Description

Before you call me crazy for pitching a $75M MCap stock that has already been parabolic this year, please read the write-up!  Then you can vote me a 1 all you want.

Natuzzi: Very cheap business that is inflecting

• Natuzzi S.p.A (NTZ) has no research coverage and has been left for dead. 

• The company trades at 13% of sales and just over half of tangible book – which significantly understates the value of the Natuzzi brand.

• NTZ has sufficient liquidity and low debt: with €31M euro in cash, ~€35M in planned asset monetization, and a pending €30-€65M Italian government loan with a very favorable repayment schedule, low interest, and no impactful covenants.

• NTZ should generate a .60 cent per share operating profit in Q4.

• The margin of safety is high, the valuation is absurdly low, and NTZ is well catalyzed.

• The stock has 3-4 bagger potential based on a 3% operating margin on $450M in revenue.

• I have yet to find a developed market branded furniture co that trades below .5x sales. Which would be $20/sh for NTZ.

Natuzzi is one of the best-known furniture brands in the world. Natuzzi S.p.A. designs, manufactures, and markets leather and fabric upholstered furniture through its own and franchised stores worldwide. The company operates through Natuzzi Brand and Private Label segments. Its products primarily include stationary furniture, such as sofas, loveseats, and armchairs; sectional furniture; motion furniture; sofa beds; occasional chairs, including recliners and massage chairs; and home furnishing accessories.

For most of the last decade NTZ has struggled to turn a profit. The primary culprits that have plagued the company include: 1) tough labor laws in its Italian operations have led to an inefficient cost structure – Italy has government protections against laying off redundant workers as well as strict unions. 2) NTZ’s private label manufacturing business had high fixed costs (although recently switching from Italy to Romania should help), margins are competed down to the bone, and the category is in decline as many of NTZ’s B&M retailers have reduced footprints.

The founder/CEO/Chairman of NTZ is Pasquale Natuzzi (80 years old). Pasquale founded the company in 1959 and took it public in 1993. Pasquale and family own ~60% of the company – Pasquale has clipped 10s of millions in dividends along the way and is a wealthy man. “Owner-operator” Pasquale and team are working hard to get the business back to a position of sustainable profitability. The company has life and is making many of the correct moves. 

Green Shoots

• Sept 30, 2019 – P. Natuzzi when asked about years of losses - “Again, we have been investing, investing, investing. Our main goal was to convert this company from a manufacturing company to lifestyle brand.”

• NTZ signed a deal in July 2018 to sell 51% interest their China JV. Kuka paid €65M total interest (€55M adj), NTZ retained 49% interest in the JV. This demonstrates the value of the Natuzzi brand and the company’s ability to monetize it.

• Q2 2020 - “As soon as the lockdown measures were lifted around the world, our business gradually started to recover, with the overall order flow from June to date increasing above our expectations. Strong demand has resulted in a significant increase in product backlog over the last few months. We are putting in place measures to increase the Group production capacity, accordingly.”

• Consumers have shifted their spending to the home. Restoration Hardware, Ethan Allen, Williams-Sonoma, Lazyboy and many others in the category are trading at multi-year highs after reporting very good numbers in recent months, they have also given strong outlooks for next year. 

• Private label is becoming less relevant. NTZ is optimizing manufacturing to increase margins.

• Branded was 87.5% in 2Q20 vrs 80.6% LY and 78% in 4Q18 2018. NTZ is becoming less exposed to the low to negative margin private label business. NTZ branded stores where they are integrated and capture margin is an exceptionally profitable model.

• 3Q19 call (Dec) – “The complete industrial review we have almost completed the shift of certain low-margin production from Italy to Romania as it was in no longer sustainable here in Italy. So we need further industrial capacity in Eastern Europe. That's why we are negotiating with third parties production players located in Belarus to get the low-cost production capacity in outsourcing to favor the unbranded business in EMEA region, we believe the production Belarus could start gradually in the second half of 2020.”

• 2Q19 call – “We are moving the production, Natuzzi Editions, from Italy to Romania, where we can improve the margin. But in order to give space, then we take out from the Romania factory production that we make for big distributor where the margin are unbranded, the margin are lower, and we will make this production in Belorussia, but over there we will not invest to open a factory. We are already at a good stage to make the product in Belorussia and make improved volume and margin.”

• 2019 20-F - the management of production excess capacity in Italy with the layoff of redundant workers pursuant to individual written agreements that will provide for one-off termination benefits. 

• Other factors that should lead to higher yoy Gross margins include a smaller mix of private label and hide prices (21% of COGS) are at multidecade lows.

• US DOS Growth Story – 

• In 4Q19 NTZ hired Restoration Hardware’s fomer CMO as president of Natuzzi North Americas. The company plans to grow significantly in the US, the economics of these integrated stores are good, they capture good margins and generate cash a couple months after opening. RH is thriving without much competition in the higher end segment, there is significant room for NTZ to expand. They will continue to profitably build out US – maybe they even find a JV partner to grow it faster and extract value out of the leading Italian furniture brand.

• Underpinning this opportunity is a turboboost from a very strong US housing market, strong 4-wall economics at NTZ DOS, large white space, Ex RH CMO that is now NTZ NA president that knows how to get the job done. With NTZ’s soon to be large cash balance and intent to attack the US opportunity – this bodes well. With RH doing $2.5B in revenue, we see no reason why NTZ US can’t get to 5% of that revenue number, or $125M, accomplished through rolling out a dozen incremental stores/yr over the next two years. In the US, La-Z-boy trades at north of 1x sales and Ethan Allen trades at .9x sales. 

• 2Q20 results - 

• The Group reported an operating loss of €7.7 million, which includes the impairment on assets and restructuring costs in China totaling €3.2 million. An adjusted -€4.5M operating profit in Q2 is not bad in a pandemic-stricken quarter, I think it shows they are tightening the belt on expenses.

• In Q2 NTZ completed the shifted out of China manufacturing to lower cost Vietnam. 

• On a like-for like basis, revenues of the 45 DOS (Directly owned stores) were up 4.2% in 2019 compared to 2018.

Modeling Q3/Q4

• 3Q20 – Gross margins to expand 2.3% to 31% due to reduced labor costs, better mix/lower private label, multi-decade low hide prices (21% of COGS).

On opex – €2.1M in savings from the reduction of tariffs, and an estimated €.9M in savings from lower labor and industrial costs having shifted to Vietnam and Romania.

NTZ should come in at -€1M operating profit in Q3.

• 4Q20 – Gross margins expand 2.7% to 34.5%, on the back of a €2M reduction of extraordinary costs related to the Italian workforce (which was a €2.8M hit in 4Q19), plus better utilization levels at factories providing 70bp lift. Adj GMs in 4Q19 would have been 34.6%. Other favorable factors are Private label being less of the mix, hide prices at multi-decade lows, outsourced operations to lower cost Vietnam and Romania. 

On opex I have just €1M savings from tariff eliminations (could be as high at €3M savings – but I don’t account).

NTZ should generate a €5.6M ($6.6M) Operating profit in Q4, this would equal .60 cents per share in EBIT just in Q4. Q4 EBITDA would be $10.1M USD or $0.92/sh.

Our checks indicate 10% revenue growth in Q4 is certainly attainable, this is also confirmed by NTZ saying “significant increase in product backlog over the last few months” – NTZ will be shipping as much product as it can in Q4. Yet another confirming source is NTZ’s wholesale director saying on Oct 15th at a furniture webinar event that “We will close with incredible numbers thanks to the sales recorded between the end of June and August. But also in September ”. (source)

Capital Structure

• NTZ has €31M in cash and €18M in debt, consisting mostly of mortgages against properties. NTZ also has ~€22M outstanding on it’s AR securitization facility – which was renewed in July and has capacity up to €40M.

Catalysts 

1. Very high likelihood of NTZ receiving a €30-€65M loan from the Italian government through the stimulus program. This will alleviate liquidity concerns for the next 18-24 months and significantly re-rate the stock.

1. The Company applied for a long-term bank borrowing, 90% guaranteed by an Italian state agency, and with nominal amount of €65.0 million, based on the measures to support businesses approved by the Italian Government with Law Decree no. 23/2020 (the “Liquidity Decree”). Although the Company’s directors are confident that such long-term bank borrowing will be received during the third quarter of 2020 for the requested amount, since the Company meets all the conditions specified in Article 1 of the Liquidity Decree, there is uncertainty about the amount of the loan that will actually be disbursed as well as the actual timing of this disbursement. 

2. The loan would entail no principal repayment until 2022, rate schedule starts at yr 1) 25bp 2-3) 50bp 4-6) 1pt. This is a basically free money, with no impactful covenants, and a LT loan.

3. Between NTZ employing thousands of Italian workers, plenty of room in the stimulus pool, and the company sounding like it meets all the steps for a €65M loan they are asking for - I believe NTZ could be receiving the money soon and in the amount close to their asking.

2. NTZ is working on €35M in non-core asset sales.

1. NTZ originally announced on September 30, 2019 it would seek to sell non-strategic assets 

including two subsidiaries (tannery and foam operations based in Italy) and real estate properties in the U.S. and Italy. NTZ broke out these assets as having €27M in book value and could likely fetch €35M at market value. NTZ owns its HQ building in High Point, NC which is likely worth ~$40M alone. 

2. “We have also decided to hire an advisor firm to support us in the sale and if needed, in the financing of such sale process.”

3. NTZ could monetize its remaining 49% equity in its China JV. This would bring in ~€35-€40M overnight.

1. The China JV reported €4.7M in EBT in 2019, the JV is adding 40-50 stores each year.

2. “the Company has determined appropriate to estimate the fair value of the retained investment in Natuzzi Trading Shanghai upon the results of a third-party independent appraisal. The fair value was estimated in the amount of 48,024.”

3. NTZ has not been receiving dividend cash flow from the JV but guided to distributions starting to come in soon.

4. NTZ is seeking the right opportunities for another JV deal (similar to China). Which could also bring in meaningful cash as NTZ monetizes its solid brand.

1. In Oct 2019 Pasquale stated they are now looking to sell JV rights - “Oscar Severi, the strategic financial manager, is pursuing – the goal of the company is to find other solution like KUKA one in Vietnam, like in India, like in Mexico, in Russia. Those are huge market but you need to be there to install manufacturing, manufacture the product locally and distribute locally through direct to store or franchising a store. We have a turnkey program, product, selection process, factory, networks, retailer, Natuzzi Italia, Natuzzi Editions, huge investment. That’s what we have done in the last 10 years. Now we look just to get a return on investment. We don’t have more time, period. We don’t have more time. We know that. And I must tell you that the management is fully aware of and very much motivated. And that really makes me feel 30 years younger, believe it or not.”

5. With a big backlog and favorable conditions in end markets, cost headwinds easing/cost cut programs enacted, NTZ should generate a sizeable operating profit in 2H20.

Why is the stock cheap?

• The stock has burned a lot of people over the last 20 years.

• A potential future rights issuance. “In light of the extraordinary challenges imposed by COVID-19 on the Group, on February 28, 2020, the Parent’s majority shareholder entered into an agreement with it setting forth its undertaking, should the Parent so request, to make advance payments of up to 15,000 to satisfy the subscription price of a future rights issue. On February 28, 2020, the Parent requested an initial payment of 2,500 which was received on March 2, 2020.”

Rights Issue

The Company undertakes to do everything in its power to ensure that, by no later than September 30, 2020 (the “First Term”), a shareholders’ meeting will be held to approve the Rights Issue reserved for subscription by all shareholders for a minimum amount (including any share premium) of Euro 15,000.000.00 (fifteen million/00), to be fully paid by December 31, 2020 (the “Second Term”), even in several tranches, by means of a cash payment, and to grant the Company’s board of directors all the powers necessary to carry out the Rights Issue according to the terms and conditions that will be determined by the Company’s board of directors.

By signing the agreement, the Shareholder expresses his intention to vote in favor of the Rights Issue and to subscribe it for the amount necessary to reach the minimum total amount of Euro 15,000,000.00 (fifteen million).

Condition Subsequent and Reimbursement

The advanced payments are to be considered payments for the future Rights Issue and, therefore, are subject to the condition subsequent consisting in the failure to approve the Rights Issue by the First Term and to execute it by the Second Term.

Consequently, if by the First Term the Rights Issue will not have been approved or if by the Second Term the Rights Issue will not have been executed, the sums paid by the Shareholder shall be immediately reimbursed by the Company to the Shareholder, in whole or in part, to the extent they exceed the amount of the Rights Issue actually executed by the Second Term.

• My counterpoint:

• The picture has changed since they announced a potential future rights. The company will be grossly overcapitalized in Q4 due to asset sales, gov loan, and they are generating cash.

• I think they are holding off on voting on the rights in anticipation of receiving the government loan and/or asset sale proceeds. If they get just €40M that would give the company plenty of liquidity – pf cash of €71M would mean a rights is not practical in the near term.

• By (potentially) going with a rights he would give all shareholders the right to not be diluted. If he had nefarious intentions, he would fill out a secondary himself at a LSD stock and significantly increase his ownership with a small(er) check size. Or if he didn’t think the company was salvageable, he would’ve done a loan with lien on assets like brand/IP. 

• Pasquale talks about how long-time employees own the stock and he doesn’t want to take them out at rock bottom. 

• If there does end up being a rights offering then I think the stock still settles at levels not too far from present. I think with existing cash, the gov loan, rights proceeds, and non-core asset sales, NTZ would have €110-€130M in cash (or $140M+ USD).

• The company has kept a low profile and has not done an earnings call in 10 months. The company has no research coverage.

Catalyst

Receipt of government loan; non-core asset sales; monetize China JV; new JVs; fundamental growth.