From at least one perspective, office furniture maker Steelcase (NYSE: SCS ) had a lousy third quarter. But as the (new and improved) saying goes, the angel is in the details.
Sales increased more than 10%, but the company didn't earn a penny more per share this time than it did last year -- just $0.22. For this, you can blame an $0.08 per-share charge "related to PolyVision goodwill and intangible asset impairments." But if you were to wave a magic wand and back out that charge, we'd be looking at a dramatic 36% improvement in profits this morning, bolstered by a 5% decline in the firm's share count (because, like rival Herman Miller (Nasdaq: MLHR ) , Steelcase has been on a stock-buying spree).
Based on what I saw in after-hours trading last night, most investors seem willing to wave that wand, or at least wave away concerns about the company's impairment charge, as the stock is trading up 13% today. And for this, I suspect you can thank two things: first, analysts' estimate that Steelcase would report earning $0.02 less than it did report; and second, management's depiction of the current business picture, and its charming prospects.
While the U.S. financial markets are volatile, management was pleased with its revenue growth and said it was consistent with its growth strategies. The numbers back that up, with international growth up 15.6% and North America up 9.4%. Along with the boost in the top line came efficiencies of scale. As a result, Steelcase was able to grow its gross margin 270 basis points to 33.5%.
Granted, the charges to earnings, plus a higher tax rate, quickly erased any benefits accruing from that improvement, but the key here is that the charges were "one-time" in nature. Over the next few years, Steelcase management promises to expand its real operating margin to 10% or 11%. If it accomplishes this, it means a doubling of operating profitability at a minimum.
Throw in continued share buybacks, and any sales growth at all -- the 4.5% demonstrated last quarter, or the 10% to 14% Steelcase predicts it will post in the current fourth quarter, for example -- and this company could be earning nearly $2 a share come 2010. With a PEG ratio of just 0.51, compared with rivals Herman Miller and HNI Corp. (NYSE: HNI ) selling at 1.15 and 1.14 PEG ratios, respectively, $17 seems an entirely reasonable price to pay today for that kind of earnings growth three years down the road.
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