Kimball Investors Looking For Signs Of A Cyclical Ramp

Summary

• Kimball should have a weak Q3 due to the delay in big companies bringing workers back to the office (especially in major cities) and high freight costs.
• Work from home will eventually transition back to work in the office. Education will come back to the classroom. Furniture demand in those end markets will increase.
• Leisure travel is already nearly back to 2019 levels. Corporate travel still has room to improve. Kimball's Hospitality business should recover soon.
• I reviewed why Kimball has the highest ROIC in the industry.
• I detailed the Poppin acquisition and the positive comments on it from the firm's former COO/President.

Photo by Spiderplay/iStock via Getty Images

Another Weak Quarter Coming For Kimball

In this article, I will discuss some of the intra-quarter trends seen in Kimball International’s (KBAL) end markets, updates on Poppin, the future trajectory of the company as discussed in its recent virtual conference on March 25^th, and a recent ex-COO interview. I expect fiscal Q3, which will be reported in early May, to be another weak quarter given the delayed recovery in corporations bringing workers back to the office. Furthermore, the company will be hit hard by the spike in ocean freight costs. Those costs will be alleviated within the next few quarters when the supply chain normalizes.

Specifically, analysts only expect Kimball to earn 4 cents in Q3 which should be the trough for the cycle. Sales are expected to increase slightly from $136.2 million to $142.35 million. I view any increase (without including Poppin) as a positive. I’m most looking forward to orders recovering. I think Hospitality orders will increase from last quarter.

The sharp improvement in profitability should come in fiscal year 2022. Analysts expect EPS to rise from 47 cents to 79 cents. I think the company could do even better than that given its great cost cutting and expansion into new markets. I expect the stock to recover to the low $20s (where it was before the pandemic started) once we get the ‘all clear’ sign that the cyclical recovery is well underway. I think we are 1-2 quarters away from seeing such a ramp in the stock price.

Work From Home Falls

Kimball is an omnichannel company now that it has acquired Poppin. However, it is still mostly a business-to-business company. It doesn’t want to lower its commercial grade quality to meet the business to consumer market which has lower margins. Through Poppin and Etc., Kimball is implementing work from home sponsorship programs with larger companies in which employees purchase furniture for their work from home spaces with corporate dollars.

Kimball advertises its work from home capabilities on its Instagram accounts because mostly consumers follow them there. However, at its core Kimball is a B2B office furniture business. Poppin’s e-business is just an alternative way to acquire customers and deliver products (drop shipping).

Kimball needs fewer people to work from home for its Workplace business to get back to normal. That looks like a 2^nd half 2021 story since Bloomberg projects America will achieve a 75% vaccination rate in 4 months. However, the early signs of improvement are here. As you can see from the chart below, Indeed shows the percentage of people teleworking/working from home because of the pandemic fell 2 points to 21% in March.

There was a 2-month reversal of the trend of fewer people working from home late last year because of the 3^rd wave of the virus. Now with the vaccines going out, the trend of people going back to the office has re-emerged.

Source: Indeed

Kastle Systems shows the 10 city average return to work barometer has been hovering in the mid-20% range in March. This relates to Kimball’s point that big cities have been weaker than secondary markets. In Q2, secondary markets had a 20% jump in order rates compared to the 3% jump in major markets. 56% of Kimball Health and Workplace sales are in secondary markets. Kimball is working on expanding Poppin’s footprint to these secondary markets.

I think we need to see the CDC give the ‘all clear sign’ for big businesses to bring people back to the office. They don’t want to face the liability risk of bringing workers back to the office a few months early, especially since this has become the new routine. Once a company sees more productivity from bringing workers back to the office, there will be a cascade effect where all its competitors will come back at once.

This should occur sometime this summer or fall. That’s why Q3 probably won’t be the amazing quarter everyone is looking for to prove Kimball is on a strong recovery trajectory. I’m just looking for a modest sequential sales improvement without Poppin. This will be the first full quarter Poppin is included in the financial results which means there will be an inorganic boost. I think the 10% improvement in Workplace orders in Q2 should lead to modest sequential sales growth in Q3.

Source: Kastle Systems

Big Recovery In Travel For Leisure

I find it interesting that Kimball is saying Hospitality will be the last to recover since most workers in big cities haven’t returned to the office, but leisure travel has rebounded sharply. I’m cautiously optimistic that Hospitality orders will turn around in Q3. It’s hard to get much worse than the 46% sequential decline in Q2. It would be hugely bullish if sales could bottom since this is Kimball’s worst business line. Sales were down 32% sequentially last quarter.

Source: The Daily Shot

We’re seeing reason for optimism in the latest travel data. As you can see from the chart above, TSA traveler throughput is more than half of where it was before the pandemic. Furthermore, a steady uptrend started in February. It looks like TSA throughput will normalize this summer. In fact, American Airlines (AAL) stated ticket sales are 90% of pre-pandemic levels. It is pulling most of its idle aircraft out of storage. I think consumers are planning trips now to get out ahead of the full reopening.

As you can see from the chart below, Bank of America’s (BAC) leisure booking proxy is only 2.1% below where it was in 2019. Corporate travel is down 77.2% which is in line with the weakness in returns to the office in big cities. Corporate travel and returns to the office should come back together within the next few months. We’re just waiting for the government to say travel is safe again after America is 75% vaccinated. The improvement in leisure travel bodes well for my expectation of positive signs from Kimball’s Hospitality segment.

Source: Bank of America

In-Person Education Coming Back

Most investors probably think of commercial office furniture when they think of the Workplace business line, but it also includes financial, government, and education. I discovered in my last article that education dragged down results in the Workplace segment in Q2. Kimball said all other areas (commercial, financial, & government) had a sequential uptick in orders. I’m quite confident most learning will come back to the classroom especially for children. Kids need to learn social skills. Furthermore, young adults in college are spending all that money on tuition to build connections which happen in the classroom and dorm rooms.

I believe education employment is a good proxy for the number of students that are coming back to the classroom. The March labor report showed signs of improvement in this area. Local government education added 76,000 jobs, state government education added 50,000 jobs, and private education added 64,000 jobs. Education should improve for Kimball in Q3. There is still much room for the recovery to continue. Those groups, respectively, are down 594,000 jobs, 270,000 jobs, and 310,000 jobs since February 2020. We might be back to normalcy by this fall.

Poppin Integration

As I mentioned, Q3 will be the first full quarter Poppin is included in Kimball’s results. Last quarter just had a few weeks. Kimball’s number one priority besides having proper inventory for the cyclical turnaround in sales will be the proper integration of Poppin. Poppin’s website had an odd decline in traffic from 130,000 visits to 85,000 in February according to SimilarWeb. I’m working off the assumption that this was a blip unless we see another bad monthly reading.

Kimball plans to open Poppin showrooms in secondary markets like Nashville and Miami to diversify its end markets to match the overall company’s sales. Poppin introduced the Kolo 4 and Kolo 6 PoppinPods which are larger. These are closed rooms within offices so teams can work in private without noise pollution. The Kolo 4 costs $21,998 and the Kolo 6 costs $29,997. The company doesn’t need to sell many of these to have a big impact on the top line.

Source: Poppin

Kimball is going to discuss how it is pushing PoppinPods in its dealer network in its Q3 conference call. Poppin benefits Kimball overall because it is digitally native. 80% of Poppin’s leads start online; 71% of the business is repeat customers. Poppin was severely hurt by the pandemic because it sells furniture to offices in cities. I think that’s why Kimball got a great deal on it. My thesis is the company bought low which is exactly what I like to see in acquisitions.

Besides applying Poppin’s digital capabilities to Kimball International, the firm plans to simplify the buying process on Poppin and add quick ship capabilities. Furthermore, it will utilize Poppin’s drop-ship capabilities across the Health and Workplace end markets.

Since the way employees work might change coming out of the pandemic once they re-enter the workforce, new office layouts and furniture might be needed. My hope is Kimball and Poppin Spaces benefit from office retrofitting in the new office environment following COVID-19. That would be a boon to sales.

Sidoti Virtual Conference Call Comments

Kimball’s CEO and CFO did an interview at Sidoti’s virtual conference on March 25^th. I think the big question investors have is whether the company is giving us an update on how sales are going in Q3 or just rehashing how Q2 went. My guess is the company is explaining how Q2 went. My reasoning is Kimball didn’t give any inclination in one of these conferences last year that it was imminently going to announce an acquisition. They just said they were looking for one.

That’s probably good news because management’s statements weren’t that exciting. They said they saw a pause in orders. They are seeing an increase in activities such as more showroom visits, more mock ups, and more funnels being filled. The company started working on projects that it was working on prior to the pandemic. New workspace strategies are being formed for the new world after the pandemic. We will see how this impacts sales starting in the 2^nd half of this calendar year. I will be disappointed if this exact tone is repeated on the conference call in May. My guess is the tone will be more optimistic given the end market improvements.

The CEO, Kristie Juster, stated Kimball is in a $19 billion market in which it has a 3% market share position. She stated the company needs to make the correct strategy decisions to gain market share. It doesn’t need to rely on the overall industry to grow. Essentially, the company needs to deliver new products to the right growing markets.

It also helps if the new products are better than the competition of course (product market fit). A lot of that involves delivering designs that meet industry trends. The Health business most revolves around meeting certain specifications. I’m most excited about Kimball’s new product launches in its Health business through the Interwoven brand. The image below shows some of Interwoven’s products which utilize its Quickship program which means they ship in 5 days or less.

Source: Kimball

I’m also excited about the new markets Kimball is entering which are senior living, luxury student housing, and multi-family housing. Kimball can develop ancillary furniture (furniture for in-between spaces such as lounges & lobbies) for the multi-family segment. This will be a big growth area as people move back to cities following the pandemic.

There was one piece of commentary I hadn’t heard before this fireside chat. The CFO stated program franchise owners/brand owners were giving buyers a price break on refurbished furniture which hurt Kimball’s sales during the pandemic. This information is becoming less useful as we exit the pandemic. As usual, the juiciest tidbits only come out after they become less relevant.

Margin Compression In Q3

Q3 should be a bad quarter for margins because of increased costs for ocean and trucking freight. Obviously, the Suez Canal was blocked, but I think most of the issues are due to the pandemic. The CFO said Kimball didn’t delay sales due to supply chain delays in raw materials such as seating foam. Hospitality is an asset-light business. 75% of its products are manufactured in Asia. The costs are highly variable. Unfortunately, higher shipping costs due to the pandemic ruined that benefit.

Kimball buys a lot of commodities. The good news is it isn’t concentrated. It doesn’t rely heavily on one commodity. The two commodities management pointed out were steel and aluminum. The company instituted a price increase on March 1^st which means we will see its full effect in Q4. The company is raising prices because of higher labor and materials costs which are more sustainable than high shipping costs. There should be a strong boost in margins in fiscal year 2022 since sales will increase (higher utilization), the price increase will be through, and freight costs should diminish.

Former President/COO Interview: Why Kimball Has A High ROIC

I will analyze a few of the unique insights mentioned in the interview of Kimball’s former President/COO on January 15^th. It gives you a better feel for the company than just reading the annual report.

The three reasons I originally bought Kimball stock were its low valuation (potential COVID-19 recovery), diversified end-markets, and its high ROIC.

Kimball’s former President/COO, who was with the company from 1991 to 2019, discussed why (sign-up required) it has the highest ROIC in the industry. One portion of that was Kimball’s low debt capital structure which is now diminished due to its Poppin acquisition. It has a 0.7 debt to EBITDA ratio which is still quite reasonable. The company hasn’t built a factory in decades. On the negative side, recent acquisitions (mostly Poppin) increased the intangible assets on the balance sheet. Kimball also has a strong cash conversion cycle.

Besides these financial points, the former COO stated,

“The company has very good manufacturers. If you went back to the records over longer periods of time, you can see shutting down multiple facilities: 400,000 sq ft, 300,000 sq ft. Now they're 400,000 sq ft down to 200,000 sq ft etc., and probably put those things 50% more furniture in at least 1 million less square feet than a decade or 12 years ago. Pretty strong, lean culture, continuous improvements. They've got a strong program there with [inaudible], eliminating waste, eliminating anything that requires transportation of a product even within feet within a facility.”

This focus on efficiency is a great explanation of how Kimball beats out its competitors’ ROIC.

The Combination Of National & Kimball

It's great to see the company has a culture of improvement. Speaking of culture, the former COO mentioned the recent combination of National and Kimball into the Workplace business line caused a minor culture shock because the folks at National were more fun and entrepreneurial National sells more resimercial furniture. To be clear, Kimball is one of the 7 brands within Kimball International.

In the end, it was a smart decision to combine the two because they were separately making calls to the same customers. Furthermore, since Kimball focuses more on selling to end users and National focuses on selling to dealers, they are a great fit. Each group can make the sales calls it is good at.

The former COO made the following point when discussing the two brands’ competitive advantage,

“The thing that Kimball and National do both very, very well, I would say stronger than their competitors, is treat dealers as customers, not just a channel, not just a means by which to get products to the ultimate end user but truly treat them as customers and the dealers really like it. Dealers are also entrepreneurs so they don't want to be told what to do and the managers often dictate. An awful lot of the dealer principals pull back. When you treat them like customers, when you have very good execution from quality, on-time delivery, damage-free, ease of installation, that's meaningful.”

The dealer network is extremely important to Kimball International’s success. Selling furniture to offices is actually somewhat complicated because there are dealers, producers (Kimball), designers, and buyers. It’s relationship-oriented.

The Etc. Brand

Kimball now has 7 brands. Besides Poppin, the two newest are Etc. and Interwoven. Etc. might get forgotten by some investors because Poppin also aims to expand in the work from home market. Outsiders might even be confused why Kimball needs Etc. However, it offers some unique aspects that can grow the company’s market share. The former COO was extremely optimistic about Etc. He stated,

“That's [Etc.] through typical contract channels also. I think that has tremendous possibilities. I have no knowledge of how it's doing but it's a different price point, different durability, it is good furniture, really good furniture. Leases are getting shorter, companies want more flexibility and ETC meets those needs [...] on that. Surely Poppins they can leverage to a significant degree in the products, the brand through contact distribution. Then the e-comm focus, the Poppin brand, I think that will move Kimball international along by I would say multiple years.”

The Poppin acquisition helps bring Etc. along because it is a digitally native brand that has expertise in work from home. Etc. clearly meets a certain market need because it is flexible, durable, and lower cost.

The Poppin Acquisition

The Poppin acquisition was Kristie Juster’s big stamp on the company. She made the smart move of getting into the e-business with the excess cash Kimball had on the balance sheet. Kimball wasn’t getting rewarded for this cash. Either the company needed to make an acquisition or do a huge buyback. The acquisition lowered Kimball’s risk of being hurt by the work from home trend and increased its long-term sales growth potential.

This purchase occurred after the former COO left the company. He stated,

“There were things I really loved about it [Poppin]. It has a good brand recognition and pretty good product. I'd love the DTC and every competitor is talking about digitization of the business in e-comm and DTC. It accelerates that significantly. I wouldn't mind some margin come along with it… A little light on the margin but they stated their investment and pooling that money in the business and I can imagine that's true. I think it would be profitable within year, I believe. I really like the company. I really like the brand. I think it's right in the wheelhouse of where the marketplace is going and what Kimball International needed. To try to develop that capability internally would have taken a very long time. That's why I think it propels them a lot.”

He says he likes the DTC business and that it’s low on margins. That’s why Kimball isn’t pursuing DTC as heavily as it is expanding Poppin’s B2B reach in secondary markets and selling the PoppinPods through its dealer network. I look at DTC as a nice bonus. I agree that Poppin will be profitable by the end of fiscal year 2022. Clearly, Kimball didn’t have the capability to replicate what Poppin does in-house.

The former COO mentioned the somewhat high valuation which was based on sales instead of profits. However, sales were suppressed because of the pandemic, making it look more expensive on a TTM sales basis. Secondly, long-term growth will give Kimball’s stock price a higher valuation. Once Kimball’s stock and business return to pre-pandemic levels, investors are going to look towards growth. That’s where Poppin will shine. Long-term investors who are in the stock for more than just the economic re-opening will be pleased in the next few years.

My Position

Kimball is 6.12% of my taxable account. It has been nice to see the stock get to a post-pandemic high. I added to my position after last quarter’s results sent shares temporarily lower. So far, my returns have been decent, but I’m looking for more. I expect Kimball to be my best stock in the 2^nd half of this year. On January 3^rd, I tweeted that I expected Cactus (WHD), Kimball, Altria (MO), and Enterprise Financial (EFSC) to be my best stocks of the year. So far, Kimball is in last place (in this group) with a 17.53% year to date return. For the stock to recover to its pre-pandemic level, the company just needs to show signs that the business is on track for a full recovery within the next few quarters.

Analyst’s Disclosure: I am/we are long KBAL, MO, WHD, EFSC. 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.