Description
Rowe Companies (Ticker: ROW)
October 20, 2004
Full disclosure: This is not a recommendation to buy or sell the stock. We own shares of the company that we may buy or sell at any time.
Rowe Companies (Rowe or the “Company”) is a furniture wholesaler and retailer (60 stores) that can be characterized as a “growth turnaround” trading at a value multiple. We believe its shares are attractively priced at approximately 10x 2005E EPS and 6.0x trailing EBITDA. Rowe Companies’ $301 mm in trailing sales are split between its retail concept, Storehouse, and its manufacturing arm. Storehouse, a peer to Pottery Barn and Crate and Barrel, is a “homerun” concept with the potential to become a several hundred store chain. Storehouse has outperformed its furniture peers this year by registering high single-digit comparable store sales (“comps”), a fact made even more impressive by difficult year-over-year comparisons (2003 showed double-digit comps). Without dramatically increasing its current infrastructure, Storehouse could grow to 100 stores, implying tremendous operating leverage as the company adds 9 stores over the next six months (a 15% increase to their current store base). The manufacturing side has been showing low-single to mid single-digit growth, providing the cash flow to both grow the retail concept and reduce the Company’s debt load. The company lowered guidance in early September due problems with an ERP implementation on its manufacturing side. While there is likely to be a slight “hangover” into Q4, this problem should be viewed as a one-time operational “blip”, and therefore should not overwhelm the stock’s attractive valuation
Business Description/History
The company has been a manufacturer of upholstered furniture since 1946. In the late nineties, the company entered the retail furniture business by growing its own chain, Home Elements, and later acquiring Storehouse. The retail operation underperformed until Caroline Hipple, a furniture retail veteran, was hired in 2001 to turn the operation around. In the first year, she stabilized the sales of the operation and recruited strong senior mangers. In 2002, she consolidated the two chains, re-branded the Home Elements stores as Storehouse and rejuvenated the in-store staff. She worked to position the chain as a lifestyle retailer offering high-quality furniture for a good value, catering to a mid- to high-end customer with an eye towards design. Storehouse is more purely furniture-focused than either of its peers (i.e. Pottery Barn, Crate & Barrel). It leverages the manufacturing strength of its sister company by offering more custom fabrics than its peers, while still providing competitive delivery times. The salespeople are encouraged to get design certification, allowing them to help the customer “design” their home, and again, providing superior customer service relative to their peers. Caroline’s efforts since 2001 have resulted in double digit comps for most of 2003 and high single digit comps in 2004. Three new stores have been opened in the last year. In the first year, the new stores are expected to generate about $2.4 mm in revenue and $0.2 mm in store-level EBIT. Given an initial investment of $0.7, a new store thus generates an attractive first year return of 28%.
Historically, the Storehouse segment has been unprofitable for Rowe Companies. This year, due to the efforts of Caroline Hipple, the segment has become EBITDA positive and is expected to become operating income positive next year. The addition of new stores as well as continued strong comps has allowed the company to leverage its bulky infrastructure to profitability. As little additional overhead expenditure is needed to expand the store base within its current footprint, tremendous operating leverage is expected as the store base expands
The manufacturing side specializes in upholstered furniture. Their primary customers historically have been specialty furniture retail stores. In addition to a strong design team, one of their core advantages has been an extensive fabric selection, allowing the end customer more options for customization than other manufacturers. The manufacturing operation has an industry-leading 30-day delivery timetable. With competition increasing on both domestic and international fronts, Rowe has initiated several new competitive initiatives. First, they are implementing a new ERP system in order to increase the productivity of their workforce. Second, they are moving to a 10-day delivery time frame by moving to a “lean manufacturing system”, in essence adopting the Toyota production methods. Combining the 10-day delivery time with these custom options provides Rowe with a powerful advantage over international competitors and helps insulate them from competing solely on price. Third, Rowe is beginning to market to department stores. In the spring season, they first started shipping orders to May Company.
Rowe Companies was on the brink of bankruptcy in 2001. Acquisitions in 1998 of Mitchell Gold (a wholesale line) and Storehouse, combined with the building of a brand new plant in 2000 brought net debt levels from $0.9 mm in 1997 to $56.7 mm in 2000. 2001 brought a recession where consumer demand for furniture stalled, resulting in the bankruptcy of two major customers. At the end of 2001, Rowe had $59 mm in debt and negative operating income and was facing a liquidity crisis. Since then, Rowe refinanced its debt, sold off the Mitchell Gold division, and decreased net debt to $34 mm by the end of 2003. Rowe’s current balance sheet is strong, with net debt to EBITDA of 1.8x, EBITDA to Interest of 4.4x, and net debt to cap of 35%.
The company is run by Gerald Birnbach, who is Chairman and President, and two other senior management positions are held by relatives of Mr. Birnbach. Insiders own 33% of the firm, per the proxy dated 2/13/04, with combined Birnbach family ownership of approximately 15%. There was some insider buying in March 2004 at $3.50. Two research firms, BB&T Capital Markets and Ferris Baker Watts, cover the company and have buy ratings on the stock with price targets of $7.
Valuation/Numbers
Market value, based on a $5.05 share price and shares of 13.6 mm, is $64 mm. Net debt is $29.4 mm as of Q3 ’04 reported on September 22, 2004. LTM sales (ending Q3 ’04): $301 mm with the following segment breakdown -- Wholesale: $163 mm, Retail: $138 mm. Sales growth in the last quarter was 5.1% on the wholesale side, and 13.6% on the retail side. LTM EBITDA is approximately $16.5 mm. This represents an increase of 56% off of the LTM EBITDA ended Q3 ’03 of $10.5 mm. The EBITDA increase is mostly due to strong performance of existing Storehouse stores, as well as the opening of three new stores which allowed the company to better leverage its operating costs. LTM EPS is $0.30/share. EPS in 2003 was $0.03/share. First Call estimates for 2005 are for $0.53/share. The company is self-funding its store expansion plans, using the strong cash flow from the wholesale side to fund new Storehouse stores while decreasing corporate debt levels.
2005E P/E : 9.9x
EV/LTM EBITDA: 6.0x
EV/LTM Sales: 0.33x
In comparison, Williams and Sonoma (owner of Pottery Barn) trades at 19x 2005 EPS, Bombay Companies trades at 35x ’05 EPS, and Pier One Imports trades at 14x ’05 EPS.
Recent/Upcoming Events
1) The company presented at the Thomas Weisel Retail Conference in New York in September ~ they have never attended a large conference of this scale before.
2) The fall furniture show at High Point, NC will be open to trade-buyers and investors started on October 14.
3) Q4 earnings are expected in mid-January
Catalyst
Catalysts/Risks
1) Opening of 9 new stores in the coming six months will drive dramatic earnings growth as well as increase Storehouse’s exposure within its existing markets. Of course, the aggressive expansion plan does add execution risk.
2) Company continues to pay down debt and focus on de-levering the company. The sale of some non-core real estate assets announced in the most recent quarter should help further decrease the debt-level in the near-term.
3) ERP system and “lean manufacturing” will be implemented over the next six to twelve months. The ERP system already hurt productivity and margins in the third quarter, and will likely pressure results for the next six months. There is always the risk that the implementation does not go well and that sales are permanently lost as customers choose other suppliers.