Lumber Liquidators Clears Up Its Legal Issues

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About: Lumber Liquidators Holdings, Inc. (LL)
by: Elephant Analytics
Summary

Lumber Liquidators has reached an agreement with the DOJ/SEC/US Attorney's Office related to an 8-K filing from March 2015.

It's paying $33 million as part of the settlement, which removes the last major legal overhang.

Various legal settlements have driven up Lumber Liquidators' debt, although it remains at a manageable level.

Focus will now turn to whether Lumber Liquidators can drive merchandise comps growth and maintain its margins in 2019.

Lumber Liquidators (LL) has settled what appears to be its last major legal issue related to its Chinese laminate flooring crisis from a few years ago. This settlement will cost Lumber Liquidators $33 million, but clears up the US Attorney's Office, DOJ and SEC investigations into Lumber Liquidators' actions at that time.

Lumber Liquidators will have significantly increased debt as a result of the various legal settlement payments, but its debt remains at a manageable level. Its focus will need to be on managing its gross margins amidst the Chinese tariffs issues as well as attempting to drive merchandise comps growth.

The Settlement

Lumber Liquidators has reached a resolution with various governmental entities with respect to the investigation into its compliance with securities laws related to its sourcing of Chinese laminate flooring. The 8-K filing that was being investigated involved Lumber Liquidators' response to the 60 Minutes story and was from before current senior management joined Lumber Liquidators.

In that filing, Lumber Liquidators indicated that its products were CARB compliant, but the investigation indicated that Lumber Liquidators appeared to know that at least one of its suppliers was likely producing non-CARB compliant products.

As part of the settlement, Lumber Liquidators is paying a $19.1 million fine and has agreed to restitution of $13.9 million, for a total of $33 million. Lumber Liquidators also mentioned that "neither the DOJ nor the SEC made any findings regarding the safety or quality of the Company's laminate flooring previously sourced from China."

While fairly costly, the settlement removes the remaining overhang of legal issues on Lumber Liquidators.

Questions About 2019 Outlook

Lumber Liquidators is set to report its Q4 2018 earnings on March 18. It also should release its 2019 outlook at that time. With Lumber Liquidators trading at around $10 per share now, expectations don't appear to be that high.

I'm looking for some more details about how the still unresolved issue of Chinese tariffs may affect Lumber Liquidators' gross margins. I have assumed that Lumber Liquidators can still generate around 35.8% gross margins in 2019 with tariffs in place, having worked to mitigate much of the impact of the tariffs. This would result in Lumber Liquidators generating around 2% operating margins.

I also assumed that Lumber Liquidators can generate slight comparable store sales growth (such as +1%) in 2019. Comparable store sales growth is expected to slow in 2019 as Lumber Liquidators

If Lumber Liquidators meets those above expectations, I'd estimate its value at around $12. A meaningful variation in growth and/or margin expectations would shift its value. For example, a 1% change in operating margins would change its projected value by $3 to $4 per share.

Liquidity And Debt

While Lumber Liquidators has historically had plenty of liquidity and relatively low debt, the various settlement payments have significantly affected those items. Between the cash portion of the MDL settlement and this new settlement, Lumber Liquidators owes around $55 million. This could push its credit facility borrowings to around $90 million depending on how its inventory levels change.

Lumber Liquidators would still have around $65 million in liquidity in this scenario, while its leverage could rise above 2x EBITDA. Lumber Liquidators is still in pretty reasonable shape by those metrics, but will need to carefully manage its expansion plans.

With a $15 million capital expenditure budget, Lumber Liquidators may be able to reduce its credit facility borrowings to around $75 million by the end of 2019, assuming 1% comps and 2% operating margins along with no significant change in working capital items.

Conclusion

The settlement of the SEC/DOJ/US Attorney's Office issue takes care of the last major remaining legal issue that was hanging over Lumber Liquidators. The settlement of those issues has come at a significant cost though and could push its credit facility borrowings up to $90 million and its leverage above 2x.

Lumber Liquidators also is attempting to mitigate the gross margin impact of the tariffs on Chinese flooring and trying to boost its tepid merchandise comps growth. Despite those issues, Lumber Liquidators should be able to gradually reduce its credit facility borrowings and improve its financial shape though, as it should be able to generate a decent amount of positive cash flow (excluding the legal settlement payments) if it keeps its capital expenditure budget modest. I estimate Lumber Liquidators' value at $12 per share at the moment, although this may change with the additional information from its Q4 2018 earnings call.

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.