Description

Natuzzi is the world’s largest leather furniture manufacturer. It’s a well-managed company with good cash flow, historical 20%+ ROEs on a net cash position, selling at a P/E of just 7x.

Natuzzi is an Italian manufacturer of leather-upholstered furniture, 50.1%-owned by the Chairman and Founder Pasquale Natuzzi, with ADRs that trade in New York. He’s done a superb job growing this company to its current US$800 million in revenues, with #1 market shares in its niche (leather furniture) in both the U.S. and Europe. From its NYSE listing through 1999, just before the industry downturn began, NTZ had compounded both sales and EPS at just over 15% per year. It’s averaged 15% operating margins as well, which is impressive when stacked up against the high single-digits that Furniture Brands or La-Z-Boy tend to do. That 15% is comparable to much-admired Ethan Allen’s margins, which I think is remarkable given that Ethan captures the retail margin as well, while NTZ is essentially a manufacturer only.

To top it off, throughout this time, NTZ has maintained returns on equity in the 19-23% range, all the while operating with net cash on its balance sheet. Thus, despite whatever images one may have about closely-held, old-line Italian companies (and Fiat has not really helped in this regard), it’s hard to argue that Natuzzi has not been quite well-managed from a financial and shareholder point of view.

Now, what’s got the stock in the doldrums (it hit a high near $30/share a few years back) is the downturn in the furniture industry exacerbated by import competition, especially from China. If you just take a look at Furniture Brands or La-Z-Boy or Ethan Allen, you’ll see that sometime around the year 2000, earnings dropped around 20-30% for most furniture companies. NTZ was not immune, but it held up a little better than the others because it only gets half of its sales from the U.S. The other half is in Europe, which only recently begun to see a big industry downturn. There’s not much anyone can do about the slump, and NTZ is just controlling costs and trying to weather it the best they can.

What’s more of a concern is the influx of China-manufactured furniture. To protect against this, NTZ created a separate, lower-end brand called Italsofa, with manufacturing in China, Brazil, and Romania. Launched in early 2001, it’s already 13% of NTZ’s sales, and has the same margins as the rest of NTZ. Just as important, it’s taken the pricing pressure off of the Natuzzi brand. It was really a brilliant move on the part of the company, and the execution has been near flawless. The segmentation of their product line into two distinct brands should protect them for quite a while, although I wouldn’t be surprised if eventually, the quality of these imports will improve enough to the point where it might threaten portions of the higher-end Natuzzi line. But I don’t see that happening for several years at least, and even then, the impact will be muted because the higher up you go in price point, the more custom-fabric and design matters. And that means an advantage for the Italy-made (as all Natuzzi brand products are) in both prestige and delivery times.

So, all that being said, what are the numbers? The stock price is $10.25 and the equity market cap is $562 million. NTZ is on track to earn just about $72 million in US GAAP net income this year, or $1.30 per share. That means the P/E is just 7.9x. Backing out the $85 million in net cash, the P/E is really 7.0x. Free cash flow generated will be around $40 million this year, but capital expenditures have picked up the last couple of years for the Italsofa launch. As this spending winds down over the next couple of years, free cash flow should start to approach, equal, and maybe exceed, net income, as it often has in the past. Other furniture companies (specifically, Furniture Brands, La-Z-Boy, Stanley, and Ethan Allen) trade at P/Es ranging from 11x to 15x. And until the recent downturn, Natuzzi itself used to trade around a P/E of 15-20x. Whatever view one may have about the near-term outlook for the industry, NTZ shares seem exceedingly cheap.

One thing I really like about this company, by the way, is that management is not averse at all about returning excess cash to shareholders. They pay an annual dividend – a 2.5% yield at current prices. And, unusually, after accumulating cash for the first five years post-IPO, they paid out special dividends in 1997, 1998, and 1999, totaling $2.32 a share. Then, after the stock tanked in 1999, they bought back a bunch of shares for a couple of years. Pretty nifty, I’d say.

Why is the stock so cheap? I’m not completely sure, but I can speculate. The liquidity of the shares are quite low. Being an Italian company probably doesn’t help. And all important to many, there’s no near-term catalyst. A lot of investors looking at furniture stocks (“a lot” being a relative term) would rather buy a Furniture Brands or La-Z-Boy where the earnings are seeing an uptick now, rather than one like NTZ where the European exposure means a lagging downturn and recovery. Also, there might be some confusion with the tax rate, which will jump from 22-23% this year to 27-30% starting next year as their Italian municipal tax breaks have expired. But that’s common knowledge, and all things equal, would translate to a 10% drop in earnings. Not enough to really change the valuation dynamics.

Look forward to questions and comments, and Buono Appetito!

Catalyst

Valuation
Use of excess cash