Hooker Furniture: A Good Play On Easing Chinese Tensions

|
About: Hooker Furniture Corporation (HOFT)
by: WY Capital
Summary

HOFT has been hit hard recently by poor macroeconomic conditions.

However, these conditions should improve in the medium to long term.

Management is conservative and the company pays a decent dividend.

Insider buying has been frequent since the price dropped.

Hooker Furniture (HOFT) hasn't done very well this year. In fact, the stock hasn't been this low since 2016. Rising trade fears, along with soft demand, have dented sales and profits, causing HOFT to fall over 60% from its all-time highs. However, we believe that easing trade fears and improving macroeconomic conditions, along with HOFT's own diversification efforts away from China, should lead to a rebound in the stock in the future.

Business Model

HOFT is one of the largest suppliers of furniture in the US and it has been designing, marketing, and importing furniture for 95 years now. It operates in three segments: Hooker Branded, Home Meridian, and All Other.

Investor presentation

Home furnishings is a cyclical industry, booming when the economy is doing well but declining when the economy is doing poorly. The industry is also seasonal, with sales typically peaking in Q4. Do note that HOFT's fiscal year is one year ahead of the current year, which means the current quarter is Q3 2020.

FRED

Hooker has made several acquisitions over the years, including HMI in 2016 for $85 million in cash and $15 million in stock. It acquired Shenandoah in September 2017 for $32 million in cash and $8 million in stock. These acquisitions have allowed sales to reach nearly $700 million in 2018.

Opportunity

In the past, HOFT had been profitable. In fact, it made over $3 in EPS in 2018. However, in 2019, the macroeconomic situation got worse. Demand slowed unexpectedly in the first quarter and tariffs were passed. HOFT was very vulnerable to tariffs as 40% of its products came from China in 2018 (fiscal 2019).

As of February 2019, Hooker Furniture Corporation imported over 40% of our product line from China.

Earnings call

However, the share of products coming from China is projected to decline to 20% by the end of 2019 as HOFT moves production to Vietnam and Malaysia. Although moving all product out of China isn’t feasible, Hooker is receiving price concessions and raising prices to customers as needed to maintain margins.

Demand was also unexpectedly low at the beginning of the year, which management blamed on a the collapse of the stock market during December, the government shutdown, and retailers being over-inventoried. However, management has also noted that demand ticked up in July moving into the fall selling season, which traditionally has been the strongest season for furniture sales.

A large quality chargeback in Q1 also led to a substantial decline in earnings for that quarter, but with the chargeback over, earnings have recovered somewhat.

We believe Wall Street has punished HOFT for poor short-term results despite the fact that results are likely to improve after just one to two quarters. This is an opportunity for more patient investors to reap profits as HOFT's results recover in the mid to long term. The poor short-term results also hide the fruits of management's diversification initiatives, which have helped the company become better able to grow.

We also believe that further upside can be unlocked if a trade deal with China is reached, which seems more likely as trade tensions continue to ease. This would benefit HOFT in two ways: Tariffs will either stay flat or may decline, and consumer sentiment should improve, which should improve sales and margins for HOFT.

Recession testing

Hooker is more susceptible to the economic cycle; therefore, we decided to look at what happened to Hooker during the 2008 financial crisis.

2010 10K

As you can see, operating earnings excluding one-time charges fell around 80% to bottom out around $5.8 million despite a recession. Hooker now has nearly $700 million in sales, and if that declines by 32%, that would lead to around $464 million in revenues. Hooker also made $55 million in operating profit, which could decline by 80% to around $10 million. This shows that HOFT will likely remain somewhat profitable even in a recession.

Hooker’s liquidity is good. The dividend only uses up around $7.2 million per year, which is decently covered by even trough earnings. We believe Hooker has little risk of bankruptcy.

Management

Management has historically been very conservative. The valuations they have paid for companies like Home Meridian or Shenandoah have been fairly low. For example, they paid ~5x 2018 operating earnings for Home Meridian and they have elected to use cash to pay down debt in recent years instead of further leveraging their balance sheet.

Currently, the company has just $28 million of debt, which is covered by an equivalent amount of cash and cash equivalents.

It is also worth noting that management has been heavily buying shares since the stock has declined below $34. This is a notable change in behavior as management had been selling shares above the $40 level from mid to late 2018.

insiderinsights

Although the conservative management does limit upside (as management isn't aggressively pursuing growth), it also significantly limits downside, which we find to be quite important for a cyclical company like HOFT.

Valuation

HOFT currently trades at around 10x estimated 2019 (or fiscal 2020) earnings, which we find to be quite low, considering earnings growth back to the 2018 level is likely going to happen in the next three to five years, whether this trade situation is resolved or not. HOFT currently trades at around 6x 2018 earnings.

It does help that HOFT pays a small but well covered dividend, which currently yields 3%. As our recession testing shows, the dividend would likely be covered even in a recession scenario.

seekingalpha

Conclusion

Overall, HOFT is an attractive value opportunity, with potential for decent upside in the short term as demand improves and the trade situation eases. The low valuation and conservative management help reduce potential downside, and the well covered dividend is an additional bonus for long-term investors.

Disclosure: I am/we are long HOFT. 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.