Hooker Furniture: Ready For Record Housing Market With 100% Upside, Thanks To P/E Of 5.4x, FCF Yield Of 17.6%, 31% Net Cash (NASDAQ:HOFT)

P/E of 5.4x, FCF Yield of 17.6%, Net Cash 31% Hooker Furniture (HOFT) stock appears to be at an inflection point as the real estate market shows a striking rebound, with existing home sales up a record 20.7% in June (the largest monthly gain in 7 years). The residential furniture […]

P/E of 5.4x, FCF Yield of 17.6%, Net Cash 31%

Hooker Furniture (HOFT) stock appears to be at an inflection point as the real estate market shows a striking rebound, with existing home sales up a record 20.7% in June (the largest monthly gain in 7 years). The residential furniture market is showing no signs of holding back in the current to medium term, as this rally looks to continue going forward. Hooker is a prime beneficiary and we expect both strong positive earnings surprise, as well as YoY EPS growth, starting with the upcoming second quarter earnings release on September 3rd.

Hooker Furniture has great valuations with a P/E of 7.7x (ex-cash P/E of 5.4x) on a more steady-state 2021 (FY01/2022). Their net cash is $80 million which is 31% of the market cap and their steady FCF Yield on EV for 2021 (FY01/2022e) is 17.6%. This healthy cash flow can be used to weather the sluggish economic environment and slow demand. The company was affected by the US-China trade war in the last year 2019 (FY01/2020) and the year before that, but they have made a sourcing transition to Vietnam, and in the process, they have reduced pressures on margins and increased investor confidence. They operate on an odd year ending January.

The recent improvement in the housing market was unprecedented and provides a great opportunity for Hooker to capitalize on. As the National Association of Realtors (NARs) puts it:

The sales recovery is strong, as buyers were eager to purchase homes and properties that they had been eyeing during the shutdown,” said Lawrence Yun, National Association of Realtor’s chief economist on July 22, 2020.

This revitalization looks to be sustainable for many months ahead as long as mortgage rates remain low and job gains continue.”

What COVID-19 has done is that it has created a shift in the work environment. People are realizing that a work-from-home setting could be very much the norm for the next 2-3 years. As a result of this, they are eager to remove themselves from the bustle of city life and move to much more affordable offerings in the suburbs. You get the added benefits of a spacious home with the ability to afford ergonomic fittings, without having exorbitant rent of city life squeezing out on your hard-earned savings. It is taking place in all big cities, with people also picking this choice because of turmoil created by temporary civil causes and rising crime which is becoming a safety concern.

We see robust growth for this company going forward because of this surge in demand for residential furniture in the market. The company has a great chart, ripe for the picking and we see a lot of upside, in fact, our $44.00 price target would simply take the stock back to its own prior highs in 2018, representing 100% total return potential. Note: many other furniture peers are already trading near all-time highs.

See below 5-year chart for Hooker:

Source: Bloomberg Terminal

So, as you can witness, Hooker is an opportune investment, with the current residential furniture market and robust valuations and fundamentals working in its favor.

Hooker Furniture: 96-year history, publicly-listed 26 years

Hooker Furniture Corporation incorporated in Virginia in 1924 and founded by Clyde Hooker Jr. (indicative of where the company got its unique and rather odd name) was publicly-listed for 26 years since 1994. Despite its long history, the stock is still relatively underfollowed and unknown with only a $261 million market cap. Hooker Furniture is a designer, marketer, and importer of casegoods (wooden and metal furniture), leather furniture, and fabric-upholstered furniture for the residential, hospitality, and contract markets. They also domestically manufacture premium residential custom leather and custom fabric-upholstered furniture. Hooker is ranked among the nation’s top five largest publicly-traded furniture sources, based on 2018 shipments to U.S. retailers, according to a 2019 survey by a leading trade publication. (Source: Annual Report)

Undervalued Relative to Peers

Hooker is fairly undervalued with an attractive P/E, ex-cash P/E (with net cash on the B/S), and tangible book value per share. On our calendar year 2021 (FY01/2022), our P/E estimate is 7.7x (ex-cash P/E of 5.4x). The valuations look attractive on a forward-looking basis. The tangible book value per share (taking out goodwill and other intangibles) is $17.80 which shows the company has good intrinsic value, and minimal downside risk, compared to a stock price of $22.41.

Net Cash is 31% of the Market Cap

Hooker had a cash balance of $51.2 million initially at the end of Q1 in April 2020 (Q1FY2021). Subsequently, as of July 23rd press release date, the cash balance increased substantially by $31.0 (to $82.2 million total cash) million due to a combination of measures including cash conservation and changes in working capital. To arrive at our net cash figure of $80 million, or $6.75 per share (31% of current stock price), we have included “cash surrender value of life insurance” of $25.6 million since we believe it to be a near-cash item which is fairly liquid and subtracted short-term debt of $28.2 million. As a result, Hooker has a very attractive net cash position with $80 million ($6.75/share) on the B/S, or 31% of the market cap.

Hooker Net Cash Calculation

Source: Q1FY21 Press Release

Cash Uses: Our estimated 5.1% Dividend Yield

With all this excess cash, the company can reinvest in itself for organic growth and it can use it for buybacks or increasing its dividends. We project that if the company continues to pay a similar dividend payout ratio of 40% ($0.60 dividends per share) on an increasing EPS trajectory, then by 2021 (FY01/2022), it will be paying a hefty dividend of 5.1% [40% * 2.90 EPS estimate over the current stock price].

Good FCF Generation

Hooker [HOFT] - FCF

Source: Investors Presentation

The FCF per share has seen good growth over the last few years, with minimum CapEx since most production and sourcing is done from abroad – see further notes in specific section. This has allowed FCF to grow and for 2020 trailing, the FCF per share was $3.00. Over the last 5 years, it has averaged $2.00 with a high of $2.50 per share.

The FCF Yield is very attractive with 2019 (FY01/2020) actuals at 13.3%. However, since we are already into the next Q1FY21, we have projected a full-year FCF Yield for 2020 (FY01/2021) and 2021 (FY01/2022) to be a robust 10% and 8.8%, respectively. On EV, the company looks to generate FCF Yields for 2020 and 2021 of 14.4% and 17.6%, respectively.

Free cash flow has a tendency to be higher for Hooker because this company has a lot of its production outsourced, so CapEx requirements are minimal.

10-Year EPS and Revenue Growth

Hooker [HOFT] - EPS & Revenue Growth

Source: Seeking Alpha Company Data

Both revenues and EPS have shown a steady growth, apart from FY 01/2020 which declined because of the US-China trade war.

Cause for lower earnings in FY20: US-China trade war

In the last calendar year 2019 (FY01/2020), consolidated net sales were down 10.6% and consolidated net income fell 57.2% YoY. These poor results were primarily because of the US-China trade war, and the stock market downturn in late 2018 which was a minor factor – our main focus will fall on the trade war.

Most of Hooker’s furniture production is outsourced and as a result, is subject to the US’s influence on foreign trade practices and imposition of taxes to control domestic competition. The situation between US and China, referred to as another “Cold War,” as both countries try to come together on trade issues. In the midst of this, Hooker has production in China, and their furniture imports have been subject to escalating tariff rates which has undermined their business beginning in 2018, as in the following official release statement:

On September 24, 2018, Section 301 Retaliatory Tariffs were imposed on most furniture products imported from China. On May 10, 2019 the tariff was increased to 25% and are expected to increase to 30% on October 15, 2019, if a trade agreement is not reached. – Hooker Investor Presentation

This increase in tariffs manifested higher product costs, higher selling costs which were pushed onto customers, and inventory disruption. Prices were hiked up 10% to offset the 25% tariff and higher freight costs on furniture shipments coming in from China.

Sourcing Transition: China to Vietnam

Since 2019, however, the company has been reducing their sourcing footprint in China. They are now increasing their presence in Vietnam, an attractive region for the company to set up logistical hub in. The company has reduced its presence in China from 39% in 2018 2H (FY01/2019) to 11% in 2019 2H (FY01/2021). Likewise, they have increased activity in Vietnam from 42% to 66% in the same time periods, as seen below.

Hooker [HOFT] Sourcing Transition

Source: Investor Presentation

This has been extremely encouraging for shareholders, as this will help to restore margins to prior levels as the US-China tension looks unlikely to stabilize anytime soon.

Pre-booking: EPS could have been ~$1.80 – $2.00 (FY20 TTM)

Hooker [HOFT]: US-China trade war impact

Source: Bloomberg Terminal

The reason that the last two quarters of 2019 exhibited such high sales growth (record, in fact – see last 2 quarters in green, and subsequent Q1 in grey outline) was that people knew about the threat of a tariff increase slated for Jan 2019, and so they went ahead and bought furniture beforehand. This led to reduced Q1 earnings in FY20. As stated by management in the annual report:

These soft sales (in 2020) were exacerbated by the fact that many of our customers were already in an over-inventoried position in an effort to get ahead of the threatened increase in tariffs on January 1, 2019.

Had this not happened and customers would have shown normal buying activity, we estimate that for 2019 (FY 01/2020) EPS would have been higher by about $0.50 – $0.60 EPS, bringing full-year EPS to around $2.00. Importantly, investors should know that Hooker has very easy and below normal comparisons for the next 3 quarters. This will set up very high YoY EPS headline growth rates over the next 3 quarters.

Estimates for current year and FY22

We expect this next upcoming Q2 (earnings to be released Sept. 3rd) to show improved earnings, and we are basing this off of our predictions that the months of June and July will yield to better furniture demand because of record housing stats. If things pan out and due to this renewed consumer sentiment, Hooker should see an EPS of approximately $0.50 – $0.60 based on an easy comparison to an EPS of $0.35 from the same quarter a year ago. See our estimates in the EPS data below on far-right for FY21.

Hooker EPS Estimates for FY21

Source: Bloomberg Terminal

In the 2H, EPS will further improve for Hooker because of our estimates of continued robust demand for the residential segment. We predict this strong sentiment to continue on into next year, i.e. FY01/2022, increasing our EPS estimate to $2.89, leading to a steadfast and healthy recovery to slightly above 2018-level EPS of $2.49. We also expect robust YoY earnings growth, so you might see stellar results in the next few quarters in terms of percentage gains as the quarters in the previous year had below normal earnings because of the US-China trade war. This will create what is known in the market as a ‘positive earnings surprise’, which will make the company look even more appealing to investors and the public.

Industry: Housing Market and Consumer Sentiment

The housing market rebounded emphatically in June, demonstrating record gains in existing home sales of 20.7% (the largest monthly gain in 7 years). Following on this positive development, in July, the housing market again beat analyst expectations, with US housing starts totaling 1.496 million in July, vs. 1.240 million expected. This just came in today: July home sales spiked a record 24.7% compared to June, as prices set a new high; and median prices of a home sold in July rose 8.5% annually. That was the strongest monthly gain recorded in history from the survey, since 1968. And this was all during a pandemic period. Unbelievably, good news for Hooker, just unbelievable.

In addition, since people are travelling less and saving more on discretionary expense – which they would otherwise end up doing on a normal year – they have more money in their wallets to spend on furniture. This was noted by Paul B. Tom Jr., Chairman and CEO:

What we’ve seen in June and thus far in July is that orders are actually at a higher rate than a year ago,” Toms said. “We believe there are several positive factors in play such as pent-up demand, more focus on home environments and less competition for discretionary consumer spending from travel, dining out, sporting events, concerts and other activities.”

La-Z-Boy & Haverty Furniture

Lot of housing stocks are up recently as a result of these two encouraging outcomes, especially companies catering to residential furniture and smaller-ticket items. Companies like La-Z-Boy (NYSE:LZB), Ethan Allen (ETH), Bassett (BSET), and Haverty (HVT), while reporting terrible YoY declines due to COVID-19, nonetheless beat expectations and, more importantly, signaled a strong rebound for the second half.

La-Z-Boy has led the drive beating analyst expectations in its latest quarterly results on August 18th, with a rally in furniture and home furnishing demand. La-Z-Boy has erased all of its losses YTD and is up 6.1% since the beginning of the year. La-Z-Boy’s stock is also very close to 5-year highs.

Haverty Furniture, which reported on August 11th, is up +38% since its earnings report (+10% YTD) and is nearing all-time highs; and this is even after it missed earnings expectations by a small account, pointing to a positive change in furniture demand. Both stocks have almost reached their 5-year highs, and we suspect record earnings yet to come in the 2H of this fiscal year. Much of these strong gains are in line with markets which already looking well beyond this sluggish period towards 2021.

Valuation and Price Target

We think Hooker has a great valuation, on the back of great news in the marketplace for residential furniture companies. We think the stock has reached its lows, offering a great buying opportunity. The company has net cash of $80 million, representing 31% of the market cap, and a projected FCF yield for 2021 (FY01/2022) of 17.6% on EV which will help act as a cushion towards these struggling times for furniture companies. The ex-cash P/E is 5.4x on our next year estimates (FY01/2022). The tangible book value per share stands at $17.80, suggesting minimal downside risk for the stock price. Importantly, Hooker is also moving its production facilities away from China, which has been a factor for increased tariffs on incoming goods and compressed margins. Their new production presence in Vietnam has been looked at encouragingly by shareholders, as it has led to better margins and has brought the company out of its temporary slump that it had faced in FY19 and FY20, setting it up for a better FY21 with the positive news on housing starts.

Arriving at a Price Target of $44.00

Looking at Hooker’s competition Haverty and La-Z-Boy, they both have an average 5-year P/E of 19x and 16.0x, with current valuations of 19.7x and 13.0x on FY2021 consensus estimates, respectively. Historically, over the past 5 years, Hooker’s stock has traded at 13-14x P/E. In arriving at a price target for Hooker, we are using a 13.0x P/E, and we believe this is a conservative approach, given that it is below the level of peers such as Haverty and La-Z-Boy, and also the overall stock market in the US has seen a significant P/E multiple expansion over the past few years.

This P/E of 13.0x when multiplied by the EPS value for 2021 (FY01/2022) of $2.85 (factoring out interest income on net cash of $0.05), yields us a price target of $37.00. However, Hooker has a huge net cash position that is not being reflected in EPS (especially in today’s low interest rate environment), so when adding back a total of $6.75 in net cash, we come to a final price target of $44.00. This represents a total return potential 99%.

On our price target, we value Hooker with an FCF Yield on EV of 7.4% and ex-cash P/E of 12.9x on a normalized FY22e.

Catalysts

Housing Market Boom: Housing sales up June, July

Housing market had a record month in June, growing 20.7% in existing home sales, and then growing further in July to 24.7% from the June period. Across the entire country, people were increasingly finding living spaces in the suburbs, fed up with living in big cities. This encouraging development continued forward into July, and we expect this trend to be the primary catalyst for this stock for a good time to come.

Strong Job Growth

Any positive development in the economy will have a “spilling-over” effect on consumer sentiment and confidence, which will lead to increased demand for furniture-related items and more sales in the housing market.

Growth in Millennials Population

Gen X with a population of ~65.7 million (born 1966 to 1981) and Millennials or “Gen Y” with a population of ~85 million (born 1980 to 1994) are the two main population demographics that Hooker caters to. The average age of millennials right now in the US is about 32 years. The company has been pivoting away from Boomers to both of these population group increasingly, and it will be their primary focus in the next 40+ years.

Hooker Target Market: Gen X and Millennials

Source: Investor Presentation

Reducing impact of China Trade War

This is what caused earnings declines in FY19 and the beginning of FY20, but the company is working to reduce their production lines with China, sourcing increasingly to Vietnam in the process.

Increasing Net Cash

The company has been increasing cash amounts, with $31 being added in this latest quarter alone (60% cash increase). With $80 million in total net cash, representing 31% of the market cap or $6.45/share, Hooker is in a good position to strategically capitalize from here on out. The company can use this cash for organic growth, buybacks, or potentially increased its dividend to ~5% on our 2021 (FY01/2022) estimates.

Dividend

The dividend yield is only 2.6% currently, but if the payout ratio continues to be 40; then the company could have a very attractive 5.1% yield for 2021 (FY01/2022).

Cyclical Recovery: Look to 2H of current year for gains

The economy looks to recover, with the company posting strong sales around the November to Feb period, so getting invested now and given the positive housing environment, could lead to stronger gains in the company share price.

Positive Earning Surprise

A positive earnings results in the next three quarters could help send the stock rallying further and could lead to increased returns for shareholders.

Strong FCF Generation

The company has exhibited strong FCF generation, primarily because of its low capital requirement due to outsourcing. The company generates good operating cash flow, and we project FCF Yield to stay above 10%.

Risks

Competition

The company has competition from numerous players, some I had mentioned earlier – La-Z-Boy, Haverty, Ethan Allen, and Bassett Furniture. Hooker needs to appropriately maintain its market position, or it risks having losses.

China Trade War

Although Hooker has significantly reduced their shares of goods being imported and produced in China, they have not completely eliminated shipments from the region. A further increase in tariffs or a complete ban on furniture products from China could adversely affect the financial results for Hooker.

Weak Economy

A weak economy could derail Hooker’s ability to shore up consumer sentiment and demand. Consumer confidence falls during a weak economy and this leads to big losses, as is being witnessed during COVID-19.

Coronavirus

Another wave could happen, you never know. This could result in losses and declines in top line.

Unemployment

If people are out of work, it will lead to curtailment of discretionary spending on goods since people will have less income. Expenditure on furniture will crater.

Conclusion

We see Hooker be a great investment because macro development in the housing market leading to a resurgence in consumer confidence and demand for furniture products. The company is trading at 5-year lows and is at an inflection point, with the potential to reach back to its 2018 highs, giving you a 100% upside. It is undervalued and has a lot of cash on its books. We think EPS numbers for the next few quarters will be high YoY, causing a positive earnings surprise for the company. Furniture companies such as La-Z-Boy and Haverty have erased their losses this year, and have reached 5-year highs and are expected to go even higher after housing news – a good sign. Given all these outlooks, we currently have a position in Hooker and are optimistic on its 2Q results this September and its performance broadly in the market going forward.

You can download our 10+ page research report: Hooker VIP Report. This report has our detailed analysis on Hooker, inclusive of a financial model: IS/BS/CF forecasts, rigorous ratio analysis, DCF valuations and price targets. A preview of the entire report can be seen below:

Disclosure: I am/we are long HOFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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