Will These Underloved Stocks Plump Your Portfolio?

Banking on a recovery in business doesn't seem to have worked out for investors in office furniture companies lately. But  some small to mid-cap companies sporting dividends can still make money for investors long term by fading their exposure to business and expanding into the higher margin consumer retail space.

Betting on a consumer kicker

Knoll (KNL +0.00%) is a designer, manufacturer, marketer, and seller of office furnishings, textiles, and fine leathers for business and the home in the US, Canada, and Europe. The 75 year old company, like many other companies with government clients, has been struggling with spending cuts as their 2012 Letter to Shareholders admitted but expects a better 2014 and 2015.

This small cap (market cap of $714.55 million) offers a yield of 3.20%. Knoll is valued at a trailing earnings multiple of 16.59 and has a 23.81% return on equity. Price to sales at .84 means you are only paying 84 cents for a dollar worth of their sales and the PEG at .48 is the lowest among their competitors, Steelcase (SCS +0.00%), Herman Miller (MLHR 2.28%), and HNI Corp.

The company is expanding from a reliance on financial and government business with a flagship design store in NYC around the corner from MOMA. Partnerships with cutting edge designers David Adjaye and Rem Koohaas are also key to "expanding their reach into consumer and decorator channels around the world."

The stock is challenged currently by those government and financial sales declines with second quarter results that can't be slipcovered over; operating margin declined from 9.4% to 5.8% yoy, diluted EPS dropped from $0.28 to $0.17, and gross profit margin contracted from 33.7% to 32.6%. To be fair second quarter numbers were an improvement over the first quarter.

All three of these office furniture companies can be affected by the number one risk factor listed in Knoll's 2012 Annual report, "Our sales are significantly affected by the level of corporate spending primarily in North America, which, in turn, is a function of the general economic environment."

Moving into China and consumer retail

Knoll's most direct competitor would be Herman Miller, a mid-to high end office furniture designer and manufacturer most famous for its iconic ergonomic Aaron chairs and sleek mid-century esthetic. The company is 98 years old but the designs look as fresh as yesterday and like Knoll many of the designs are featured in museums like MOMA.

Herman Miller is a bigger business than Knoll and  more global, in over 100 countries. It also offers a yield of 2.00% but has a higher earnings multiple of 21.96 but a forward P/E of 12.61. Price to sales is also fairly low at .88 but the PEG is a high 7.94.

Herman Miller's fourth quarter performance, reported in June, was decidedly better than Knoll with an increase in net sales of 9.3% from the year ago quarter and doubling diluted EPS yoy from $0.20 to $0.40. Margin contracted slightly after the company purchased Maharam Fabric Corporation to get into what CEO Brian Walker calls the, "margin-rich textiles and wall coverings categories, with further opportunities to extend Maharam's reach into new consumer and international markets."

Like Knoll, Herman Miller's Specialty & Consumer segment performed better than the North American and Non-North American Furniture Solutions, their corporate office furniture segment, and was the star of the full year and quarter report. 

Herman Miller also noted the effects of the sequestration on its call and guided lower.

Herman Miller was named to Industry Week's 50 Best US Manufacturers ahead of some tough mega cap competition like Chevron and Altria. Herman Miller actually moved up from spot 29 in 2012 to 21 in 2013. The company also won overall Best of Competition at the 2013 NeoCon, the industry's premier trade show.  For socially responsible investors the company has been named one of Fortune's Most Admired and Best Companies to Work For and a winner of several green and human rights awards. 

On the conference call Walker detailed progress on their two pronged growth strategy, more consumer retail where the  higher margins are with their purchase of Maharam, and more emerging market exposure with an integration of POSH manufacture, one of their design lines, in China and the construction of a UK facility in Spring 2014 to consolidate EMEA operations.

Finally, the third office furniture play is century old Steelcase which is losing its 19 year veteran CEO Jim Hackett next year.The company also offers a 2.70% yield but has a much higher trailing earnings multiple of 50.00 compared to these other two and the industry average of 17.60. Also, its net profit margin at 1.40% is the worst of these.

First quarter revenues declined year over year and EPS was flat which was an improvement over a loss of $0.22 per share in the  preceding quarter.  Although CEO Hackett expressed disappointment in ending a three year streak of consolidated organic growth he noted, "Given that we saw improvement in adjusted operating income even without a rise on the top line, that was worth noting, and that's true in every segment. Even with the continuing economic challenges in Europe and the kind of sluggishness in Asia, our margins were better and our operating expenses were well controlled." 

The Foolish takeaway

Steelcase doesn't have that retail consumer kicker to offset any government or overall business economy declines and vice versa. For that reason I prefer these other two. It will also likely be a transitional period for several quarters after Hackett retires so I would stay away.

Both Herman Miller and Knoll are promising with an expansion of their higher margin consumer segment but prefer Herman Miller given its emerging market exposure will likely help them outperform Knoll.