Lumber Liquidators Looks Ready to Rebound

Lumber - low cost wood flooringIf a lumber company falls during a stock market rally, does it make a sound? This philosophical puzzle refers to what happened last Thursday to the nation's largest hardwood flooring specialist, Lumber Liquidators (LL), which operates 250 stores in 46 states and Canada.

After the company cut its full-year revenue forecast in an impromptu business update Thursday, investors took Lumber Liquidators to the woodshed, sawing 28.5% off its share price. But while the short-term macroeconomic headwinds will undoubtedly be challenging, this highly profitable company still has a strong competitive position and ample room to expand, which is why I think this flooring retailer is a good prospect for investors' portfolios right now.

The lowdown on low-cost flooring

Lumber Liquidators provides its customers the widest range of hardwood flooring options in the industry at prices lower than its competitors can offer. What makes this possible is the company's uber-low-cost store format: bare-bones warehouses in low-rent areas and just a store manager and two or three sales associates running the show. By ordering its inventory in bulk, Lumber Liquidators is able to keep its merchandise costs low.

The company's streamlined format produces phenomenal returns on capital. It costs Lumber Liquidators $300,000 to open a new store -- and all but $75,000 of that amount accounts for the inventory. The average new store is profitable within three months and returns its initial cash investment in less than a year. And because it's so cheap to build a new store, Lumber Liquidators has been able to grow at a breakneck pace. The company has expanded from 57 locations at the beginning of 2005 to 250 today, and management has set an eventual target of 400 stores.

But won't the big-box stores snap Lumber Liquidators like a twig? Don't count on it. Lumber Liquidators' locations may not be as convenient as competitors' such as Lowe's (LOW) and Home Depot (HD) or even your local mom-and-pop flooring shop, but customers are happy to drive a few miles out of their way to save hundreds of dollars on a new floor or browse a wider selection. In fact, it's the local flooring stores that should be concerned in this equation. These inefficient operators currently control about two-thirds of the market, but I expect Lumber Liquidators and the big-box stores to continue to steal those sales over time.

Why Wall Street pulled the rug out from under Lumber Liquidators

As you might imagine, this economy is a difficult environment for a company that sells big-ticket, discretionary, housing-related products. With the housing market and economy hurting, Lumber Liquidators' customer base has become much more price sensitive. While this trend should actually play to Lumber Liquidators' strengths, the company was caught off-guard this quarter and could not rein in its expense structure in time.

Part of the problem is Lumber Liquidators' fault. The company's botched implementation of a business software package last year has dragged on results for the last three quarters. While the company insists that the software issues are in the rearview mirror, last week's near-30% scalping indicates that the investment community has lost patience with Lumber Liquidators.

Opportunity knocks, investors

The market's knee-jerk reaction suggests to me that many investors are focused on the wrong metrics. While Lumber Liquidators' reduced revenue guidance was disappointing, it's clear that new Chief Operating Officer Rob Lynch's margin improvement initiatives are already bearing fruit. By renegotiating contracts with vendors and diversifying the company's supplier base, Lynch has Lumber Liquidators poised to post record-high margins by the fourth quarter.

Despite the dour macroeconomic climate and subpar first-half performance, Lumber Liquidators still expects to earn between $1.00 and $1.15 per share this year. At $18.50 per share, the market is pricing the company as if its sales trends and margins will never improve. But if Lumber Liquidators can generate a slight improvement in either category, I believe shares should be worth about $28 -- and if the housing market recovers, that estimate will likely prove conservative.

The bottom line

It's not often that one gets a chance to buy a fast-growing, highly profitable business at a bargain basement price. Take advantage of the stock market's short-term mindset and open up a position in this long-term winner today.

Senior Motley Fool analyst Rich Greifner does not own shares of any company mentioned in this article. The Motley Fool owns shares of Lumber Liquidators.

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Michael McDonald

July 23 2011 at 12:15 AM Report abuse rate up rate down Reply

Dear Mr. Greifner,
I am so glad that you feel you can call me an inefficient operator......"retail flooring store". Just to set the record straight....I can sell laminate and hardwood that is not discontinued....that is not second quality....that can be purchased with the correct moldings to go with the material for the same price as Lumber Liquidators. And....while you are at it.......please know that I have my own installers that have worked for me for the past 9 years that do know how to install hardwood and laminate and do it properly. So......the next time you want to write an article and slam the retail flooring stores....please get some facts straight you certainly are doing a disservice to many people out there.

July 13 2011 at 3:44 PM Report abuse rate up rate down Reply

Having been in the wood floor business for 52 years in New York area and having a family member run an on line direct business, the feedback for Lumber Liquidators is as follows:
1)promises not kept- 2) late deliveries 3) poor product quality They profited -2008 by purchasing millions of dollars of inventory from the defunct Hoboken wood flooring empire . I sold this stock short at 28 -- again at 25 and will keep shorting it at 18. For you investors look up a company called Color-Tile who went the bankrupcy rout

July 13 2011 at 2:02 PM Report abuse +1 rate up rate down Reply
1 reply to hardw99's comment

I second that, I worked at Hoboken and the products lumber liquidators bought was the products that no one else would buy, I feel bad for those customers who purchased them but....then again buyer beware! If your looking for a product and you find it cheap at a liquidators co, there is a reason its so the fine print.

July 13 2011 at 2:18 PM Report abuse +1 rate up rate down Reply

The problem with Lumber Liquidators is that they sell a lousy product that they do not stand behind. my sister-in-law was told that she had to use their recommended installer, who turned out to be the salesman who sold the product. When they botched the installation, they would not stand behind it. Just a lot of runaround. For this reason, I do not think it will be a good stock buy. Failure to take care of your customers complaints does not lead to a good business outcome.

July 13 2011 at 1:44 PM Report abuse rate up rate down Reply