Should You Liquidate Lumber Liquidators?

Lumber Liquidators Holdings (LL -2.89%) has had a rough 2014, with its stock falling close to 50% in this year alone. Lumber Liquidators' precipitous drop sharply contrasts with the performance of its bigger competitors in the home improvement sector, The Home Depot (HD -1.44%) and Lowe's Companies (LOW -0.88%), which have stocks that have been relatively flat on the year on both the positive and negative sides:

LL data by YCharts

The almost-50% decline in 2014 accelerated when Lumber Liquidators' management revised its guidance for all of 2014 and reported less-than-stellar sales for the company's 2014 second quarter. Sales in the second quarter were buoyed by new store openings and increased 2.3% to $263.1 million, but the company's sales at stores open for at least a year fell by an eye-catching 7.1% in the quarter. Moreover, the $263.1 million sales figure came in well short of Wall Street's average estimate of $303.2 million for the second quarter. On the bottom line, Lumber Liquidators' management now expects EPS in the $0.59-$0.61 range, which is far away from the average analyst estimate that called for EPS of $0.90 in the second quarter .

The expected results for all of fiscal 2014 also received a downgrade and the company's management now expects sales of $1.05 billion-$1.1 billion as opposed to a previous expectation of $1.15 billion-$1.2 billion. Further, management now expects resulting EPS of $2.65-$3.00 in 2014 versus a prior EPS estimate of $3.25-$3.60.

As a result of the downbeat quarter and guidance, Lumber Liquidators' stock dropped by almost 22% after the issue of the aforementioned revisions.

Has the decline created an opportunity?
Sharp drops in stock prices can create opportunities and an almost 50% decline can create a big opportunity. Although its current quarter and year may be sub-par in comparison with its past, Lumber Liquidators has a solid operating history and an attractive valuation, which could lead to an acquisition by a competitor or a buyout by a private equity company. The latter scenario is augmented by the fact that Lumber Liquidators carries no long-term debt on its balance sheet.

Lumber Liquidators generates above average returns on equity and capital and has averaged 19.8% in both areas over the last five years . Furthermore, Lumber Liquidators generates significant amounts of cash and has been free cash flow positive for the last three years. The free cash flow could be used to service the debt load in a potential leveraged buyout by private equity or other investors.

Similar valuations

Data Source: Yahoo Finance & Morningstar

Interestingly, Lumber Liquidators, Home Depot, and Lowe's carry similar valuations on a forward P/E, five-year PEG, and EV/EBITDA basis. Lumber Liquidators has a relatively high valuation on a cash flow basis, however, with a P/CF ratio of 24. The P/CF ratio only considers cash flow from operations, though, so Lumber Liquidators may not be as expensive as what its P/CF currently shows; this is because Home Depot and Lowe's carry debt loads and have to service them with outflows of cash that are not included in their operations.

Lumber Liquidators is also significantly smaller than either Home Depot or Lowe's on a market capitalization basis, so a larger number of suitors could buy it. Lumber Liquidators' market cap is currently $1.48 billion, while Home Depot's is $109.4 billion and Lowe's is $47.4 billion.

The ability to rebound
Lumber Liquidators has a great operating history with solid returns on equity and capital. Moreover, the company has no long-term debt, which makes it attractive to potential buyers. Even without an acquisition, the company has the financial profile to deploy capital and return itself to strong growth. Therefore, investors should not liquidate their Lumber Liquidators shares in light of the recent quarter and guidance. Current investors should hold onto their shares, while new investors have an interesting investment opportunity before them.