Description

INVESTMENT THESIS

Hooker Furniture (HOFT; $22.25) is a boring stock, in a boring business. With only one analyst covering it, it is an overlooked small cap designer, manufacturer and importer of furniture. The nearly 100-year-old company owns furniture brands covering all tiers of the marketplace – from high end to mass market. With the stock trading at a single digit forward PE, the stock looks cheap, especially if margins normalize as management expects, resulting in a resumption of EPS, EBITDA and Free Cash Flow growth.

Many furniture stocks are in a bear market. Tariffs and fixed cost deleveraging from softness across 2018 and 2019 in the furniture category have impaired many margin structures. With tariffs now mostly in the run rate and sluggishness across the category appearing to lift, it seems the tide could be turning for many of these players. Hooker in particular looks attractive due to its differentiated business model. Over its many years in business, the company has transitioned to an asset-light model as mostly an importer and distributor, with only a small portion of its revenue dedicated to high end manufacturing here in the U.S. As a distributor of several well-regarded brands, the company has chosen to forego physical retail stores, instead employing a channel-agnostic approach that allows it to grow with partners like Costco and Wayfair that have successfully figured out how to reach the customer. While a smart strategic model, its highly variable operating cost model also carries minimal capex needs leading to high free cash flow conversion. The company has been profitable on annual basis for each of the last twenty plus years.

INVESTMENT CONSIDERATIONS

Long history – HOFT has been in the furniture business for nearly 100 years. CEO Paul Toms has family ties to the business and has been in place at the company since 2000. This long history also results in strong relationships with the many mom and pop furniture dealers throughout the country that carry Hooker’s furniture brands.

Margin improvement – Current gross margins are depressed primarily due to tariffs. We believe this is being worked through and anticipate gross margin normalization in the next 6-18 months. The company now imports around 20% of product from China (down from 40% in mid 2018). This transition out of China should enable the company to recapture their prior gross margin levels, which we expect will begin to show up in the coming quarters. 

Pristine balance sheet – Hooker has a solid balance sheet with $26M of gross debt as of the end of the most recent quarter. Hooker, unlike its peers, also has no stores and therefore has no lease liabilities. We suspect the company will again be debt free in three to four quarters and will continue to maintain and likely grow it’s $0.15 quarterly dividend.

Asset light / high ROIC business model – The company’s low variable cost operating model also requires little in the way of ongoing maintenance capex. This flexibility has allowed the company to remain profitable across various cycles, including 2008 and 2009. Accordingly, Hooker has historically generated a very respectable low teens return on equity. Because of the large balance of intangibles and goodwill, the returns on tangible equity are considerably higher.

Brand positioning – With the acquisition of Home Meridian in January 2016, the company is now solidly positioned across all price points in the furniture market.

Channel agnostic approach – Hooker has held fast to its strategic decision to not open stores. This has enabled it to efficiently and flexibly partner with any number of store or non-store-based retailers who have found varying degrees of success in reaching the customer in the current dynamic and changing retail environment. The company is well positioned with Costco who is a near 10% customer, as well as Wayfair, who we believe is an ~8% customer. This also means the company has little exposure or liabilities tied to real estate locations like malls that have seen declining foot traffic trends. Accordingly, Hooker’s store-based retail sales closely mirrors the industry average of 85% as a mix of sales.  

Ecommerce – Approximately 15% of Hooker’s sales go through the e-commerce channel, which is growing in the low double-digit levels. As they do not own any stores, they also do not own any direct-to-consumer websites or offerings. Hooker has developed, and will likely continue to develop, packable furniture that is easy to ship and assemble at the customers’ home. Their higher end products are also available for white glove delivery. We note the company has a strong relationship with Wayfair as a channel partner and actually see some blood relatives of the current Hooker team that are long time employees there.

Share gain initiatives – The company continues to come up with innovative products and packaging to gain share in the industry. For example, they are currently rolling out ready-to-assemble furniture that is exclusive to Walmart.com and Target.com. If successful, these products will likely end up in physical stores as well as continue to be sold online.

Supportive macro backdrop – Low interest rates, increasing household formation amongst millennials and low unemployment are all excellent tailwinds for furniture purchases. Recently, existing home sales have resumed a positive trajectory after an ~9 month spell of negative growth in 2018 / 2019.

Corporate history – The company was founded in 1924 by Clyde Hooker Jr and is located in Martinsville, VA. Steady leadership and a long-term owner’s mentality have allowed the company to successfully the navigate the twists and turns the US furniture industry has endured over the years. Hooker maintains a long-tenured management team, with CEO Paul Toms having held the position since 2000, and CFO Paul Huckfeldt having been with the company since 2004. Toms is the grandson of Clyde Hooker Jr. In 2000, nearly 70% of Hooker sales were from furniture made in their factories in the U.S. That changed as production moved to China, and in 2007, Hooker fully exited the manufacture of domestic wood furniture in the U.S. It is also worth noting ~20% of shares used to be held by the company’s ESOP, though this was dissolved over a decade ago.  

Capital Allocation– Historically, Hooker concentrated on their core products and built up a substantial war chest of cash after committing to modest growth in annual dividends. More recently, the company signaled a more aggressive approach towards acquisitions in early calendar 2016 with the acquisition of Home Meridian International for $100M. Home Meridian put Hooker in the mass market channel where they previously had minimal presence. We believe the Home Meridian acquisition was done at around 5x EBITDA. They continued this acquisition path when they re-entered the domestic manufacture of upholstered furniture by acquiring North Carolina based Shenandoah in 2018 for $40M. These two deals complete the brand portfolio, positioning Hooker across most major price points. We believe these two deals also create substantial value for shareholders. The company has committed to using all free cash flow to pay down debt. Gross debt today is a very modest $26M versus our estimate of $40M in adjusted EBITDA this year. We believe the company will continue to evaluate acquisitions where they make sense and continue to pay down debt and build up cash.

GROWTH PROSPECTS

Sales growth – In a normalized environment, we see topline likely to go grow at mid-single digits rate or a little better. This incorporates furniture category type growth of moderately GDP plus as well as a 1 – 2% for inflation. Share gain opportunities could add a further 1 – 2% to the topline. In the short term, we see the potential for a bit of a bounce-back year as inventory and demand normalize.

Continued Margin Expansion – We believe gross margins and ultimately ebit margins can again approach the levels of FY16 – FY18 in coming years.

In this scenario, we can see the company earnings $3 or more within two years, as they did in 2018, which looks to be a very undemanding valuation for a company with a clean balance sheet and satisfactory returns on capital.

RISKS

-         Cyclicality. Furniture, either casegoods or upholstered, are large ticket items for most consumers. A weaker economy will naturally result in weaker furniture sales.

-         Sourcing. The company aims to have 20% of its furniture sourced from China in the next 12-24 months. If this fails to occur, margins will continue to be depressed.

-         M&A. The company does not have a long history of doing deals. Their stated goal of additional acquisitions down the road could bring on added risk.

-        Customer concentration. The Home Meridian segment sells through club stores who are very dominant due to their size and overall purchasing power. Recently, Costco, an ~8% customer, sent $2.2M and $3M worth of chargebacks to Hooker in 2Q and 3Q 2019, respectively. They were largely driven by quality issues from a headboard product and a power recliner. These chargebacks negatively impacted operating margins in the segment. The issues appear mostly behind them, but should they continue to linger or damage the relationship, further sales and margin impacts could occur.

-         Trends. Hooker must stay on top of style trends to stay relevant and excite both the retailers who sell their product, as well as the end consumer who uses the product.

-         Tariffs. The tariff situation is unpredictable and could change for the positive or negative in the future.

Catalyst

-        Earnings reports and continued progress towards margin normalization.

-       Share repurchases. The company does not have a history of major share repurchases. However, with insiders recently buying and cash continuing to build, management and the board may begin to evaluate this as a capital allocation option.

-        M&A. The company has done two deals totaling $140M over the past few years at attractive multiples. There is potential for more deals like this, which we would generally view as a positive.

-          Insider buys. Insiders, who have rarely purchased stock in the past, have collectively purchased nearly $600,000 worth of Hooker stock since the beginning of the year.