Lumber Liquidators Now Appears Modestly Undervalued Even With Tariff Risk
Summary
- Lumber Liquidators has dropped to its lowest closing share price since March 2016.
- While tariffs remain a risk, the delay in implementation of the 25% tariff rate offers some hope.
- The company is in good financial shape with only a modest amount of debt, and should be able to deliver positive cash flow in 2019 even with increased tariffs.
- It has an estimated value of $13 per share with a tariff increase, and could be worth several dollars more if a deal is reached.
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With Lumber Liquidators (NYSE:LL) falling to its lowest closing share price since March 2016, it now appears to have some decent upside, despite the challenges it still faces with tariffs and sluggish comparable store sales growth.
Although the tariff issue is still weighing on the industry, the delay in implementing the 25% tariff rate to allow for additional negotiating time gives some hope. However, even if that doesn't get resolved in 2019, Lumber Liquidators looks to be modestly undervalued based on its current share price and projected 2019 EBITDA.
The Issue Of Tariffs
The tariff on imports of various Chinese goods (affecting flooring) was expected to rise from 10% to 25% on January 1st. This has now been delayed until early March to give time for additional negotiations. While there is still a fair amount of scepticism that a deal will get done within that window, the odds of an agreement have increased modestly.
Even if the 25% tariff rate goes into effect, Lumber Liquidators should be in good shape to mitigate much of the impact. SA author Donovan Royal mentioned in his article that his sources indicated that the company was quite proactive in dealing with the 10% tariff rate through negotiations with vendors, while he also noted its ability to source hardwood from other countries if needed.
I am keeping my estimated value of $13 per share for Lumber Liquidators, which is probably a bit on the conservative side, as it assumes that 25% tariffs are imposed on its Chinese imports in 2019. If a deal is reached and the tariffs are eliminated, then the company should have several additional dollars of value per share.
Solid Financial Condition
I had previously projected Lumber Liquidators to end up with approximately $41 million EBITDA in 2019. This incorporates the estimated effect of increased tariffs on its gross margins and comparable store sales. With that level of EBITDA, Lumber Liquidators' current $43 million credit facility borrowings translates into a reasonable 1.0x debt-to-EBITDA ratio. The company had $12 million in cash on hand and $102 million in availability under its credit facility at the end of Q3 2018, so it has plenty of liquidity as well.
If Lumber Liquidators can generate $41 million EBITDA, it may also be able to generate around $15 million in positive cash flow after capital expenditures (at around $20 million per year), interest costs (of $2 million per year) and income taxes (of $4 million per year).
Tepid New Housing Market
I have been using +1% comparable store sales growth in 2019 for Lumber Liquidators in my most recent calculations. This assumes a slowdown in comps by a couple percent compared to 2018 levels, due to the potential impact of increased tariffs combined with a sluggish housing market.
US new home sales fell below expectations in October and ended up at the weakest level in two and a half years. The general expectation is for new housing construction to show little growth in 2019 as well. That being said, the company notes that the forecasts for remodelling activity appear to be strong still, which can drive flooring industry growth despite the lack of new housing-related growth.
Conclusion
Lumber Liquidators is in a fairly healthy state at the moment. It has plenty of liquidity and only a modest amount of debt. If the company can grow comps by +1% in 2019 and keep gross margins at around current levels, it should be able to generate around $41 million EBITDA in 2019. This would result in around $15 million in positive cash flow and an estimated value of $13 per share. If the tariff issue gets resolved, the company should be able to do better on both gross margins and comps, helping push its value up by several more dollars per share.
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