It's been a tough year for Lumber Liquidators Holdings (NYSE:LL). The company spent most of 2013 crushing it, growing sales at existing stores at double-digit rates, before a lackluster housing market took all the wind out of its sales in 2014.
The result? Comps actually declined through the first nine months of 2014, and the stock has done this:
The chart above starts right before the Q4 2013 earnings release last February, when things began turning for the worse.
Here we are again, with earnings for Q4 just around the corner on Feb. 25, and the stock actually on a bit of an uptick during the past few weeks on some positive economic news, and better-than-expected earnings from fellow specialty retailer Tile Shop Holdings. There are three key areas that investors should watch when Lumber Liquidators reports, and while the company doesn't have total control over one of them, they are all important to the company's success. Let's dig in for a closer look.
1. Comparable-store sales growth
Comps is the one area where the company probably has the least control, but it's important. As I wrote in my earnings previews for Tile Shop Holdings and for Trex Company, Inc., sales of existing homes is an important measure for these companies. Unfortunately, 2014 was worse than the year before:
The good news? If you look at the far right, you'll note that sales began to rebound a little at the end of the year versus 2013's precipitous fall that lasted into the spring. However, even after picking up late in the year, existing home sales still dropped 3% from 2013.
From a macroeconomic perspective, there are plenty of reasons to think that investors are on the right side of the trend for Lumber Liquidators. While 2014 has been a tough year, the U.S. economy has only grown stronger. Unemployment has fallen to the lowest levels in years, and is firmly below 6%. Even Wal-Mart is moving to increase pay in an effort to retain employees, committing recently to spending about $1 billion annually to increase the pay of about 500,000 employees. Rising wages and falling unemployment have historically been positives for the housing market, and the trend is solidly positive right now.
A best, however, we should hope for stabilization of comps at this point, not a big rebound. Comps fell 4.9% in Q3, though management said they improved each month in the quarter. Let's hope that trend continued in the fourth quarter.
2. Keep expanding, but maintain financial discipline
Just because the macro environment isn't perfect doesn't mean the company shouldn't grow. To the contrary, with just more than 350 stores, there remains a huge opportunity for Lumber Liquidators to grow its store base, as long as growth is at a rate well within what the company can afford. So far, that hasn't been a problem, as the company carries no long-term debt.
It doesn't carry a lot of cash, either, but instead uses a $50 million line of credit for liquidity. So far, this strategy has worked, as the company is able to use cash flows and its line of credit to fund capital expansion, and then use those cash flows to quickly pay down the credit facility.
Cash on hand has fallen sharply in the past year:
In large part, cash has been used to fund a major expansion to the company's distribution network. Through the first nine months, the company invested $28 million in its East Coast distribution center. Over time, this will add to the bottom line by reducing shipping costs from the company's other distribution center in California.
Furthermore, the company spent $52 million on stock repurchases through the third quarter. While the average price -- $77.68 -- is above current market price, buybacks in the third quarter averaged $57.24, almost a 9% discount to recent prices. Frankly, I remain torn on the company's buyback policy, as it seems to be walking a relatively fine line with its capital position, expansion plans, and share buybacks. There's just not much room for error there.
3. Cost containment, inventory efficiency
The inventory struggles the company has dealt with remained a problem for much of the third quarter -- so much so that management blamed part of the drop in sales on it. Until the company is able to finally put this to bed, it will remain a drag on sales, and on margins. Hopefully the addition of a consolidated East Coast distribution center will help address this. The new distribution center was scheduled to open in December, but the company hasn't made any announcement to date.
Lumber Liquidators also continued to expand its in-house manufacturing. Its plans for 2014 included doubling its internal processing and finishing capacity, with much of that investment to be made in the fourth quarter. Don't expect this to have any impact on fourth-quarter sales, but the company said that this new capacity would be up and running in early 2015.
Lastly, management claims that its past issues with potentially illegal wood should be in the past by now, but we were also told that inventory issues hurt sales last quarter. The reality is, if inventory continues to be an issue, one will have to question if the company's stricter guidelines will be a continual problem. Something might have to change.
It would be unfair to expect Lumber Liquidators to report a blowout quarter, but it's reasonable to look for incremental improvements, and tighter execution on inventory management and cost containment. Furthermore, the company should keep expanding in a methodical, and cost-effective way.
Short term, there's really no telling what will happen. Long term? If management can tighten up on the sore points and keep things progressing, Lumber Liquidators looks like a cyclical winner.
Jason Hall owns shares of Lumber Liquidators and Tile Shop Holdings. 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.