A good company in a so-so industry that is going through bad times. Not a particularly compelling investment thesis, and this isn’t the best or the cheapest company offered up here. Still it’s an easy to understand company providing a 8.45% FCF yield at current prices that is both well run and under-leveraged considering the cash it generates. The last point will likely be remedied due to a massively stepped up its buyback plan to allow for a notional reduction in share count of nearly 20% at recent prices.

Stanley Furniture (STLY) is active in the upper-middle end of the residential wood furniture market as a manufacturer and distributor. Aside from STLY and other furniture makers being met with general investor disinterest in all things housing-related, business has softened and many of STLY’s competitors have been putting in appearances on the 52-week low list.

 

Judging solely on the mercifully low standards by which furniture companies are judged, you might conclude STLY is side-stepping whatever’s hitting its peers. For instance, they achieved an ROE of 17.49% last year with cash on the books. Other stats – such as the halving of incremental margins to 9.9% last year and the painfully obvious drop in revenue and net – suggest the they’re getting hit just as hard. Frankly, I don’t know which conclusion is correct or when things will improve.  But given STLY’s rather unique operating model (described below), and the likelihood of modest seasonal improvements beginning this quarter, I don’t think STLY will follow its peers should they go much lower. Some background is in order before moving on to the business model.

 

 

The company dates back to the 1920s. In 1985 Albert Prillaman, essentially a lifer at Stanley, succeeded to the company’s chief executive office. Prillaman began differentiating the company from its competitors by shortening production runs, with the lag between orders and shipments narrowing in consequence. To this day, Stanley averages less than two weeks between receipt and shipment on orders. DSOs last year were just under 40, though this rose to 46 at the end of Q1 06. I’m showing that competitor Bassett Furniture averaged something like six times this in 2005.

 

There were a few organic growth initiatives (a brief excursus into the upholstered segment ended when returns didn’t measure up to expectations), but Prillaman largely focused on the niche STLY had staked out. Performance proved the wisdom of the move. When competitors were running themselves to ground, STLY began a run that would end in Q3 2000 with 21 consecutive quarters of record earnings.

 

2000-2001, though, brought upheaval at Stanley (which hitherto operated basically as a straight-up manufacturer) as imports began squeezing the industry. HomeLife, the company’s largest customer accounting for 7% of sales, was bankrupted and shuttered, and Stanley wrote off everything it was due. Management began instituting change.

 

 

 

Most immediately, a facility employing 13% of STLY’s workforce was closed. More importantly, management moved to a “China-proof” blended model where they continued to manufacture goods on which they could maintain margins while importing pieces on which they felt they could not compete realistically. Crudely put, big irregularly shaped items are manufactured while flat-stacking numbers are sourced from Asian vendors. STLY is currently sourcing about a third of its sales from overseas.

 

As can be expected, the sourcing initiative lead to inventories swelling. Somewhat counter-intuitively, though, the larger inventories permit them to maintain their 14-day receipt to delivery turns (the paired Asian chairs have to be on hand to complement the STLY-made table). Despite the need to now maintain an inventory, they’ve done a pretty fine job managing their working capital. STLY is one of those companies where you can only look at their Value Line page and marvel at the regularity.

 

Last year they began stumbling a bit. Briefly, they disappointed sales expectations on the past few quarters – though these were comp-ed on prior years that saw double-digit growth. Q2 results showed sales were down 7.36% while net plummeted 32.43% on a YOY basis.

 

Reasons are several. First, energy and materials (lumber) costs were up. Second, margins were down on account of a seasonal inventory build (normal), depressed sales (worrying, but again having a seasonal component and typical of the industry as a whole) and operating inefficiencies. Management has indicated inventories will likely be worked through in the second half, when sales are historically higher. On recent calls, STLY reported inaugurating Toyota-style lean manufacturing and lean office programs.

 

 

 

I imagine these would be foremost among the concerns of potential investors. Housing I’m agnostic on. As to the others, I am mindful of them, but can’t help but note that they’ve long been in operation, often in less ameliorated form. For those with some interest, there has been some good give-and-take on these matters in prior furniture write-ups here, and I refer readers in particular to the excellent Furniture Brands treatment (and subsequent Q&A) submitted by wizard877. I agree with most of what he/she said on regarding these, and indeed would amplify much of it in the case of STLY: I have now read several accounts of middlemen getting damaged goods or getting their orders so late from Asian suppliers that cost advantages are lost. There was an article in the Daily Deal a few months back about Pennsylvania House having to throw away truckloads of Chinese goods, the pieces being so shoddy and remedy being remote, costly and time-consuming. Yes, this is anecdotal, but it goes to what I believe is a superior operating model providing durable competitive advantage for STLY.

 

 

 

That’s what this ultimately is. While also paying a modest (but growing) dividend, management is a keen buyer of their own shares when prices are right. Long periods can pass when no shares are bought back, but when prices are right the purchases are dramatic. 1.06 million were bought back in 2005. As of the start of the present quarter, they had bought something like 635,000 shares back for an average of $25.44 per – almost 10% above today’s close.

 

Before announcing recent results, the company announced the board had increased the amount available for buybacks to $50 million. More on this below.

 

 

 

Valuations of the sort detailed by Greenwald et al in their excellent Value Investing: From Graham to Buffet and Beyond are becoming a prerequisite here. The formulas are given in the book, and I tried to bake some conservatism into the calculations by understating some of the assumptions. I upped the WACC to 8.25 from what I calculated as 7.9. Revenue growth since adopting the blended model has been almost 9 percent. I used 5 instead as five years of history is pretty inconclusive. I went with an ROIC of 11.75, which is the average since they started importing (it has been rising – last year’s was a bit north of 13). This got me to $28.40 per share, almost 20 percent above the current. If they were to leverage up and complete their buyback tomorrow, the notional reduction in share count and WACC gets me just over $40 per share.  

 

As noted in the most recent earnings call, the $50 million is about what they spent on buybacks over the last 18 months. If it takes them that long to spend their knot this time around, the approximate $30 million in cash they generate over those 18 months will largely provide the funding, leading to a less pronounced leveraging benefit.

 

 

Bassett Furniture (BSET), Haverty Furniture Companies (HVT, which yesterday reported a 10.3% jump in same store sales), Chromcraft Revington (CRC – subject of an excellent treatment here by cogitator505) and Hooker Furniture (HOFT – via which steve308 delivered members a triple in under two years) are some of the logical comps, though none shares STLY’s exact niche. Yahoo!, first resort of the slothful, is source for the data in the below, hence any variation from above figures for STLY:

 

 

 

Note: For FCF I used net income plus D&A minus total CapEx, as I can’t really tell how much is maintenance.  CapEx last year was $4.9 million versus generous depreciation of $5.6 million. I’ve used 2005’s full-year figures in the present calculations as the numbers are incurred and recorded irregularly. Management has suggested these numbers will come in relatively unchanged this year.  Warehousing requirements have been a topic of conversation on the last several earnings calls. While they’ve been leasing space as required, there is a possibility that they’ll build a facility of their own at some stage. Balancing this to a degree are statements over the past year that they believe they have surplus plant capacity to do as much as an additional $100 million in sales.