Disclaimer
CULP is a microcap and is best suited for small funds and PAs.

Summary
CULP is one of the leading manufacturers of mattress fabrics and marketers of upholstery fabrics in the US that is trading below tangible book value due to tough times in the industry and presents an attractive risk/reward situation for investors with a decent probability of doubling invested money within 2-3 years.

Reasons to buy:

●       Valuation. Market cap is $61m, cash in the bank is $15m, company has no debt and expects to go back to profitability in 2 quarters. CULP trades today at 0.75x TBV while last decade’s mean figure was 2x. Going forward, as the industry turns around, 15% revenue growth from today at a 5% EBIT margin would confidently produce $13m of FCF, which at 10% yield results in $130m MC.

●       Company is a survivor. It has a history of successfully adapting to whatever current environment demands and survived GFC, Covid, major industry changes while maintaining their market leadership position and good brand name.  

Why does the opportunity exist?

●       Wellbeing of CULP depends on mattress and furniture sales in the US, which in turn heavily depend on home sales. While it is always dangerous to call out a cycle bottom we can confidently say 2023 has been a really bad year. Existing home sales in December came to 3.8m annualized figure, which makes 2023 the worst year for the housing market in nearly three decades. This correlates well with the historically decade-low figure of US produced mattresses.

●       This is a boring microcap that produces fabrics for furniture and mattresses.

Thesis is very simple here - a pick-and-shovel play in the bedding and furniture industry which today finds itself at near-bottom levels of cycle.

Brief history

CULP was founded in 1972, IPOed in 1983 as CFI and changed its ticker to CULP in 2017. Company started in the upholstery business, got into mattress business shortly after (founder made a good call) and since then it has always operated as a business with two divisions.

Over half-century period CULP had four CEOs - Robert Culp II (the founder by the nickname “Bullet” for making fast decisions), his son - Robert Culp III (current CEO’s father), Franklin Saxon (CEO from 2007 to 2020) and Robert Culp IV (goes by “ee-v” and not “the fourth”). As we can see, there is an interesting dynamic of almost family run business that happens to be public. Setup has its own advantages and disadvantages - more on that later.

CULP was written up on VIC by roy915 almost 20 years ago. Company still has the same two divisions, however, we can confidently say that a lot has happened since then! Let’s briefly look at the two divisions - upholstery fabrics division - Culp Upholstery Fabrics (CUF) and mattress fabrics division - Culp Home Fashions (CHF). Sales are roughly 50/50 between the two businesses today. 

Upholstery fabrics market kept being pressured by cheap imports and unsurprisingly all production today is in Asia (and recently Haiti). CULP is basically a marketing company in the US with production in China (two manufacturing facilities in Shanghai). For the most part this division served the residential and commercial furniture markets. Since Covid, CULP got into the hospitality market and is seeing good progress there today. For example, in the latest quarter, hospitality sales represented 33% of the CUF segment.

Mattress fabrics division has been steadily growing since 2008 and for the most part remained a North American-based business due to its “just-in-time” nature (short lead time demanded by mattress manufacturers). With the growth of eCommerce and increasing acceptance of rolled-up cheap mattresses from China local manufacturers have been hurting in recent years. Indeed, we saw a rise of many bed-in-a-box companies who made their way through social media platforms during and after Covid. The Department of Commerce was playing catch-up in this game: first imposing anti-dumping duties against China in 2019 and then against Cambodia, Indonesia, Malaysia, Serbia, Thailand, Turkey, and Vietnam in 2021. CULP has manufacturing facilities in North Carolina and in Quebec, Canada. Some of the mattress cover production is also done in Haiti.

The mattress industry has put on a great show since roy915’s writeup. There are no “four S’s” of mattresses – Sealy, Simmons, Serta, and Spring Air - anymore. Simmons filed for bankruptcy protection in 2010 and got merged with Serta. Tempur Pedic acquired Sealy in 2012 and today trades as TPX. Serta Simmons Bedding filed for bankruptcy in 2023 again. Steinhoff, the troubled South African retail conglomerate, acquired Mattress Firm for $3.8bn in August 2016. TPX lost Mattress Firm as a customer in 2017. Mattress Firm wanted to IPO in 2022, but instead got acquired by TPX in 2023. DTC players like Casper, Purple, Nectar and others are trying to find their footing. Ironically, this industry has not been asleep.

Competition, concentration

Mattress division

CULP keeps changing language from “the largest producer of mattress fabrics” to “one of the largest” in their presentations. According to the latest pitch deck mattress fabrics industry is a $500-600m industry and CULP owns 20-25% of it being a “top 2 player”. The biggest competitor is likely BekaertDeslee Textile which is part of BekaertDeslee global fabrics conglomerate. These guys are owned by Franz Haniel group - German investment holding which is one of Europe’s largest privately owned businesses. Another competitor here is Global Textile Alliance - North Carolina group which has been in the textile and bedding industry for more than two decades.

CULP serves all the usual suspects of the industry like TPX, SSB, SNBR, Casper, and others. From the latest 10K, no customer contributed to more than 10% of revenue in this segment. Some time back SSB contributed up to 13-15% of revenue. I believe this figure fluctuates and depends heavily on the state of the market in general.

Upholstery division

The industry is very fragmented. According to CULP’s pitch deck it is a $1.5-2b market of which CULP owns 8-10% share being a “top 5 player”. 10-K lists Dorell Fabrics Co, Morgan Fabrics, Richloom Fabrics, Specialty Textile Inc, and ZhongWang Fabrics as main competitors none of which are public companies. I believe CULP has the most recognizable brand here purely from the time they have been present in the industry.

CULP serves leading manufacturers of upholstery furniture in the US - Ashley, Flexsteel, La-Z-Boy and others. La-Z-Boy is the largest customer and accounts for 15% of revenue in the segment. This is a big number but I believe the relationship between the two is very solid. Tracing back all the 10-Ks from the past decade and more, we can see that La-Z-Boy has been a consistent customer with roughly the same level of revenue contribution.

Financials

LTM revenue is at $230m with roughly an even split between upholstery and mattress divisions. The mattress division is a better business with normalized EBIT margins at 9-10% while the upholstery division carries normalized 6-7% EBIT margins.  

Fiscal 2023 was the first time after many years when CULP operationally lost money. High interest rates killed demand, supply chain issues caused increased input costs which killed gross margins. Fiscal 2024 will be operationally at a loss too, but management guides things will revert from there. They improved operations and were able to reprice products. We can clearly see this in the financial statements - GM has been improving for the last five quarters. At the recent Water Tower Research conference management guided $2m operational loss for upcoming Q3 results. Previously they guided return back to profitability in Q4. I expect them to confirm this guidance at the Q3 conference call or push it further by one quarter.

Pitch deck guides for “normalized” combined 5% EBIT margin at $300m revenue in a couple of years. This is not a wild fantasy but a decent projection in my view. Company has $15m in cash and no debt, so CULP can withstand a setback or two on the way there.

Cash, AR, inventories and properties make up most of the assets and the company's tangible book value is at $82m. There is also an $20m valuation allowance that is not reflected on the balance sheet. I believe downside protection is decent.

Valuation

SP - $4.91
SOI - 12.4m
Equity - $61m

Debt - N/A
Cash - $15m

EV - $46m
TBV - $82m

MC/TBV - 0.75

If we assume 15% revenue growth and 5% EBIT margin for FY2025 we’ll get $13m in EBIT. Bar working capital changes, with D&A and capex balancing each other we get 21% FCF yield on equity. I believe these assumptions are not outlandish given where the industry is today. And even if it takes a bit longer to see the tailwinds, a clean balance sheet and absence of debt makes the wait quite tolerable.

Not so great

CULP is a public company which bears the name of its founder and current CEO - Robert Culp. However, insiders own less than 7% of the company and the CEO owns mere 2.6% while his total compensation last year was $1.2m. There is not much financial alignment per se with the minority shareholders. In my opinion, there must be plenty of motivation to protect the legacy of the family in a way. An asset like culture, though intangible, is very important. However, higher financial incentives would have made the thesis even better. On a positive side, the new mattress division president bought more than $130k worth of stock a few months ago along with other insiders who were buying a bunch throughout the last year.

Company is based in North Carolina and is apparently a nice place to be in. Indeed, we can see that many employees stay with the company for years, some - decades, which is generally a good sign. Especially when a company prefers to promote within, which is the case here. On the other hand, we can argue that people might get pretty comfortable here and coast. Company corporate structure is bloated - we can find 18(!) vice presidents on LinkedIn. I have a feeling it is a little too many for a company with a market cap of $61m.

CULP historically generated free cash flow consistently and paid dividends. There were a few attempts to do something else and they were not great. In 2018 CULP acquired eLuxury, an eCommerce company that sold mattress pads and other bedding accessories. CULP paid $18m for 80% interest in a company which had an annual revenue run rate of $22m. This endeavor didn’t work out and they sold eLuxury during Covid for pennies on the dollar. In the same 2018 CULP acquired Read Windows - company that sells window treatments and sources upholstery fabric. They paid $4.5m for $11m of revenue. Arguably, this acquisition helped CULP to enter the hospitality business. I am not sure how windows treatment was a good idea. During fiscal 2022 CULP repurchased $1.8m worth of stock at an average price of $14.8 but is too cautious to buy back stock today when SP is lower than $5. Company also has a “rabbi trust” for participants of their deferred compensation plan. Rabbi trust consists of investments in a money market fund and various mutual funds that are classified as available-for-sale. I am not sure how I feel about mattress and upholstery fabric company doing this.

All of the above is to say that capital allocation is not Buffett-like here, but nothing too disastrous either. For what it’s worth - CEO admitted that one of his biggest mistakes was decision to diversify and invest outside of his main course in a Furniture Today interview. He didn’t specify anything but I suspect he was talking about eLuxury acquisition.

Mill Road capital owns 5.5% of CULP. It’s a small position for them but should management do something really bad I think Mill Road will get involved. As an example, they got heavy in Superior Industries recently. I doubt it will come to this but knowing that there is a fund on the shareholder register that can speak up is reassuring. Another fund out of Seattle, 22NW Fund, owns almost 10%. It’s a decent amount to have a right to raise your voice in case you don’t like something.  

Risks

●        Poor capital allocation decision.

●        Further market conditions deterioration, GFC-like event.

●        Lifting anti-dump duties against China and others.

●        Inputs to CULP’s products are derivatives of petrochemicals. Prolonged high oil price might hurt the business in the long run unless the company can pass on the cost.   

Conclusion

CULP is an industry leader that trades below tangible book value, has no debt, 25% of MC in cash and about to return back to profitability. Without any heroic assumptions the company can achieve $13m of FCF in a few years which at 10% yield will result in a 100% share price appreciation.