Description

STLY represents the opportunity to invest in a newly breakeven/profitable (on pro forma basis) furniture  manufacturer with a meaningful net cash position at a discount to TBV, and a sharp discount to where peers trade on EV/Sales or EV/GP.  I think a >40% return is reasonably probable in the coming year, and a >100% return is possible in the coming several years.  I believe that the reason for the opportunity is that, while the situation has been well covered in the past, the lack of detailed segment disclosure historically and the lack of specific guidance going forward have resulted in a somewhat unclear future.  As details are filled in, I expect the investment to become more appealing to those who need more clarity, and the stock to re-rate accordingly. 

History

I refer readers to prior write-ups on VIC, one as recent as July 2013, for some more detailed history.  This iteration will not argue for the turnaround of Young America (“YA”), which is being shut down, but rather look ahead to life with only one brand, Stanley Furniture (“SF”). 

Focusing only on leadership, this company was carved out from Mead Corp. in 1993, run by Albert Prillaman, a former high school basketball coach who had worked his way up through sales.  Al retired four years ago, and his son Glenn, now 42, inherited the top role.  Micah Goldstein, 43, has been CFO/COO for almost four years.  The two have complementary skill sets and work well together.  They tried heartily to revive a second brand, Young America, which did approximately $120m in sales in 2005 but recently comprised only 40% (or $39m) of 2013 total company sales of $97m.  Young America was Glenn’s biggest interest, and he was reluctant to give up on what seemed to be a valuable niche brand with significant growth and profit potential, but time ran out and the company announced it had decided to shutter the brand on April 1 of this year. 

Impact of Closing  YA

The sole remaining brand, Stanley, recently reported $58m sales in 2013, down from an estimated $210m+ in 2005.  This brand has certainly lost market share (others are down much less since the peak – see former write-ups), but it has stabilized, with sales flat since 2011, and current trends reflecting the modest growth seen by other wood casegoods vendors.  The uncertainty currently revolves around trying to predict what SF looks like without YA.  However, I think that based on recent comments and disclosures, it is fairly easy to predict what this will look like when YA is gone.

First, with respect to timing, they are still filling orders for YA and expect to wind down the factory in early Q3 (if not late June).   This will likely push discontinued ops reporting into Q3, at the earliest, and this disclosure still might not be that helpful at first, as it will be backward-looking.  But I think we can estimate sales, gross margin and SG&A from recent comments.  For sales, SF order trends were up double digits in Q1, and management seemed to imply a rosy outlook for the year.  I am tempering my view to reflect the fact that competitor Hooker (HOFT) said the same in mid-April when they reported their fiscal year ended January, but were more cautious when they reported their April quarter this past week (6/5).  They had been seeing reduced order volume trends in casegoods, although still up mid-single digits.   Accordingly, I think SF sales will come in around $62-65min 2013.  Gross profit at SF, while previously undisclosed, was mentioned by the CEO as comparing favorably to peers.  HOFT reported casegoods segment gross margins in the 27% range during each of the past two years; however, I believe these may have been aided by a move into direct, and my guess is SF is running closer to 25%.  As for SG&A, I believe we can use recent SG&A around $20m and assume that it falls in line with sales in terms of allocation.  I am therefor assuming $8m of SG&A at YA, and assuming that at least 75% ($6m) can be cut, leaving total operating expenses around $14m.  So my best guess for this year looks like this:

For those interested in book value, TBV was recently $71.4m, or $4.80 per share.  I expect that there is roughly $10m of inventory at YA, and that this might need to be written down by two thirds in aggregate, resulting in a 40c writedown.  There will be some incremental losses as well, including severance and other shutdown costs, before profitability is reached – maybe another 20c.  And then the vast majority of PP&E is at YA (their modern plant in Robbinsville), and this may or may not yield an attractive salvage value, depending on how it is disposed.  We should have clarity on the disposal of these assets before year-end and possibly much earlier, but suffice it to say, at current prices this will still trade well below book value when the dust clears (discount of maybe 20-35%+). 

Where Should STLY be Valued?

STLY has 14.9m diluted shares outstanding and a little under $17m in net cash (zero debt).  I am guessing that cash will decline in the next quarter or two, but recover when Robbinsville is sold/liquidated, so I think using this cash balance is safe.  Upside exists if any buyer treats Robbinsville as anything more than a liquidation sale.  It is a recently built, modern factory, and somewhat unique in its capabilities and domestic location (allows for much quicker delivery with more complex finishing options, something YA customers and designers found valuable), and WSM (Pottery Barn Kids) and others may have an interest in Robbinsville beyond liquidation value.  But even if not, I think TEV is currently about $22m, which is 0.35x Sales and 1.4x GP based on my SF-only estimates for 2014 discussed above.  

Today, the closest peers in my mind are HOFT, and to a lesser extent, FLXS. These each trade for 0.6x Sales and around 2.5x GP, based on 2014 calendar estimates.  At these multiples, STLY would be valued at around $3.75, or 40-50% higher vs. the current quote.   I think that while STLY is smaller, as the dust clears, the stock should attain this valuation.  If anything, its size makes it a sitting duck to those who would look at STLY’s $14m in pro forma SG&A as ripe for reduction under a larger roof.  To put into perspective, management thinks 15-18% of sales is about right for this company... but may not be able to get there at current scale.  HOFT and FLXS are already in this range.  Applying to SF sales, this equates to maybe $6-8m in EBITDA at current levels, and implies an undemanding valuation 5-6x EBITDA at $3.75. 

However, there is no reason to think this cannot be a $100m brand in the next several years (still less than half its prior peak).  Housing needs to be pretty cooperative, and/or they need to recover market share, but it’s not unthinkable, and I believe this is the option management is playing for.  At $100m in sales, and $25-27m of GP, we can get to EBITDA in the high single digits ($8-10m) as a standalone company.  At these levels, the stock could easily trade for $5-6 a share (0.6-0.7x Sales, 2.5-2.7x GP, 7-8x EBITDA, and still a prime takeout candidate).  So, from $2.60, I think we’re playing for exciting upside with reasonably limited downside. 

Management

I think highly of management, which is not necessarily a consensus view.  Micah (CFO/COO) is high quality for a company this size (or larger), and Glenn, while an optimist, is principled in the end, as evidenced by his recently buying into the YA shutdown.  I do not believe either of these guys wants to run this company forever as just SF, which probably can never be a company sufficiently large enough to fully justify its public listing, and neither do they seem to have any ambitions that should give shareholders concern (acquisitions, another money-losing growth concept, etc.)  They understand that shareholders do not want any more cash burn now that the YA recovery attempt has concluded, and management has expressed unwillingness to burn cash irrespective of the external environment. 

My guess is that they pursue the currently “free” option on sales recovery at SF, and then ultimately sell the company whether or not they get there.  They have each invested in the stock personally through open market purchases and the 2011 rights offering in ways that are material (and at higher prices), and Glenn’s father (former CEO) still owns a significant chunk through various family partnerships.  Management has also been granted a significant amount of restricted stock, and they have change of control provisions which, while not prohibitive from a buyer's perspective, would also be attractive to them.  The Chairman also recently bought stock, seemingly before the YA announcement was determined.  Based on their history, I wouldn’t be surprised to see additional insider purchases once management becomes unrestricted if the stock remains near current levels.  They are motivated to maximize shareholder value, and I think they are looking at similar potential outcomes as I have laid out above.  There is probably no multi-bagger here over any reasonable time horizon, but I like the risk-reward. 

Catalyst