Stanley Furniture (STLY) designs and sells high-end wooden casegoods under two brands: Stanley (adult furniture, 62% of 2012 sales) and Young America (nursery and youth furniture, 38% of 2012 sales).  STLY: 1) has no debt, 2) had $1.57 per share in cash at the end of June, and 3) trades at 65% of tangible book value and about 90% of a crudely-calculated liquidation value.  Stanley appears to be in the 7^th inning of a turnaround, with all significant cash restructuring costs (~$14mm) behind it.  The company has previously been written up on VIC as a long, and since its latest discussion in June 2012, quarterly sales levels have largely remained flat amid weak demand for high end wooden furniture.  During this time the company has burned approximately $23mm in cash (with most reinvested into the business), and its share price has fallen by 10%.  I came to learn about Stanley when my wife insisted we buy “Made in the USA” nursery furniture before welcoming our first child late last year.

Management claims the top priority of it and the board is conservative cash management, and has repeatedly stated the company will become cash breakeven at an approximate $120mm run-rate of annual sales.  This is 25% above trailing 12 month sales levels and notably, well-below the ~$300mm annually the company was achieving just prior to the housing crash.  It’s very important to note that the Stanley line, which is now entirely outsourced to higher-end factories in Indonesia and Vietnam, is already running at positive cash flow.  Losses at the Young America (YA) segment however, overshadow the Stanley line’s profitability.  Using management’s $120mm breakeven bogey implies that YA needs to grow its sales by almost 60% in order to achieve company-wide profitability.   Though it’s a tall order, I believe this is achievable within the next 12 to 24 months as Stanley: 1) mends and expands its relationships with YA retailers after months and months of frustration brought on by the company’s restructuring; and 2) benefits from macroeconomic tailwinds including a housing recovery and the return of first-time home buyers.  Note that at its current sales run-rate, Stanley will likely burn approximately $2-3mm of cash per quarter.

Amid a nursery & youth market rife with inexpensive Chinese imports, and with sales significantly hurt by the recession, management decided its only viable strategy with the YA business was to move further upscale.  Hence over the last two years, management has invested approximately $12mm to bring YA production entirely onshore via repurposing its aging plant in Robbinsville, NC.  Over this time it also upgraded the design, hardware, and customizability of the entire YA line.  And though YA certainly sells for a significant premium to nursery furniture imported from Asia, it is unique in that it can claim it’s made entirely in the United States and meets Intertek and Greenguard certification standards (see: http://youtu.be/khtWOzYq7qE for a quick look at the revamped-- and currently under-utilized-- NC plant, as well as http://www.intertek.com to learn more about Intertek’s testing methodologies for determining safe design, and http://www.greenguard.org to learn about Greenguard’s chemical emissions standards and testing methodologies).  The Wall Street Journal even profiled Young America last May as part of its “Remade in the USA” series (http://on.wsj.com/JsFP94).

In addition to quashing fears about dangerous chemicals potentially being found in imported Chinese furniture (i.e. formaldehyde), YA incorporates best practices for safe design, including tip resistance, automatic soft-close drawers (which make it nearly impossible to pinch fingers), and adjustable levelers.  Even the design of its dresser hardware is excellent.  First, the metal hardware is encased inside the dresser itself so a child can’t cut themselves on exposed metal tracks while the drawer is open.  Second, the drawer removal mechanism is controlled by two non-greasy and easy-to-squeeze levers (think bicycle brakes) found underneath the drawer near the front of the drawer’s face. Lastly, for those parents attempting to color match their child’s nursery, the entire YA line is available across numerous wood stains, nearly two dozen paint colors, and up to five finishing techniques.  This level of finish customization is simply not available on most entry level nursery and youth furniture from Amazon, Babies R’ Us, Buy Buy Baby, or something in stock at a discount furniture store given the long lead times and domestic warehouse requirements of imported furniture that prevent customizability.

As mentioned above, Stanley’s restructuring strained its relationships with YA retailers.  Repatriating YA manufacturing, while revamping the entire line with new designs and hardware upgrades, essentially prevented the company from taking new orders.  Retailers couldn’t replace showroom floor sets with the most-up-to-date models, and any customer orders for new models faced significant delays.  Supply chain issues are in the past however, as Robbinsville is up and running, and the company is completing the roll out of a new ERP system that will be both customer-facing and deal with inventory management. 

In addition to self-inflicted wounds, the weak economy continues to be a headwind for the company.  According to management, casegoods typically lag general housing activity by 12 to18 months, which may explain why sales have been hovering near historic lows.  Companies that have exposure to upholstery have generally performed well.  Stanley’s LTM sales stand at just 32% of 2006 levels, vs. 65% for a basket of publicly traded furniture makers.  Standouts include La-Z Boy at 82% of 2006 sales, Basset (BSET) at 92%, and Ethan Allen (ETH) at 73%.  Laggards include Stanley as well as Furniture Brands International (FBN) at 44%.  It should be noted that FBN is dealing with high debt levels amid sluggish end demand.  It appears FBN management may be lowering prices to help unlock working capital as its margins have been deteriorating.  I believe a restructuring of FBN would yield either more rational pricing or lead to the exit of certain unprofitable business lines altogether.

On the economy front, I argue that YA in particular has been hurt two dynamics which are very likely correlated: 1) first time home buyers have largely been absent from today’s housing recovery (the WSJ had a front page article on this very subject on 7/23/13 which can be found here: http://on.wsj.com/15DfFqa); and 2) brought on by the US recession, birth rates have been declining (especially among those whom I guess to be the affluent target market for YA furniture).  On point #1, I expect that as mortgage refinancing activity slows due to recent spikes in bond yields, banks will be forced to relax underwriting stringency to maintain volumes, which will capture younger borrowers.  On point #2, according to the CDC the number of U.S. births resulting in triplets or higher per 1,000 women between the ages of 15 and 44 hit a 15 year low in 2010.  I use the number of high multiple births as a directional proxy for YA’s core affluent market given the likelihood such births were the result of some type of fertility treatment (usually reserved for those that can either afford such treatment or have “Cadillac” health insurance).  While detailed information about multiples is not available beyond 2010, I do note that total U.S. births finally reversed a 4 year decline, with 2012 births of 3.958mm up very slightly over 2011.  Overall, I believe that birth rates will return to more normalized levels, providing a tailwind for YA.

The crux of my investment thesis is that, although it may take a few more quarters of treading water: 1) YA’s lost footing among retailers has been largely temporary and should be regained; and 2) macro trends should be a tailwind for Stanley going forward (i.e. a US housing recovery with first time buyers returning to the market, a generally improving economy, and stabilizing birth rates).  If these assumptions are proven incorrect, Stanley can shut YA down entirely while liquidating any associated PP&E, or perhaps it can begin producing an off-label brand or become a 3^rd party manufacturer in order to get plant utilization rates high enough to absorb its fixed costs at Robbinsville.

Risks

• Though there are many well-respected value investors in the stock who might not normally shy away from becoming active (Royce & Associates, Third Avenue Management, Fidelity, Heartland Advisors), given the tiny absolute size of the company, such efforts may not be worth their while.
• Ability to grow sales of premium-priced wooden furniture, especially for nurseries and kids’ bedrooms, in today’s economy is by no means a sure thing.
• The furniture business is a tough way to make a living- plagued by overcapacity, high capital requirements, fierce competition, and end demand which can be deferred leading to cyclicality.
• Relationships with customers may have deteriorated to the point of no return. Management acknowledges this risk, but assures investors that the disruptions are behind Stanley and now the company is actively trying to repair these relationships.
• Though the company is trading below TBV, and its major restructuring cash burn is behind it, cash balances will continue to slowly dwindle until the company’s sales improve by ~25%.  Thus the P/TBV metric will deteriorate as a result.

• revenues increase to lift company operations above FCF breakeven.
• management fixes the YA segment (as planned, or through other methods if the former fails such as divestiture, shutdown, etc) to bring company above FCF breakeven.