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Is the Worst Over for Lumber Liquidators Holdings Inc.?

By Rich Duprey - Feb 5, 2016 at 7:48AM

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The flooring specialist still has a federal inquiry hanging over its head.

Lumber Liquidators sales have been floored by multiple investigations and internal strife that left the flooring specialist crippled for most of the past year. Photo source: Mike Mozart.

Lumber Liquidators (LL 6.70%) was sentenced for importing hardwood from protected forests in Russia in violation of the Lacey Act, a conservation law that protects plants, fish, and wildlife. The flooring specialist will have to pay more than $13 million for having lied about its flooring's origins, saying it came from Germany rather than actually being manufactured in China from eastern Russian trees that were illegally harvested from habitats for endangered Siberian tigers.

The sentencing closes a particularly ugly chapter in Lumber Liquidators' history, one that threw the flooring retailer into tumult and contributed to the resignation of three executives in quick succession: the CEO, the CFO, and the chief compliance officer. But the travails of the company may not be over.

The larger issue still hanging over Lumber Liquidators is the health risks posed by its flooring. While questions about the off-gassing of formaldehyde fumes have floated around for years, it wasn't until hedge fund operator and noted short seller Whitney Tilson funneled the allegations to the 60 Minutes news program, which aired a segment on the issue, that they really gained traction.

Despite Lumber Liquidators' having plenty of advance warning that the show was going to air and put the company in a bad light -- it even announced the potential for damage during the company's earnings conference call the month before the show aired -- as well as having a very valid rebuttal to the allegations, it did not respond to the issue when it broke.

Lumber Liquidators let the matter fester for nearly two weeks before it issued a statement that indicated the tests 60 Minutes had referred to were flawed. By then, though, the damage was done and its stock cratered, losing half its value.

The subsequent announcement by the Consumer Products Safety Commission that it was going to investigate the matter didn't help, even though the agency said it would test the products in a way Lumber Liquidators says it found preferable. Instead of destroying the flooring it by cutting the wood, as 60 Minutes did, the agency will test it as it's used in the home. That ought to result in a finding favorable to Lumber Liquidators.

But having failed to respond to the charges and then getting investigated for the illegal importation of protected wood crushed the flooring specialist's sales. In November it said revenues over the first nine months of the year fell 4%, but the decline was accelerating, as third-quarter revenues tumbled more than 11%, to $236 million, from the year-ago period.

Rivals such as Home Depot (HD 1.35%) and Lowe's (LOW 2.12%) may be the beneficiaries of Lumber Liquidators, which could make it more difficult for the flooring specialist to bounce back.

Home Depot generated about 7% of its sales from the flooring department in 2014, while Lowe's got about 6% of its annual revenues from the segment. Both have also taken major strides in eliminating harmful chemicals from their products.

Not even Tilson's covering his big short bet against the flooring company in December helped Lumber Liquidators stock, which now trades at less than $13 a share, an 80% loss of value from when the matter first broke and a near 90% plunge from its all-time high achieved two years ago.

While it's reasonable to suspect the CPSC investigation will fall its way, there are no guarantees, and Lumber Liquidators remains a risk. Its reputation has been damaged by these separate incidents and the company's response to them. The flooring specialist may have turned the page on its illegal wood importation charges, but the chapter on the health risks of its products hasn't been written yet, and it still needs to rehabilitate its image with consumers. There's a long way to go before we can say the book is closed.

Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Home Depot and 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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Stocks Mentioned

LL Flooring Holdings, Inc. Stock Quote
LL Flooring Holdings, Inc.
$10.51 (6.70%) $0.66
The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
$314.89 (1.35%) $4.20
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
$206.47 (2.12%) $4.29

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