The Lovesac Company (NASDAQ:LOVE) designs, manufactures, and sells furniture. We have published an article on the firm in June 2022, titled: "Declining Consumer Confidence May Slow Lovesac's Growth". At that time, we have rated LOVE's stock as a hold, due to the following reasons:
Since our writing, the firm has lost more than 37% of its market value, substantially underperforming the broader market.
Today, we are revisiting our thesis on LOVE's business and highlight some of the key results from the third quarter.
LOVE's net sales have increased once again by double digits, 15.5%, year-over-year.
While growth has slowed compared to the prior year, we believe that in the current market environment these results may be a proof that there is a demand for LOVE's products, even during periods of poor consumer sentiment.
The following table breaks the sales results further down.
Total comparable sales have increased by 8.9% (in contrast to the more than 47% increase in the year ago period), comparable showroom sales have grown by 18.5% (in contrast to the more than 53% growth in the year ago period), while internet sales have declined by 6.3%.
The main drivers of the comparable showroom sales growth, compared to the prior year period, were:
The reintroduction of physical pop-up-shops in Costco and the addition of 17 new Best Buy shop-in-shops, for a total of 22 Best Buy shop-in-shop locations have also contributed to the revenue growth.
The reason for the internet sales decline can be largely explained by the changing consumer behavior. As the impacts of the Covid-19 pandemic are fading, people are spending more time shopping in physical stores, rather than online, causing the internet sales metrics to decrease, in the case of LOVE.
While the gross profit has increased along with the net sales, the gross margin has contracted by as much as 300 basis points compared to the same period in the prior year. The two primary factors leading to the contraction were:
We would like to pay attention to the declining product margin here. In order to support the sales growth, the firm has had to spend substantially more on advertisement.
Advertising and marketing expense increased 20.3% due to continued investments in marketing spend to support our sales growth and expand brand awareness. As a percent of net sales, advertising and marketing increased by 50 basis points due to a slight increase in media spend to support our third quarter net sales growth.
They have not been able to offset these cost increases by pricing, meaning that the demand for their products is likely to be relatively elastic. For this reason, we believe that as long as the consumer sentiment is poor, we are not likely to see a reversal of the margin contraction.
Further, SG&A expense as a percent of net sales have also increased, by as much as 720 basis points. Deleveraging of employment costs, infrastructure investments, rent, selling related expenses, travel, and insurance have been the primary contributors, partially offset by the increase in the equity-based compensation.
As a result of the cost increases, the firm ended the quarter with an operating- and net loss of $11.6 million and $8.4 million, respectively.
Inventory management plays a key role, when it comes to margins. Rapidly increasing inventory may be a sign that the demand for a certain product is not as strong as expected. It may be a temporary or a permanent phenomena. If it is a permanent one, then the firm likely needs to use significant discounting to get rid of their "obsolete" goods and reduce their inventory.
The firm has made the following comment one their inventory levels:
Total merchandise inventory was $154.5 million as of October 30, 2022 as compared to $94.5 million as of October 31, 2021 with the year over year change principally related to a stock inventory increase of $43.2 million coupled with an increase in freight capitalization of $16.9 million related to an increase in inbound freight expense.
In our opinion, an increase of $43.2 million in the stock inventory is substantial. When considering investing in LOVE's business, one has to keep in mind that margins may be hurt in the near term by inventory management issues.
In our opinion, the firm has done a great job by achieving sales growth despite the challenging macroeconomic environment. On the other hand, we need to highlight that growth has substantially slowed compared to the prior year and that they have spent a lot more on advertising, which has led to margin contraction.
The firm has not been able to pass over the excess costs to the customers, which may signal that the demand for LOVE's products is elastic. For this reason, we do not foresee a substantial improvement in the margin in the near term.
The growth of inventory levels may be concerning. If inventory becomes obsolete, larger discounting may be needed to get rid of the excess inventory, which may hurt the margins.
We maintain our "hold" rating.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Additional disclosure: Past performance is not an indicator of future performance. This post is illustrative and educational and is not a specific offer of products or services or financial advice. Information in this article is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. This article has been co-authored by Mark Lakos.