Lumber Liquidators: The Impact Of 25% Tariffs

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

Lumber Liquidators performed as expected in Q1 2019.

25% tariffs may add another 300 basis points of margin headwinds though.

This will probably only modestly affect 2019 results, but could push its 2020 adjusted operating margins down to 0% if the tariffs continue throughout 2020.

The company can probably at least operate at neutral cash flow in such a scenario.

Lumber Liquidators could benefit in the long run by becoming leaner and more efficient as a result of the tariffs, assuming they are eventually removed.

Lumber Liquidators (LL) reported Q1 2019 results that were around what was expected. However, the escalating trade war with China and the implementation of the 25% tariff rate on Chinese-made flooring have served to significantly weigh on the stock in recent days.

Q1 2019 Performance

Lumber Liquidators' Q1 2019 performance was largely as expected. The company reported -0.8% comps during the quarter and left its full-year guidance for flat to low-single digits comps growth (and mid-single digits total sales growth) intact. Lumber Liquidators' Q1 2018 sales benefited from the Hurricane Irma and Harvey rebuilding efforts, so Q1 is probably the toughest year-over-year comparison of any of the quarters this year.

I continue to expect that Lumber Liquidators will report somewhere around +0% to +1% comps growth during 2019. Getting to +1% for the full year would require it to deliver around +1.6% comps during the last three quarters of 2019.

As well, the company reported adjusted gross margins of 35.2% during the quarter, along with an adjusted operating loss of $1.1 million. This was slightly better than its guidance for 34.5-35.0% adjusted gross margins and an adjusted operating loss of $3-5 million.

Tariffs And 2019 Outlook

My outlook is for Lumber Liquidators to deliver around $42 million in Adjusted EBITDA and approximately $20 million in positive cash flow (excluding legal settlements and working capital changes) in 2019, assuming the 10% tariff rate remains unchanged.

While the trade war has escalated and there is now a 25% tariff rate on Chinese flooring, this may not affect the company's 2019 results that much. Lumber Liquidators is working down its inventory a bit, after starting the year with elevated inventory levels due to the previous threat of the 25% tariffs potentially starting on January 1st. As well, shipments that have already left China will be only subject to the 10% tariff rate, while there is still around five weeks of time for negotiations before the shipments leaving China following the increase to a 25% tariffs rate reach the US.

If the 25% tariff rate remains in place for a while, Lumber Liquidators will likely see its margins take a significant hit though. The impact to margins in Q1 2019 from the 10% tariff rate was said to be around 200 basis points. Thus, the full impact of a 25% tariff rate may be another 300 basis points.

This could reduce the company's adjusted operating margins down to around 0% with a full year of impact from 25% tariffs. Lumber Liquidators is currently projecting adjusted operating margins of 1.9-2.4% with a 10% tariff rate, so if it is able to mitigate the impact of the increased tariffs by an additional 100 basis points, it would still only get to around 0% adjusted operating margins after subtracting 300 basis points for the impact of a move from 10% to 25% tariffs. That would the company's adjusted EBITDA at around $19 million and probably fairly close to breakeven cash flow.

Growth Expectations

I think it would be reasonable to say that Lumber Liquidators is unlikely to repeat the frenetic double-digits comparable store sales growth that it displayed six or seven years ago.

By 2014, Lumber Liquidators had already hit a bit of a rough patch, with comps down -4.3%. The negative publicity surrounding Chinese laminate flooring in March 2015 dealt a significant blow to Lumber Liquidators' sales and brand, and the company has found it challenging to rebuild sales after suffering that brand damage.

2012 2013 2014 2015 2016 2017 2018
11.4% 15.8% -4.3% -11.1% -4.6% 4.5% 2.6%

A couple years ago, I had generally assumed that Lumber Liquidators could achieve low-single digit merchandise comps growth as it recovered. Growth has been a bit slower than that assumption, as whatever growth it has achieved has mostly been from services.

Conclusion

Lumber Liquidators' recent business performance has been around what was expected, so I would reiterate my estimate that it is worth around $11.50 per share with 10% tariffs. The 25% tariff rate could reduce the company's adjusted operating margins down to 0% if it lasts for a quite prolonged period, and that could push the stock down into the single digits.

I'd probably consider taking a position in Lumber Liquidators if it fell to around $9, based on the assumption that the tariff issue will eventually be resolved and that the company appears able to operate at least around neutral cash flow even with 25% tariffs. Then, when the tariff issue is eventually resolved, Lumber Liquidators should be a pretty lean and efficient company.

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.