Since the announcement that Lumber Liquidators (NYSE:LL) settled with the Justice Department over its violations of the Lacey Act regarding the illegal importation of environmentally protected wood, its stock has soared more than 25%.
Under the terms of the agreement, the flooring specialist has plead guilty to violating the Lacey Act, a conservation law regarding the protection of plants, fish, and wildlife, and it agreed to pay $10 million in fines, community service payments, and forfeited proceeds.
The news brings more clarity to what has been a very chaotic situation, but investors should still be wary about joining in the rush to bid up Lumber Liquidators stock. With one investigation out of the way, here are three reasons this company is still not a buy.
1. There's plenty more where that came from
The DOJ probe was just one of many outstanding issues still confronting Lumber Liquidators. While the illegal importation of lumber was always a sticky matter, a bigger, potentially more ruinous investigation is still going on regarding the health and safety of the flooring products it imports from China.
It was, of course, the 60 Minutes TV news programs that revealed Lumber Liquidators flooring contained dangerously high levels of formaldehyde, levels well beyond EPA standards, that set in motion the dramatic decline in its shares. The company's Chinese suppliers were filmed admitting they were improperly labeling Lumber Liquidators product as being compliant with air quality regulations when they were not.
Lumber Liquidators forcefully rebutted the charges against it, and now the Consumer Products Safety Commission is testing the flooring to determine how much danger it actually poses. While the test sought to back management's position, it remains a wild card.
There are also lots of lawsuits pending against Lumber Liquidators over the sourcing scandal, and their outcome will hinge on the CPSC's results. A negative assessment will pummel the stock and probably force open the flooring specialist's pocketbook to settle these cases.
2. Don't sell short its chance of being sold short
Noted hedge fund operator Whitney Tilson fairly rejoiced at the settlement news that sent Lumber Liquidators stock soaring. He believes it's only a matter of time before the stock falls from grace once more.
He wrote at Seeking Alpha the other day: "Normally after a stock declines more than 80% from the price at which I first shorted it, I declare victory, cover the position, and move on. But in the case of Lumber Liquidators, I haven't: I added to my short position at numerous points on the way down, and, though I've taken a bit of profits around today's prices, it remains a substantial short position in the funds I manage."
With more than 11 million shares already sold short -- more than 60% of its float and requiring 10 days to cover (anything over seven days is a lot) -- it's likely the continued upward pressure on the stock is coming from a short squeeze. That's where short sellers have to buy back their positions at higher prices, fueling a cycle of additional cover that pushes the stock even higher.
At some point, it becomes advantageous to short the stock in anticipation of its fall once again, and Tilson is an investor who can ride out a squeeze longer than most, particularly because, as he notes, he's already taken profits.
3. C-suite confusion remains.
For several weeks as the scandals were breaking, the door to the executive suite at Lumber Liquidator became a revolving one. First its CFO resigned, then the CEO, and finally the chief compliance officer quit in quick succession. It created a situation with terrible optics, and the brain drain was a serious blow to investor confidence.
Faith has yet to be restored, the DOJ settlement notwithstanding, and Lumber Liquidators remains a company in a state of flux. A bet here would be just that -- a gamble that the cards will all turn up in its favor, and those seem high odds indeed.
What it means for investors
Having to pay a $10 million fine to put an ugly chapter behind it is good news for Lumber Liquidators, but it's one of several fires the company is trying to put out. Because there are so many wild cards still at play, it remains a stock that's just too risky to buy. I wouldn't go shorting it, either, since, as famed economy John Maynard Keynes once warned, "The market can stay irrational longer than you can stay solvent."
Lumber Liquidators has a long way to go yet before it can prove to investors it is a viable business again.
Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Lumber Liquidators. 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.
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