the turnaround is not going to occur soon as the credit line might help the company in the short-term but unless they start selling some of the inventory it might be hard to create enough operational cash.

Conclusion

I believe that it is still better to be on sidelines. Last quarter showed that the company is going to have to go through a prolonged turnaround which is currently mired in significant operational challenges.

While the activist group should ensure that the business is going to create shareholder value in the end, the current valuation is not showcasing enough margin of safety that would offset the long-term nature of this possibility.

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. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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Tagged: , Home Furnishings & Fixtures, Earnings
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