What happened

Lumber Liquidators (NYSE:LL) shares fell through the floor in the first quarter of the year, losing more than one-third in value; they regained some ground to end the first half of 2018 down 22.4%, according to data provided by S&P Global Market Intelligence. Going by the stock's recovery in the past couple of months -- July has also been strong so far -- it seems investors are betting on better days ahead for the flooring retailer.

So what

The stock's biggest drop -- nearly 18% -- came after Lumber Liquidators reported its first-quarter earnings on May 1. At that point, shares were already under pressure after investment firm Wedbush Securities downgraded Lumber Liquidators in early February and slashed its price target on the stock by nearly 30%.

Wedbush raised concerns about Lumber Liquidators' decelerating sales growth and margins, as the company shells out more money on promotions even as transportation costs remain a headwind. Investors waited with bated breath to see whether Lumber Liquidators' fiscal 2017 report would confirm Wedbush's fears. It didn't.

A shocked man reacting to a falling stock graph.

Image source: Getty Images.

In March, Lumber Liquidators reported 7% growth in revenue for 2017 and shrank its net losses by more than half to $37.8 million. Its same-store sales, from stores open more than 12 months, climbed 5.4%. Yet the market wasn't impressed: Revenue fell short of analysts' estimates.

Lumber Liquidators' first-quarter report on May 1 hit the market even harder, after the company reported 5.4% growth in sales but a muted 2.9% growth in same-store sales. In particular, lower footfall, as reflected in a 1.8% decline in the number of customers invoiced, spooked the market.

Also, the retailer's merchandise sales grew a paltry 0.2% year over year during the quarter, as sales are primarily being driven by add-on services like installation. What's worth noting is that installation and delivery services made up only 9% of the company's total sales last year.

Now what

Management's guidance for fiscal 2018 includes:

  • Mid- to upper-single-digit revenue growth
  • Mid-single-digit same-store sales growth
  • Low- to mid-single-digit growth in adjusted operating profit
  • Between 20 and 25 new stores, compared with 11 new store openings last year

LL Operating Margin (Quarterly) Chart

LL Operating Margin (Quarterly) data by YCharts.

Investors should watch the trend in same-store sales, as it's imperative for Lumber Liquidators to unlock value from existing stores even as it pumps capital into expansion. As CEO Dennis Knowles reflected during the company's last earnings call: "... ultimately, we know the future of our company is dependent on us being able to service our existing customer base and drive new traffic in our stores."

With advertising expenses on the rise, only stronger sales for high-margin products can boost Lumber Liquidators' weak operating margins and help the company return to profitability this year.