Kimball's Organic Sales Probably Just Bottomed
Summary
- I believe Kimball's organic sales bottomed in Q3. The coming return to offices and increase in travel should provide growth in fiscal year 2022.
- Kimball reported bad Q3 results which were a little worse than I expected. It was hurt by the pandemic, supply chain issues, and rising commodity costs.
- We're seeing early anecdotal evidence that employers will bring workers back to offices this summer. This was confirmed by Kimball's increase in orders in April.
- Domestic travel should rebound this summer which will provide a tailwind to the Hospitality business in fiscal year 2022.
- Poppin's integration started in May with the launch of sales through Kimball's dealer network. Poppin also unveiled Spaces which is a flexible walls product.
Q3 Was The Bottom For Kimball
Kimball (KBAL) reported dreadful numbers in Q3 which makes sense because January was the peak in COVID-19 cases. However, investing is about looking forward. It doesn’t make much sense to sell the stock because January was weak since we know COVID-19 cases have been falling due to the increase in vaccinations. I think Q3 was the bottom in organic sales for Kimball.
Anecdotally, we are seeing early signs that people will return to the office later this year. Goldman Sachs set June 14th as the date for workers to return to its offices in America. JPMorgan is opening its US offices on May 17th for voluntary returns before making it compulsory in July.
It’s notable that Kimball stated secondary cities will recover quicker than major metro areas. These major banks are mostly in major cities which means Kimball should start to see an uptick in office furniture sales before these banks return. That will be the start of the multi-quarter cyclical recovery that will go throughout fiscal 2022.
Furthermore, Kimball faced higher freight and commodity costs in Q3. The company raised prices on March 1st, but that was too late to help Q3 margins. The benefit will start to be seen in Q4 and will be fully realized in Q1. I believe the supply chain issues will be temporary since they have been catalyzed by the pandemic. It has little impact on normalized earnings projections. Keep in mind the loss of operating leverage caused by the sales decline had much a bigger impact than commodity prices or the supply chain.
Specifics Of The Lousy Quarter
I knew Q3 would be a weak quarter, but it was modestly worse than my expectations. Specifically, organic sales fell sequentially from $133.519 million to $129.808 million. I understand that the Workplace and Health business typically have a 10% sequential decline in sales in Q3. However, sales missed Kimball’s estimates.
I’m particularly disgruntled with the reason for the miss. The firm blamed slower than expected order rates early in the quarter. Weak orders in January led to weak shipments in February. However, when the company gave guidance in early February, it already had access to the January order data just like the company currently has access to April order data. Order rates increased throughout the quarter which is good.
I understand why orders were weak in January; it was the height of the pandemic. I just don’t know why Kimball didn’t account for this in the guidance they gave in February. The company should have used its order and backlog data to make a better prediction.
The only positive here is that if the company ignored weak order rates in January when setting Q3 guidance, it might be ignoring positive order rates in April when setting Q4 guidance. April’s numbers look dramatically better than January’s numbers, yet the firm sees no sales improvement next quarter.
Net sales were $138.7 million. Poppin contributed $8.9 million in sales in the quarter. Poppin had $11.5 million in sales in the 9 month ending March 31st, 2020. This suggests Poppin is recovering better than Kimball overall (organic net sales were $411.3 million in the 9 months ending March 2020 & just $129.8 million in Q3).
I’m not that concerned with Poppin yet because Kimball hasn’t integrated it. I’ll be much more focused on Poppin in fiscal year 2022. The first step is for the macro recovery to take place. Kimball needs to have a strong place in the new work environment.
I knew Q3 would be a brutal quarter for the bottom line heading into the report. It was the least of my concerns which is unusual for a value stock. Top-line sales growth will drive operating leverage in the next few years, making it more important. I was cautious heading into the quarter because of supply chain issues and commodity costs. Those costs ended up being a problem. The company reported an adjusted loss of 3 cents and gross margins of just 28.7% (down 530 basis points from last year).
The good news is the company raised prices by 3% to 4% in the Workplace and Health business lines. This will boost gross margins by 300 basis points in Q4. I think there will be a little more improvement in Q1 2022 because that’s the first quarter the full backlog will be worked through (full price realization).
With the spike in steel prices, I wouldn’t be surprised if the company implements another price increase in the next few months. I’m more focused on the company boosting organic sales in the next few quarters to increase operating leverage. That’s what the company said is necessary to get it back to 35% gross margins.
The 3 Business Lines Reviewed:
Hospitality
Now let’s look at the results from each business line in terms of sales and orders.
The Hospitality business grew sequential sales 61% to $35 million which isn’t as great as it sounds. It was boosted by the company working through its backlog. Orders actually fell 40% to $12 million. It’s hard to imagine this getting any worse unless COVID-19 comes back or the company suffers severe brand/market share setbacks due to the pandemic.
The company expects Hospitality sales to fall sequentially in Q4 which makes sense because the increase in Q3 was more of a one-time event. I wish we could see some sort of normalized number because the macro picture should get better for the leisure and hospital industry.
People will spend more on domestic trips this summer than in 2019 due to pent up demand. Leisure travel is definitely going to recover before business travel. Some firms are even suggesting that they won’t spend as much on business travel as they did before the pandemic.
The firm mentioned custom products were 50% of sales year to date which was up from 30% in the prior year which boosted margins. The supply chain issues in Hospitality are masking this benefit (75% of Hospitality production is outsourced).
Workplace
You can certainly spin Workplace’s 10% sequential sales decline (to $79 million) as a positive. The company usually has a 10% decline. January was the heart of the pandemic, stunting results. However, my counter is that Q2 sales were quite weak. It was an easier comp than usual. Unfortunately, most companies still hadn’t brought workers back to the office in the first 3 months of 2021.
The good news is order rates improved throughout the quarter and into April. Q3 orders grew 2% to $89 million. The company said bidding activity increased at a strong double digit rate in Workplace and Health. Furthermore, the company said education had an increase in order rates. Q3 is the buying season for education. Most children and young adults should be back in the classroom this fall.
The slide below shows Kimball should experience an uptick in orders first because 80% of its Workplace business is in secondary markets like Miami, Austin, and Nashville. Poppin is in the major cities which means its recovery might be a quarter behind. Kimball believes it has the product market fit for the new work environment because 85% of its products are in the ancillary market.
In the long run, this quarter won’t matter much. Once we see the macro recovery start, we will see if Kimball’s plans and positioning were smart. 27% of the firm’s Workplace sales were from new products in Q3.
Speaking of the future, Kimball is working on building its B2B corporate sponsorship programs in the work from home category. It has over 100 agreements in place so far (still early). This is important because more people will work from home than before the pandemic. The new work environment will be a hybrid model which includes offices as a central hub, satellite offices, and work from home.
Health
The Health business had a 9% decline in sales to $25 million. The company highlighted Health as the first business line to recover from the pandemic. This is a hit to that narrative. Yes, I know order rates increased throughout the quarter and that Q3 is sequentially weak.
I’m still modestly disappointed by this result since 21% of sales came from new products. This innovation should be helping sales more. Remember, the firm recently launched the Interwoven brand to improve Health sales. In Health, the firm really emphasized its sales to the Veterans Administration. It has 600 products qualified for purchase by the VA.
Sequential Health orders were down 4% to $26 million which doesn’t signal an impending sales improvement in Q4. However, January submarined this reading. I expect sales to grow in Q4.
Green Shoots Seen By Kimball In April
The firm mentioned a potential ramp a few times on the call which is a good sign. An analyst referred to modeling a return to normalcy in the next 3 to 4 quarters which is probably what most investors are anticipating.
The most exciting thing I heard about the future on the call is that the company is planning a sequential increase in SG&A in Q4 to set itself up for this ramp. Prior to Q4, the firm had been gating spending. Regardless of what the firm guides for, actions speak louder than words. The spending spike will be on Poppin’s expansion, return to work programs, and the Health business.
The second most exciting news of green shoots was that Workplace and Health had a 6% monthly increase in order rates in April (bidding opportunities increased double digits).
We should look at the results monthly, not quarterly. Orders have been improving in each month since January. Organic sales should be higher in Q4. I expect the biggest uptick in sales to be in the first half of fiscal year 2022.
Finally, the third green shoot was that the firm had a significant increase in what it calls day to day orders in April. These are orders of $50,000 or less. They react quicker to macro factors than bigger projects that have longer lead times. April’s day to day order performance was the strongest in the past year. That’s amazing news.
Not Great Q4 Guidance
Despite all this positive discussion of green shoots on the call, the firm sandbagged Q4 guidance. The firm stated it expects Q4 sales to be similar to Q3. Keep in mind Poppin doesn’t impact this comp because it was fully in Q3 numbers (unlike Q2).
The firm stated there will be a sequential increase in sales in Workplace and Health, but there will be a sequential decline in Hospitality based on information from its backlog and order flows. Since Q3 is usually weak for Workplace and Health and April order rates were much better than January, this guidance is probably too cautious. If overall sales are the same in Q4 despite companies bringing workers back to the office, I will need to re-evaluate my position.
Hospitality is definitely going to see a sales decline, but I don’t think it will be large enough to counteract the positives in Workplace and Health. I see Hospitality sales falling $10 million to $25 million based on improving macro factors and the backlog effect going away.
I see Health sales increasing $3 million to $28 million based on the seasonal factor going away and new products coming out. Finally, I see Workplace sales increasing $15 million to $94 million based on early return to work trends, the seasonal factor going away, and Poppin’s integration starting to drive growth. That equates to an $8 million increase in sales from Q3’s $138.7 million.
Macro Factors In Play
I am mapping the return to work to see when Kimball will have a sales recovery. The chart below shows the weekly office occupancy rate according to Kastle. This just shows the top 10 metro areas.
Kimball is bigger in secondary markets which are seeing quicker improvements. The occupancy rate rose from 24% on April 7th to 26.5% on April 28th. If you believe this rate will increase on a national level in the next few months due to vaccine distribution, Kimball is a good investment.
According to LaSalle Network's survey of 350 business leaders, a majority of respondents stated they plan to have employees back in the fall of 2021. 70% plan to phase employees back into the office slowly. 77% said they will have a hybrid model with some employees working in the office and some working from home.
Kimball’s hospitality business had sort of a one-time benefit that will be gone in Q4, but the macro environment should provide a multi-quarter tailwind to results. Vaccinated consumers are going to spend a lot on domestic vacations. As you can see from the chart below, in May hotel Google searches in the US hit the highest level since 2004. Kimball will probably talk about green shoots in the Hospitality business in Q4’s call.
New Products
Despite weak end markets Kimball continued to innovate this quarter. We will find out how valuable these innovations are when the macro environment picks up in the next few quarters.
Firstly, the National brand launched Eklund which is flexible seating for open social settings. As you can see from the image below, Eklund unifies spaces. It can be used in lobbies and student unions. I am very excited for Kimball to go after the education market more strongly with its foray into student housing. I think getting into student unions makes it easier to get into student housing.
Source: Kimball's National Brand
Etc., which is Kimball’s brand that is focused on work from home products, expanded its work from home desk assortment. Kimball launched this brand last year. Remember, Kimball is not going after consumers. This is a B2B business which sells through corporate sponsorship programs. It is going to take a few quarters for workers and businesses to get used to buying through this channel.
Investors hope work from home isn’t that much bigger than it was in 2019 because that is certainly a disruption in how furniture is ordered. I can see workers wanting to go through consumer channels on their own. The products are cheaper and they are easier to acquire. However, employers will pay for furniture if employees go through sponsorship programs. Plus, B2B grade furniture is much higher quality than consumer grade furniture.
The Interwoven brand launched Embra which is a family of seating in healthcare. It has a modular flexible design which has storage and power outlets. Embra has a residential feel. Remember, Interwoven is the other new brand Kimball launched in 2020. These new brands and Poppin are why I think Kimball can emerge from the pandemic stronger than it was prior to it.
Poppin Integration
Poppin just started being included in Kimball’s numbers in December. We need to wait another 1-3 quarters to see how well the integration is going. The firm is launching its Poppin Pro dealer network in May which means we should see a small bump in Poppin sales in Q4. The Poppin Plus dealer network will have more ‘on the ground’ support.
The macro improvement will overwhelm any improvements we see due to integration. The good news is this is a great time for this expansion. It’s great to launch this brand through Kimball’s network of over 1,000 dealers right before office spending picks up this summer. Kimball will be launching more work from home products through Poppin this summer as it scales its corporate sponsorship program.
Kimball’s increase in SG&A expenses related to Poppin in Q4 are only the beginning of its support for the brand. Kimball will be opening 5 new Poppin showrooms in 2022. It is considering 10 new ones it total. The goal is to get Poppin to expand in the secondary markets Kimball does the best in. Poppin’s Pods product will launch through the dealer network. The product had a good start before the pandemic, but then it tailed off.
The success of Poppin Pods and Spaces will go a long way in determining the success of the acquisition. Specifically, Spaces is Poppin’s new flexible walls product. Herman Miller (MLHR) recently acquired a company that sells these products.
Spaces is all about customizing the workspace in a flexible manner (it will also be sold in the Health division). It supports popup offices. It’s great for meetings and teleconferencing. Both Pods and Spaces will have a new ecosystem of ancillary products to support them.
Risks
The two main risks to Kimball are that its new plans won’t work when the pandemic is over and that the pandemic permanently changed work to the point that office usage is severely diminished.
I don’t believe the past few months are a leading indicator in determining whether offices will make a resurgence. Businesses are simply being cautious. It makes perfect sense to be cautious now since America should be a few months away from being fully vaccinated.
Skeptical investors probably read my detailed explanations of Kimball’s plans with disdain. Organic sales have been falling. These positive adjustments don’t matter if sales keep falling.
My contention is that we will see the improvements work all at once when the macro environment recovers within the next few quarters. I don’t think Q4 will be strong, but I think it will be the first quarter with green shoots. The full recovery should mostly take place in fiscal year 2022.
This article was written by
Analyst’s Disclosure: I am/we are long KBAL. 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.
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