|Shares Out. (in M):||15||P/E||0.0x||0.0x|
|Market Cap (in $M):||57||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-50||EBIT||0||0|
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I believe Stanley Furniture (“STLY” or “Company”) is near an inflection point which makes the stock an attractive investment opportunity for a potential 50% return or more in two years or less. This assertion is likely to drive significant disagreement (but that’s obviously what makes a market) since the Company has incurred a decline in sales in each of the past six years and it hasn’t generated one year of positive operating income since 2008 (adjusted to exclude restructuring charges and the impairment of goodwill). However, I believe those in disagreement are not ascribing much weight to the Company’s strong balance sheet ($3.45 in net cash per share), the equity’s substantial discount to its tangible book value ($6.58 of TBV per share), and the benefits that are likely to materialize from management’s strategic and restructuring actions.
Although the majority of my thesis is based on the downside protection of the balance sheet coupled with the likelihood I am ascribing to a successful execution of a turnaround to improve margins and free cash flow, a potential rebound to the housing and/or remodeling market would provide an additional tailwind that is not reflected by the current equity price. There are many articles everyday that characterize a potential rebound to the housing market and there are persuasive articles each day that refute the housing market rebound assertion. Suffice it to say that a housing rebound is a favorable tailwind to the furniture industry and therefore also to Stanley Furniture to the extent the Company executes effectively in the marketplace.
As a result of the decline to demand for almost anything related to the housing sector compounded by typical transition challenges when moving manufacturing operations, the Company’s results in the past few years have been extremely poor. For the years 2009-2011, the Company lost $51.5M in total operating income, it lost $34.5M of total EBITDA, and burned through a total of $25.7M in cash. However, in the prior seven years (2002-2008), the Company generated an average of $23M in operating income and $30M in EBITDA (the median figures are higher). The housing market was clearly much better for the period 2002-2008 and that’s quite evident by STLY’s sales in 2011 (~$105M) being down by more than 60% from the Company’s average for the period 2002-2008 (~$281M).
Although I am not asserting that STLY will generate anything close to $20M of operating income anytime soon, I believe that positive operating income is finally probable this year. In the most recent annual report, the CEO wrote, “We believe we are better positioned for growth than we have been in years, and we also anticipate reaching operational profitability at some point in the second half of this year.” My thesis is based on 2012 continuing to be a transition year that drives towards a much improved top-line and margin in 2013-2015.
I do not believe the ~$7M of current enterprise value (adjusted to include the $40M of cash recently received as reported in an 8K on April 25th) ascribes much likelihood to any positive income being generated this year or anytime in the near future. The stock currently trades at 60% its tangible book value and although I anticipate cash burn this year, the $3.45 in net cash per share plus an additional $3.13 of tangible book value (primarily in finished goods and PP&E) provides an investor with both attractive downside protection and a source of potential upside. The peer group currently trades at a multiple of TBV from 0.7-2.3x, for an average of 1.3x. The peer group multiples of revenue, EBIT, and EBITDA are currently 0.4x, 10.6x, and 7.7x, respectively. STLY doesn’t have positive EBIT or EBITDA but is currently trading at 0.07x its revenue.
Revenue Gross Profit EBITDA EBIT
2011 $104.6M $12.9M $(4.7)M $(6.4)M
2010 $137.0M $(5.7)M $(16.9)M $(26.3)M
2009 $160.5M $7.0M $(12.8)M $(18.8)M
2008 $226.5M $34.4M $12.3M $3.5M
2007 $282.8M $45.5M $20.0M $10.9M
2006 $307.5M $58.8M $28.6M $22.7M
2005 $333.6M $75.1M $43.1M $37.4M
2004 $305.8M $70.7M $40.3M $34.7M
2003 $265.3M $58.5M $32.0M $26.2M
2002 $243.5M $55.7M $33.6M $25.9M
Stanley Furniture has been undergoing a major restructuring based on moving their manufacturing operations for the namesake brand abroad and moving their manufacturing operations for the Young America brand back to the U.S. In 2009, the Company ceased all overseas production of the Young America line, moving it to the United States. In May 2010, Stanley Furniture conceded that its days of being a predominantly domestic manufacturer would end with the termination of over 500 jobs in Virginia (or more than 40% of its workforce).
Although the Company is still not profitable, it’s on a trajectory to achieve such this year. The restructuring is evidencing improvements as most recently shown by gross margin in the first quarter which improved by 420 basis points, but at just 13.2% gross, there’s much opportunity that still remains to be achieved. In 2011, the Company’s gross of 12% compared favorably to the prior two years at negative 4% in 2010 and positive 4% in 2009 but much worse compared to the 20% average achieved by STLY from 2002-2008 (over this period, STLY generated a range of gross margins at 15-23%). The peer group (adjusted to exclude the retail segments) generates gross margins at ~20%. Management has said its gross margin for the Stanley brand (~60% of overall company sales) is similar to the peer group but the Young America brand is well-below. This is largely because sales at Young America are not yet at a requisite level coupled with a domestic manufacturing strategy that has yet to be optimized for efficiencies.
In 2007, management estimated that 80% of the wholesale residential wood furniture market sold in the U.S. came from Asia, primarily China. Since Stanley Furniture has only recently initiated the outsourcing strategy, management believes they lost market share as is described in the Management Discussion and Analysis of their recent 10K. “We also believe some loss of market share resulting from the transition caused by the major restructuring of our business contributed to the decline.” The decline that management refers was the 35% decline in revenue that materialized from 2009-2011. Over this same period, the peer group averaged a 3% increase in revenue.
From discussions with interior decorators, furniture design showrooms, and numerous furniture retailers, there is an overarching perspective that Stanley is a strong company that lagged the industry (e.g., less new designs, less customer service focus, less intensity of focus) in the past 2-3 years but there is also a shared perspective that improvements continue to be made across numerous areas (e.g., more innovative designs, more customer service focus, a better value proposition). In general, the anecdotal commentary from this primary research suggested an increasing intent to purchase from Stanley Furniture. There was also a consensus view that the Young America product is differentiated and commands a premium price accordingly.
In addition to the substantial downside protection provided from the balance sheet, it’s noteworthy that management is not communicating wildly-optimistic expectations, and thus setting more appropriate expectations for a turnaround which can often take more time than initially envisioned. The CEO recently wrote in the Company’s annual report, “Our near-term outlook on consumer demand in the premium segment remains unfavorable, but certainly more favorable than a year ago. I will also readily admit to the challenges that lie ahead for our company—and our industry—as we have much work to do and we have not yet seen sustainable signs of a recovery in either housing or consumer confidence.” However, a more optimistic tone was communicated several times on the most recent earnings call as it pertains to the ongoing turnaround efforts. Management emphasized the strength of their balance sheet, especially with the pending $40M of cash that was anticipated (and now has been received), and that neither management nor the Board viewed the magnitude of the Company’s net cash position being required to execute their turnaround. Management cited more than once that “this is the shareholders’ cash” and although they were not specific about any intent to return that capital, I expect either a dividend (it was $0.40 annually per share until it was terminated in January 2009) to be re-instated, a special dividend to be paid, and/or a buyback to be announced.
A few insiders have shown their personal confidence regarding the longer-term investment opportunity as evidenced by the CEO, CFO and a Board member purchasing over $320,000, in aggregate, at a range of $2.75-5.37 since March of 2011; the Board member made a purchase of 10,000 shares one month ago at $4.52. It’s also interesting to note that Peninsula Capital owned ~8% at the beginning of 2009. Peninsula Capital was led by Ted Weschler who closed his firm when he was selected by Warren Buffett to be a co-portfolio manager at Berkshire recently.
As with any turnaround, I do not envision the trajectory to be linear but I am confident, after speaking with management, former employees, and furniture buyers, that Stanley Furniture is well-positioned to improve its status in the home furnishing industry and consequently generate more attractive financial results. The balance sheet affords time to do such and I anticipate some capital will be returned to shareholders before the turnaround is deemed “completed”.
Summary Company Description
Stanley Furniture is a leading designer, manufacturer and importer of wood furniture in the premium segment of the residential market. The Company targets the adult market with its Stanley Furniture brand and the children’s market with its Young America brand. An import model serves the demands of the Stanley Furniture customer, while a domestic manufacturing model supports Young America.
Management markets the Stanley Furniture brand to the upscale home furnishing segment and seeks to differentiate Stanley from competitors through styling and finish execution as well as wide selections for the entire home including dining, bedroom, home office, home entertainment, and accent items. The Young America brand is marketed as the trusted brand for child safety. In regards to the children’s market, management believes that its customers associate a higher level of product safety and quality to products that are “Made in the U.S.A.” Although management decided that it was prudent to move production of the Stanley Furniture brand abroad to improve manufacturing cost efficiencies, they decided they could differentiate their youth product by controlling the production for the Young America brand and do so primarily through their North Carolina manufacturing facility.
Every item shipped from Young America on or after September 16, 2009 has been made in the United States, and comes with a five-year manufacturer’s warranty. In addition, Young America manufactures the only cribs in America to be certified by both the GREENGUARD Environmental Institute and Intertek for child safety. The Company’s cribs meet the California’s strict chemical emissions test for building products used in schools, offices and other environments where children are present. Young children spend nearly 85% of their time indoors, where the air can be two-to-five times more polluted than outdoor air because of toxic chemical emissions from everyday products. GREENGUARD Certification means that Stanley’s Young America products have been independently tested to meet the most stringent chemical emissions standards in the world. Although there is a premium price paid for Young America, there’s a category of parents and grandparents that will always opt for paying the premium to be assured of leading quality and safety standards. However, as noted earlier, the Young America brand has yet to achieve the economies of scale warranted to achieve an attractive gross margin. This is a critical area of management attention.
2011 was the first year when the Stanley brand was all manufactured overseas. Although much improvement is still required, the brand was profitable. Management believes the Stanley products have styles and finishes that make the brand known as the value alternative to the luxury market. Style and finish are the critical components of product differentiation in the luxury residential wood furniture market. There is currently little differentiation from one furniture company to another in the ability to deliver on a timely basis from offshore manufacturing sources without excessive inventory exposure. However, management believes this is an opportunity where they can achieve logistical improvements and gain share. The Stanley Furniture product line is imported from a small number of specialized furniture manufacturers in Southeast Asia, primarily in Indonesia and Vietnam. Management believes that it is the most important customer to a minimal number of smaller, specialty manufacturers.
The Young America brand is not yet profitable. Management believes they are roughly half of the way towards modernizing manufacturing processes that include more factory automation. Management envisions that control of the domestic Young America manufacturing operations will, in addition to appealing to a higher-end consumer focused on child safety, create a flexible manufacturing footprint that enables a more favorable cost structure, shorter lead times, and higher inventory turns. In 2011, the Company invested $4.2M in new machinery and equipment and in 2012 another $4-5M will be invested to sufficiently automate the plant. Furthermore, since management wants its customers to have better information supporting the sale and delivery of STLY products, the Company will have invested ~$3M by the end of 2013 for new systems that should make “doing business with the company more desirable.”
The Company has a broad domestic and international customer base. Their products are sold primarily through independent sales representatives, independent furniture stores, interior designers, small specialty retailers, regional furniture chains, buying clubs and e-tailers. In 2011, the Company sold product to ~2,300 customers and recorded ~11% of sales from international customers. No single customer accounted for more than 10% of sales in 2011. At year-end 2011, the Company employed 540 associates domestically and 55 associates overseas. None are represented by a labor union. The Company’s ~$176,000 in revenue per employee (or “associate”) in 2011 was ~37% more than the average over the 2002-2008 period. Although STLY has yet to demonstrate the requisite improvement in gross and operating margin, the improved productivity metric as evidenced by revenue per employee demonstrates important progress.
Selected Risk Considerations
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