The housing recovery continues with the Case-Shiller Home Price index up 1% so far this year. Investors may want to consider hardwood flooring retailer Lumber Liquidators (NYSE:LL), luxury furniture seller Restoration Hardware (NYSE:RH), and tile retailer Tile Shop Holdings (NASDAQ:TTS).
However, from an owner's standpoint you want a company that generates cash and possesses enough sense to hold a little back for a rainy day. You should also prefer companies that don't take on a great deal of debt because interest on debt chokes earnings and cash flow, which both drive capital gains and future dividends. With that said, let's take a look under the proverbial hood at these three companies below.
Hardwood flooring with a smile
Lumber Liquidators maintains that its competitive strengths lie in the fact that it sources its merchandise straight from the mills. The company maintains a customer centric focus by staffing its 318 US and Canadian stores with knowledgeable associates who help the customer decide what they want and/or need. Company efforts paired with the housing recovery resulted in robust sales which increased 23% in 2013. Lumber Liquidators' net income also increased 64% during 2013. However, free cash flow declined 28% during that time frame due to increased capital expenditures stemming from store expansion. Lumber Liquidators possesses an excellent balance sheet with cash amounting to 26% of stockholder's equity and no long-term debt. The company pays no dividend as it uses cash to reinvest in the business.
Restoration Hardware sells luxury furniture through a variety of channels including catalogs, websites, and stores. Restoration Hardware wants to switch strategies to focus on "Full Line Galleries" which offer the greatest market potential and encompass a greater assortment of merchandise according to its 10k. Looking at the fundamentals, Restoration Hardware grew its revenue 30% last year. Its net income swung from a net loss of $12.8 million to a net income of $18.2 million in fiscal year 2013. Negative free cash flow shrunk from $53.2 million to $6.3 million in 2013. A 90% increase in capital expenditures stemming from expansion and investments in supply chain and distribution infrastructure accounts for the reason that Restoration Hardware's free cash flow remains negative. All of this spending doesn't leave much cash on Restoration Hardware's balance sheet with its $13.4 million cash balance only representing 2% of stockholder's equity. The company currently carries no long-term debt.
Tile Shop sells every kind of stone tile you can think of from granite to quartz to ceramic and more. Like Lumber Liquidators, Tile Shop purchases directly from producers. Last year, Tile Shop grew its revenue 26%. Net loss shrunk from $46.9 million to $35.7 million. Tile Shop's free cash flow swung from a positive $18.2 million to a negative $31.7 million during 2013. Changes in the fair value of stock warrants represents the reason the company turned a loss in 2013. Like Restoration Hardware, The Tile Shop increased capital expenditures in an effort to expand its store base. This led to a low cash balance amounting to only 2% of stockholder's equity. The company also took on some long-term debt last year with long-term debt to equity coming in at 115% in 2013. The company pays no dividend.
What should investors do?
Lumber Liquidators has the greatest investment potential with a balance sheet full of cash and no debt. No long-term debt means no interest expense to choke out profitability and cash flow. The company plans to open 30 to 40 new stores and remodel 25 to 35 current locations this year. Any company that can do that without taking on debt belongs in your portfolio.
By contrast, Tile Shop took on debt last year and both Tile Shop and Restoration Hardware lean heavily on capital spending, leaving little on their balance sheets to carry out expansion plans. This significantly boosts their fundamental risk which you don't want to see in your portfolio during another housing downturn. Successful investors hold for the long-term and that's easier if the companies in your portfolio possess enough cash to weather any storm.
William Bias has no position in any stocks mentioned. The Motley Fool recommends Lumber Liquidators and Tile Shop Holdings. The Motley Fool owns shares of Lumber Liquidators and Tile Shop Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.