Description

Elevator pitch

High-ROIC, free cash flow-generative business with iconic products. The company is recently experiencing record demand from individuals setting up home offices. Amazon pricing data and anecdotal evidence suggests that demand is outpacing supply. Now that Herman Miller’s production facilities are back online, they will be working at full capacity to work through the backlog that has built up during the pandemic. This is likely to lead to a rebound in earnings. 

Why Herman Miller is a high-quality company

We believe that Herman Miller is a decent company that will prosper for decades to come.

The company has existed since 1905 and has been inventing iconic furniture designs since the 1930s. Their furniture products include office chairs such as the Aeron, Equa and Eames as well as home furniture such as the Noguchi table. While Herman Miller’s products are not cheap, they have carved out a niche as the go-to-brand for high end office furniture. When a financial services firm opens a new office, Herman Miller Aeron chairs are often the obvious choice. Each chair comes with a 12-year warranty, and they are likely to be used for 8 hours+ per day. Companies that can afford them are unlikely to try to save a few hundred dollars on an unproven brand name. 

The company’s financials suggest a strong competitive advantage. The return on equity has consistently been 20%+ with hardly any use of debt. While operating margins are in the single digits, they are higher than those of competitors, including Steelcase. Herman Miller’s free cash flows have been around $100-150 million per year after capex, leaving plenty for dividends and share buybacks.

Employee reviews on Glassdoor.com are positive, with an average score of 3.6/5.0 and 73% approving of CEO Andi Owen (https://www.glassdoor.com/Reviews/Herman-Miller-Reviews-E1485_P3.htm).

The long-term growth picture is hard to judge. We expect mid-single digits growth top-line growth at best, given the maturity of the business.

Downside risks appear to be limited given the modest debt load. Gross debt / EBITDA of 2.1x is well below the covenant limit of 3.5x. At 4QFY20 Herman Miller had cash available of $454 million, including a withdrawal of $265 from its revolving credit facility. Despite an incredibly challenging environment in 4QFY20, the company remained cash flow positive with CFO of $30 million and capex of just $13 million.

What the stock is worth

Herman Miller obviously suffered during the Coronavirus-related lockdowns that took place globally from January onwards. Retail stores closed and production facilities shut down for a number of months. 400 associates were laid off and pay was significantly reduced for the remaining workers. New orders for the contract business for the 4QFY20 quarter ending 30 May 2020 dropped by 31% for the American business and 19% internationally. Subsequently, Herman Miller took impairment charges of $205 million and suspended all future dividends.

While COVID-19 has been a life transforming event for many, we believe that demand for office chairs will eventually recover. The experience of many individuals forced to work from home was that of temporary computer set-ups, or sitting with a laptop at the kitchen table. As it became clear that the pandemic would last longer than expected, people started upgrading their work-from-home set-ups. During the 4QFY20 conference call, Herman Miller said that the pattern they are seeing with their customers was an initial caution as they took a pause to figure out what they were doing with their offices. Later on during the spring, customers started transitioning into longer-term solutions with more elaborate set-ups. Life will return to normal eventually - and perhaps sooner than what many expect.

The stock has historically traded at a PE of around 15x – a multiple we think is fair given the cash flow generative nature of the business and the potential for price increases, at least in line with inflation. With historical net margins of around 6% and projected sales of $2.7 billion for FY2022 in our base case, ending up with a value per share of $41, an upside of about +75% from the current price of $23.7. The stock traded above $40 in early 2020, so a rebound to these levels is not unrealistic on a two-year time frame.

Short-term catalysts

Only 16% of revenues come from the retail segment. This fact has made investors wary of the stock, thinking that it will be difficult for retail buyers to counteract the negative effect from the B2B business.

But the weak numbers we saw from Herman Miller in 4QFY20 was primarily due to the shutdown of Herman Miller’s production facilities in the United States and China. And new orders were down initially, as companies exercised caution and customers were unable to visit Herman Miller’s stores. All manufacturing and distribution facilities are now back up-and-running, and all retail studios and outlets have at least partially re-opened. (https://www.hermanmiller.com/press/press-releases/herman-miller-update-on-managing-through-covid-19-pandemic/).

Many companies have now started to subsidize expenses for office chairs, to compensate workers that are forced to work from home. Google, for example, are letting their employees expense $1,000 worth of office furniture such as standing desks and ergonomic chairs. (https://nypost.com/2020/05/26/google-will-let-workers-expense-1000-worth-of-office-furniture/?utm_source=twitter_sitebuttons&utm_medium=site%20buttons&utm_campaign=site%20buttons)

Despite falling new orders, the backlog as of 30 May 2020 actually rose +19% compared to the same period last year. In other words, the effect from closing down manufacturing facilities outweighed the weaker order intake. Herman Miller will now have to work hard to satisfy customer orders.

The consumer business seems to be on fire:

• The number of Google search queries for Herman Miller chairs has more or less doubled compared to the same period in 2019. Try other keywords and it will be clear that the demand for office chairs has gone ballistic.

• A competitor said that they are experiencing difficulties meeting customer demand: “Hayes says business is suddenly so brisk that the company’s most popular chair — a $279 ergonomic number —  won’t be available again until September. They can’t make it fast enough.” (https://techcrunch.com/2020/06/11/covid-19-nearly-killed-this-office-furniture-startup-turning-to-home-offices-may-save-it/)
• From my own experience setting up a home office in August, work chairs and desks have been difficult to get hold of. They are sold out.
• Prices of Herman Miller chairs from third party sellers on Amazon are going through the roof:

• On Herman Miller’s own store on Amazon.com it says that Aeron chairs are out of stock, not knowing when the chairs will be available again.
• Visits to Herman Miller’s website are up significantly – both in absolute terms, and compared to competitors such as Steelcase:

• Amazon Alexa website ranking is also showing an increase in consumer interest for the brand:

• During the summer, Herman Miller launched a gaming chair in co-operation with Logitech, aimed at e-sports enthusiasts. While the price tag of the chair is steep, Logitech has excellent distribution and the launch is time perfectly during a period when many people prefer playing video games or working from home. (https://www.nytimes.com/2020/08/07/style/gamer-chair-market-herman-miller.html)

The question is how fast the contract business will recover. If offices are being reconfigured to allow for proper social distancing, that could set off a refresh cycle for the office furniture industry. Such a refresh cycle may be a few quarters’ off. Mobility trackers for the United States and Western Europe show traffic down roughly 10% year-on-year. We don’t have a strong view of when the inflection point will come but we believe that it will come at some point. The rising prices of Herman Miller chairs on Amazon does suggest not only strong consumer demand – but strong demand generally. Either way, with a decent backlog, Herman Miller’s results should recover nicely in the quarters ahead as their production facilities are now back-up-and-running.

Management commentary on the 4QFY20 call was positive:

• “As we look at the funnel of project opportunities, we’re fairly encouraged”
• “We have seen some cancellations, that’s been more of an edge condition, not a trend, which has been encouraging.”
• “The reschedule of order ship dates has occurred because either our factories were closed for a portion of the quarter or, of course, our customers are facing a lot of the same types of disruptions”
• “When you net it all out, we actually feel really good about the continued opportunities and a lot of inbound calls from customers.”
• “Our retail segment has actually been quite strong. As I mentioned on the call, in relative terms we were down only 5% for the fourth quarter, and we’ve seen a pretty positive sign to begin Q1 - it’s early.”
• “Since China and many of our Scandinavian countries are a little bit further along on the virus curve, we’re really starting to see them inch along in their recovery process… China is even further along, not only showing an improvement in trend but the last four weeks orders have been ahead of prior year levels as well, so we’re actually pretty optimistic as we move forward in those order trends.”
• “What we’re hearing from our contract clients, we’re really looking at supporting a more meaningful shift into work-from-home through the end of the year”
• “A lot of corporations or many of our contract customers are just now beginning to work through what their work-from-home policy for their employees is… we anticipate there will be a second wave as people start to reimburse to people who have more longer term work-from-home situations.”
• “We do believe that companies are going to need offices, and the question will be to what level do they need to be reconfigured… if we see that, we fully expect that we’re going to see a fair amount of refresh of business, and that’s going to help offset what would likely otherwise be a lower spend per for home office users.”

Additionally, Chairman Michael Volkema purchased 50,000 shares in May and July this year, with a total value in excess of $1 million. That shows some confidence in the turnaround potential of the business.

Catalyst

2QFY20 earnings on 17 September 2020 will most likely show a strong rebound in YoY sales, EPS growth and new order flow.

More data on the success (or lack thereof) for the Herman Miller Embody gaming chair.