Business Description / Background:

-          Bassett Furniture Industries, Inc. (BSET) is a manufacturer, importer, and retailer of home furniture. The Company’s segments include Wholesale, Company-Owned Retail, and Logistical Services. Its wholesale segment involves sourcing, sale, and distribution of furniture products to a network of Bassett Stores (company-owned and licensees) as well as independent furniture retailers. Its retail segment consists of Company-owned stores and its logistical services segment provides furniture shipping and delivery services.

Intro

3 straightforward items

-          Despite recovering to pre-Covid levels, the stock is cheap (3.0x our conservative 2021 EBITDA) and at a multi-year low.

-          Fundamentals are inflecting positively for the first time in 3 years, which has not been priced in yet as the stock has almost no coverage nor buy-side interest.

-          The business is well positioned to be a long-term beneficiary of the virus environment from a top and bottom-line perspective, whereas consensus expects only a short temporary boost to the top line.

If current trends in furniture demand and wholesale orders even remotely continue, 2021 sales should return to at least 2017 levels when the company did $450M in revenue, but with increased leverage on operating expenses due to permanent cost cuts. Assuming modest EBIT margin expansion on what should be record sales, our base case estimates a return to $40M in EBITDA, implying a current valuation of 3.0x EV/ EBITDA. Assuming the stock trades at the recent multiple of 6.5x, that gets you to $29.20 (68% upside). If it trades back up to 2017 levels of 10x that gets you to $43.30 (150% upside).

The Stock is Cheap

-          BSET trades at 3.0x on our conservative 2021 EBITDA of $40M (7.5x on consensus estimates) right now, which is far below any other publicly traded furniture company. Its EV is only $125M with no debt and almost $50M in Cash and ST Investments.

-          The company doesn’t guide nor conduct earnings calls, so consensus estimates are far too conservative. There’s also basically no buyside interest nor coverage with Sidoti being the only major firm that still publishes quarterly reports.

o   Case in point, the company increased its dividend back to pre-Covid levels on 10/8/2020 along with announcing a quarter-to-date acceleration in wholesale orders, which was met with no reaction from the sell-side and minimal price movement.

-          The stock is currently at $17.37 when it was almost $40.00 3 years ago before a continuous decline.

Fundamentals are inflective positively for the first time in 3 years

-          Background

o   From the start of 2018 through Covid, there was a continuous trend of declining sales, lower operating income, and lower EBITDA margins. EBITDA was roughly $40M in 2016 and 2017 before falling to $27M in 2018 and $15M in 2019.

o   The company historically had close to zero e-commerce presence nor did they engage in digital marketing.

o   There was no go-forward strategy to grow units beyond the limited footprint of only 66 company-owned stores and a handful of licensee Bassett-branded locations.

-          Inflection – BSET is a general beneficiary of the stay-at-home boom in consumer demand for furniture

o   Company-owned and licensee stores are benefiting from record orders, the likes of which they have never seen.

o   The largest contributor to their recent order growth comes from new business from independent furniture dealers, which is scalable, sustainable, and profitable.

o   They developed a new re-branded e-commerce strategy, allowing them to double online sales last Q and provide an additional revenue channel.

o   Last quarter, BSET outlined a new outdoor furniture commitment to also further growth going forward (see other beneficiaries like HOME and KIRK).

o   This conservative management team has an all-time high level of confidence with significant open market purchases from insiders, including members of the founding family over the last 3 months. This is in addition to restating the dividend earlier this month.

Causes of the Positive Inflection

-          BSET is among many beneficiaries of the massive consumer demand for furniture, yet the stock price has only recently returned to pre-Covid levels unlike many other names in the space.

o   Wholesale orders increased 117% from 2Q (ended May) to 3Q (ended August) with an August 2020 backlog 223% higher than August of 2019.

o   Incoming orders across all channels accelerated each month to 40% in August with no slowdown in September (still up 39%, which was announced on 10/8).

o   The stay-at-home trend is likely a short AND long-term structural benefit to the top line, causing never-before-seen demand. Channel checks with resellers and at the store level also confirmed no slowdown and anticipation of continued strength.

-          The newest growth channel is with independent furniture dealers, which is profitable and scalable.

o   In August, wholesale orders were up 40% (10% for Bassett-branded stores (58% of total orders) and up 61% to third party retailers).  

o   This is a structural change with both short and long-term implications. Our channel checks with re-sellers and store-level checks suggest that the pickup in business is from both existing AND new accounts.

§  Nebraska Furniture Mart and Star Furniture have increased orders, while Bassett has also added new accounts at Art Vann and RC Willey. Industry contacts have noted that a substantial portion of this business derives from Bassett taking market share away from their major competitors. Most notable is Flexsteel, which offers very similar products, but has lost share with dealers as it has struggled with quality, inventory, tariffs, and poor management. As a matter of fact, Bassett hired 4 of Flexsteel’s representatives in the last quarter to pick up even more of their existing customer base.

§  This is a short-term and long-term benefit to BSET as they steal share in a currently booming market to become the leader in higher-end home furnishings to third-party furniture retailers.

o   Historically, sales were split equally (40% each) between Retail and Wholesale, with the remaining 20% in logistical services. Last Q, there was a shift to 45% Wholesale.

o   Profitability-wise Wholesale has a +MSD EBIT margin, whereas retail’s is generally -LSD to -MSD. So, this sales growth is not only strong and sustainable, but also more profitable.

-          BSET has also made strides in their website and e-commerce offering.

o   These last two quarters marked their first significant digital marketing spend as they pivoted away from television and direct mail advertising.

o   They revamped their website, which led to a 63% increase in traffic and a 118% increase in web orders (just under 10% of total). Our web data sources imply this growth has continued to accelerate.

-          BSET has recently expanded into outdoor furniture.

o   As we know from HOME, KIRK, and others, demand for outdoor furniture grew even more than overall furniture demand this summer and will likely continue going forward.

o   BSET Outdoor Division sales increased by 34% last Q with the first full quarter of the existence of Lane Venture (an acquisition), which should help diversify its product offering both now and long-term.

-          Positive Insider / MGMT Signals

o   This management team is, by admission, exceptionally conservative, preferring to never take on debt and does not provide guidance.

o   In the past 4 months, we’ve observed an unprecedented amount of insider buys from senior personnel. The most notable case would be the Chief Operations Officer (and family heir) who increased his position by 8% in May.

o   As another sign of confidence, the company reinstated its quarterly dividend to pre-Covid levels last week while also announcing September wholesale orders up as much as they were in August.

The business is well positioned to be a long-term beneficiary of the virus environment from a top and bottom-line perspective whereas the market is expecting a short-term temporary boost.

-          Conversations with MGMT confirm a roughly 8-10 week delay between when an order is written and when it is delivered. Given this timing and the strength of wholesale orders in 3Q, we project that 4Q (ending November 2020) will be the first quarter of positive revenue growth this year (+MSD), with every quarter of 2021 being up +DD. Our conversations with channel partners and the CFO have indicated no slowdown in order trends, so it is only a matter of timing for them to be delivered. Our checks have revealed that while production has been difficult to ramp up (as with all other furniture wholesalers right now), capacity is rapidly increasing, which is why lead times are at least stable rather than increasing like at many competitors.

o   This compares to sell-side estimates, which are still far too low and anticipate only a 13% growth in revenue in 2021, which would have sales lower than in the past 5 years.

-          In conversation with the CFO, he implied that he believed the company would be more profitable today than in 2017 on the same level of sales. Gross Margins have been exceptionally consistent for the past 4 years (always hovering between 60-61%). This leaves SG&A where the company has permanent cut roughly 20% of corporate and in-store labor (the largest costs of the line item). In fact, SG&A was flat quarter-over-quarter from 2Q to 3Q despite sales accelerating over 20 ppts.

o   This compares to consensus estimates of only a 4.1% operating margin in 2021 vs. 6.0% in 2017.

Valuation and Price Target

-          Base Case

o   Our conservative base case assumes that with record demand, revenue returns to $465M (which is still only 2-3% higher than in 2017 and 2018 when the company normally did around $450M in annual sales).

o   Given a normalized sales trend, we assume gross margins return to 60% (as stated previously the rate was exceptionally consistent between 60-61% in the past 4 years).

o   SG&A margin of 53% vs. 54% in 2017 (as per our conversation with MGMT).

o   2021 Rev. of $465M (20% growth) vs. cons. Of $418M (13% growth)

o   2021 EBITDA of $40M vs. cons. Of $17.5M

o   Assuming it trades at its recent multiple of 6.5x, that gets you to $29.20 (roughly 68% upside). If it trades back up to the 2017 levels of 10x, that gets you to $43.30 (roughly 150% upside) and about $3 above the 2017 price.

-          Upside

o   Our upside case assumes that the furniture demand trend continues in 2021 and revenue grows to a record $482M.

o   Gross margin expands to 61% (the higher end of the 4-year range).

o   Higher leverage would lead to SG&A margin of 52% vs. 54% in 2017 and consensus of 56%.

o   2021 Rev. of $482M (24% growth) vs. cons. Of $418M (13% growth)

o   2021 EBITDA of $60M vs. cons. Of $17.5M

o   Assuming it trades at 6.5x, that gets you to $42.30 (or roughly 143% upside). If it trades back up to 2017 level of 10x, that gets you to $63.40 (or roughly 265% upside)

Risks

-          There is risk in the sustainability of stay-at-home furniture demand trends, particularly if wholesale orders substantially decelerate into the holiday season and 1H 2021.

-          Supply chain disruption

o   There has been continued difficulty with rehiring labor for factories due to stimulus checks. At this moment in time, there has been no substantial increase in canceled written orders, but this could flip if delays continue and lead times grow.

o   Sourcing of fabrics, foam and wood has been difficult as raw material suppliers are still ramping up to pre-Covid levels. However, management has noted that they expect the situation to improve in the next couple of weeks.

-          Recessionary Pressures

o   Stimulus checks were a major factor in driving recent furniture demand trends.

o   However, it should be noted that Bassett generally caters to higher-income individuals with larger and consistent disposable incomes. The brand is not believed to have been a major beneficiary of fiscal stimulus but rather benefited from a shift in consumer behavior during Covid.