La-Z-Boy: Time To Spend Some Cash

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About: La-Z-Boy Incorporated (LZB)
by: Timothy Shumsky
Summary

La-Z-Boy stock was hurt when a change of directors was announced last August, coupled with margin shrinking later that month.

Possible changes in housing trends could send the stock price higher.

Margin convergence with the rest of the industry.

La-Z-Boy (NYSE:LZB) is currently operating in an industry that has lagged behind the growing economy. The company seemingly benefits from both ends of the business cycle: peak and contraction. The company benefits from new home sales through outfitting new homes with decor. Home sales are typically strong during the peak of the business cycle, which this company benefits from. LA-Z-Boy can also be seen as defensive because demand for home furniture is typically seen as a necessity and thus is very inelastic. This is why it may perform well during a contraction.

August Price Shocks

Looking at the technicals of the company over the past year, a point in August really jumps out. August 22nd saw the stock price fall from $31.25 to $24.95 - this represents a huge 25.25% decrease in price. This was due to margins shrinking in the upholstery segment. This news was also on the back of a change in director announcement just 8 days prior, which caused a huge near-5% drop. The drop 8 days prior meant that the margins announcement came during downward momentum. After reviewing this data, it is hard to assume there was not an overreaction. La-Z-Boy is a seasonal company, and it has struggled historically at this time. Couple this with the fact that it is now trying to deploy capital into the retail segment, which will obviously yield smaller margins, and the only explanation is an overreaction.

A final note is that although margins have returned to historic levels in the most recent earnings call, the price has certainly not; this again indicates that there was an overreaction in August and the stock is now mispriced.

Tax Implications

Companies that are very sensitive to margins are often also sensitive to taxes. This makes sense, as taxes are a huge factor when looking at differences between operating margins and net margins. The company’s effective tax rate for continuing operations for 2017 was 33.5%. It has also been accumulating deferred tax assets over the years. La-Z-Boy currently has $40.1 million in deferred tax assets on its balance sheet. This is amount of differed tax assets is material, as it represents 42.7% of last year’s net income.

Due to the new legislation, it can be assumed that La-Z-Boy's U.S. divisions will face a 21% corporate tax rate. The company currently uses a straight-line depreciation model for its property, plant, and equipment, as stated in its 10K. Although it was hard to find what type of depreciation method La-Z-Boy used for taxes, it can be assumed the company uses a more aggressive model because of its ability to amass deferred tax assets.

La-Z-Boy currently gets 88% of its revenue from the US, 7% from Canada, and 5% from "Other". Assuming the "Other" segment of its revenues is a combination of mainly UK and Ireland, a weighted average of tax rates, if the revenue breakdown were to hold, would be 12.1225%. This tax breakdown seems aggressive, so 22% was used to be slightly more conservative. The assumption is the company would not use any of its deferred tax assets in the model, although using them would lower its tax rate further.

Created by author using Bloomberg Terminal

(Source: Created by author using Bloomberg terminal)

Source: Created by author using Excel

(Source: Created by author using Excel)

Economic Data Ratio

The country has recently undergone significant growth. This growth is showcased in economic data. Data like unemployment rates being down over the past six months and wages being up indicate that growth has certainly had an impact. One piece of data that seems to be lagging is the housing market. New housing starts have just not followed in the success of wage growth and unemployment. This trend is odd, because as people received more money, an assumption can be made that they will either buy their first home or upgrade their current housing situation. Another perplexing reason why housing should have risen is due to the fact that unemployment rates have decreased in targeted age groups of 25-34 and 25-44; these are the precise age groups that would be buying their first house and upgrading from a starter home or a rental respectively.

Although housing has been lagging, there may be critics who believe that it will not improve anytime soon due to expected interest rate increases with increases in inflation. A counter to this claim could be that interest rates have been unprecedentedly low recently and a basic economics concept may apply: when something is very cheap or a small piece of a relatively larger income, buyers' demand will become more elastic. For these reasons, the housing market may see a boost. New houses should equate to more sales for a company that furnishes homes.

(Source: Created by author using Excel; Data from Bloomberg)

(Source: Created by author using Excel; Data from Bloomberg)

(Source: Created by author using Excel; Data from Bloomberg)

(Source: Created by author using Excel; Data from Bloomberg)

Multiples Model

Looking at the multiples, it was important to find peers that had similar operations as La-Z-Boy. To do this, the most important idea was that their segment must match, or at least serve as a proxy for, the segments of La-Z-Boy. To find reasonable competitors, it was essential to look for companies that had very efficient operations within the upholstery market. Efficiency was key, as La-Z-Boy had moved a lot of manufacturing to China and Thailand in order to achieve greater efficiency.

Next was tackling the idea of case goods being a very high-margin area which does not seem to be in maturity yet; because of this, the belief is that the company will begin to converge as it starts to reach maturity. Converging with competitors in the case goods section is the reason that Masco Corp. (NYSE:MAS) was added. Culp Inc. (NYSE:CULP) and Hooker Furniture Corp. (NASDAQ:HOFT) serve as upholstery proxies; and Masonite International Corp. (NYSE:DOOR) was added because it operates in a relatively similar space with a similar market cap, so there isn’t much market cap bias here. In comparison with its peers, La-Z-Boy looks cheap in each of the four categories selected in this multiples valuation.

(Source: Created by author using Bloomberg terminal)

DuPont Analysis

(Source: Created by author using Excel)

Looking at a company against its peers is a great way to see whether it has room for growth. A company underperforming its market can often converge with market averages when reaching maturity. A DuPont analysis is a great way to see La-Z-Boy against said peers. Using an extended DuPont analysis to look at net profit margin, La-Z-Boy looks to currently have an ROE of 14.65% over the LTM.

(Source: Created by author using Excel)

Looking at its competitor Culp Inc., it is clear that La-Z-Boy is outperforming the company, specifically in terms of asset turnover. The place where Culp is doing better than La-Z-Boy is in net profit margin. To address net profit margin, it has been broken down further. Upon further inspection, it is clear that Culp benefits from a lower tax burden and a greater operating margin. It would not be unreasonable to say that the tax benefits before could address some of the shortcomings. It is also not unreasonable to assume that La-Z-Boy could converge with these margins in the future.

(Source: Created by author using Excel)

When looking at a case goods competitor, Masco, it is clear Masco has much better margins. Looking at Masco serves the purpose of seeing what would happen if La-Z-Boy decided to inject some of its cash into this segment. The story is much the same - La-Z-Boy falls short in net profit margin. The difference here is that net profit margin is far higher, and that this entirely comes from a much better operating margin.

(Source: Created by author using Excel)

Assuming that La-Z-Boy is able to converge with competitors in the upholstery segment in both margins and tax burden, it would be able to achieve a very high ROE. If the company decides to inject some of its cash into the case goods segment, a huge increase in margins may be seen. The ROE would become very high - far higher than that shown below.

(Source: Created by author using Excel)

Excess Liquidity

After 2008’s meltdown, La-Z-Boy decided to follow the path shown by many companies, especially those in the retail sector, and unlever its balance sheet. This was received with open arms initially, but as time progressed, the company has gone from reducing leverage to stockpiling cash. Although this is good in the sense that it gives investors a sense of security, at some point the company will have to use this cash.

La-Z-Boy is dominating the upholstery industry, so this may not be a great use of its cash, and the company has also been slowly purchasing its franchisees to gain a larger presence in retail. Although it has been repurchasing franchisees, this has not dramatically dwindled its cash holdings; actually, La-Z-Boy has increased its cash holdings while doing this over the past 3 years. The company seemingly has only one option - to deploy cash into the case goods industry, a segment that does not seem to be in maturity yet.

(Source: Investor Presentation)

Case Goods

La-Z-Boy has capital it must deploy, and the only feasible option seems to be in its case goods segment. The proxy chosen here is Masco. More specifically, Masco’s decorative architectural products and cabinetry segment, as these seem to be the best fit to what La-Z-Boy has or can add to its market line. Taking a weighted average of the two segments based off sales means that the proxy segment could have an operating margin of 15.73%.

Let's assume asset turnover holds and the company uses 70.42% of current cash holdings, $100 million, as capex injection into the case goods segment. With capital injection of this magnitude, the company may come close to converging with its competitor Masco with regard to operating margins. This segment should grow to $287.1 million, holding asset turnover constant. The segment should also have an operating margin of 15.73% if it were to converge with the weighted average of Masco's two proxy segments. Assuming the other two segments grow at a rate of 2%, which is near GDP growth, meaning they would be at maturity and also very conservative, the company would have a weighted average operating margin of 9.863%. This would impute a 1-year target of $36.33, according to the pro forma used.

Conclusion

La-Z-Boy is currently cash-rich and has the ability to dump it into an industry that currently holds greater margins than its upholstery segment. The company seems cheap on a multiples valuation standpoint. There looks to be some added benefit from economic data in the future, and this should boost revenues (these boosts were not added into the model due to conservatism). The company also looks as though there have been a couple of over-reactions. This, paired with thin volume, seems to have resulted in mispricings.

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.