The cyclical nature of Ethan Allen Interiors (ETH) and the need to invest in customer service and CRM initiatives increase the risk that ETH will underperform the market in the long term.
A record of revenue declines increases the risk to investors as competition mount and peers expand their operations. A solid reversal in revenue, supported by fundamental changes in the company is necessary for a more favorable risk/reward balance.
Despite that ETH’s dividends are fully covered by net income and yields 5% annually, I think investors are better off investing in the SPY index, which provides about 2% dividend and is currently trading at 3-months low compared to ETH, which currently trades near 6-months highs.
ETH is a furniture manufacturer offering a broad range of products such as dining, office, bedroom, outdoor, and living room furniture sets.
A substantial portion of ETH furniture is custom made. Clients work with designers to have their unique furniture built. This has created customer loyalty and recurring orders. The product quality is appreciated by customers, as evident by high Amazon customer review ranking.
The COVID pandemic pushed businesses to conduct their operations differently. Online and phone sales skyrocketed, while branch sales decreased, raising demand for customer service. Some businesses adapted better than others and it seems ETH falls in the latter category.
Don’t get me wrong, the company has great product offerings but needs to invest more in customer service to adapt to the new working environment imposed by COVID. This might be challenging given that the company still has to pay rents and overhead costs for its branches.
Customer relationship management
One of the theories of the increased valuation in the stock market is the evolution of the data economy. Companies are not only producing goods and selling to customers but also have intangible assets embodied in data about their customers. Companies such as Salesforce have emerged strong winners in recent years as they developed more smart ways to collect, analyze, and predict customer behavior.
I believe that ETH is not utilizing the most out of its data from customers. While researching customer reviews, I stumbled upon a verified customer complained about ETH website:
On July 31st, I purchased a sofa online. As I was ordering this sofa, the price came up of $1450.00. Then the screen quickly changed to a new price of $1650.00
I tested the ETH website, and the problem still exists. This technical error has been sitting there for at least three months. Such technical issue would have been detected and fixed in a company that has a strong CRM. In a world where each click and online transaction is analyzed, stored, valued, and many times sold, it is unexpected to see a rudimentary piece of product information, such as the product price, incorrect on the company’s website.
Yesterday, ETH announced quarterly earnings for the three months ending September. ETH fiscal year ends June 30 of each year, so the quarter ending September is the first quarter of the fiscal year.
Sales gradually increased in the past months as people adapt to the new reality imposed by COVID, and because of the relaxation of some social distancing rules and the lift of the lockdown.
Nonetheless, Q1 results were less than last year by about 13%. That’s not a catastrophic result, and the company still has a positive net income and generates cash.
The company has a strong backlog, which are the orders that are still to be fulfilled. The custom-designed furniture takes from 6-8 weeks to be delivered to the customer once the order is made.
Customers usually pay a deposit once the order is made, and the remaining balance once the furniture is built. That’s when the amount is recognized in the income statement. Customer deposits now stand at $90 million representing 22% of the market value of $409 million at the time of this writing. The company doesn’t share the value of the backlog orders, but one can assume it is bigger than the deposit.
The company currently pays $0.21 per share quarterly, amounting to a 5% annual yield based on a share price of $16.32. This is an attractive yield but the question is, is it sustainable?
In Q1, the company earned $9.4 million in net income. As of October 22, 2020, ETH had 25,053,082 shares outstanding. At 21 cents per share dividend, cash distributions amount to $5.3 million, which are well covered by net income.
- Stock performance
On Friday, three of the ten closest ETH peers were lower by more than 5%. Although it was a risk-off day for the market, the magnitude of the decline and the sheer number of companies point to the risks of the industry.
|Lovesac Co (LOVE)||-7.44%||$ 464.9M|
|Virco Manufacturing (VIRC)||-5.77%||$ 32.8M|
|Purple Innovation Inc (PRPL)||-5.28%||$ 1.6B|
|Interface Inc (TILE)||-3.62%||$ 380.0M|
|Ethan Allen Interiors Inc (ETH)||-3.43%||$ 430.2M|
|La-Z-Boy Inc (LZB)||-1.72%||$ 1.7B|
|Kimball International Inc (KBAL)||-1.34%||$ 413.0M|
|Sleep Number Corp (SNBR)||-0.83%||$ 1.8B|
|Knoll Inc (KNL)||-0.61%||$ 679.0M|
|Hooker Furniture Corp (HOFT)||-0.36%||$ 357.7M|
|Bassett Furniture Industries (BSET)||0.75%||$ 155.9M|
Source: Table created by author. Data from Seeking Alpha
Over the past year, leading furniture manufacturers demonstrated diverse stock performance, ranging from +226% to -63%. Purple Innovation (PRPL), The Lovesac (LOVE), and Sleep Number (SNBR) led industry gains, while Interface Inc (TILE), Knoll (KNL), Virco (VIRC), and Kimball International (KBAL) experienced more than 50% declines in the period.
PRPL, LOVE, and SNBR earned investors’ confidence as they posted record revenues this year.
Each of the industry underperformers have unique circumstances that led to their decimal stock performance. TILE, which has less product range than its peers, saw revenues decrease 26% and also was affected by a fire in one of its facilities during the lockdown. KNL, which focuses on office furnishing, was particularly hit, as businesses found new ways to conduct business remotely and at least forgoing the need to expand office space in the near term. VIRCO, which focuses on school and office furniture, also faced challenges in generating revenue as social distancing rules resulted in schools being closed and adopting remote teaching methods. KBAL focuses on commercial furniture, similar to KNL, which faces risks stemming from a shift to remote working.
ETH faces strong competition from both residential and commercial clients. The company has a contract with the Federal government, supplying office furniture to government offices and buildings.
ETH price-to-earnings ratio “P/E” is in line with its peers. Excluding PRPL, which is experiencing rapid revenue growth that is driving higher valuation, and TILE which its unfortunate luck hit it with a fire disaster in one of its storage facilities, the average industry P/E ratio is 13.28x almost equal to 13.36x for ETH.
Ethan Allen Interiors is a leading furniture manufacturer that designs and builds custom made pieces by bringing customers and designers together. This unique business model enabled the company to develop a loyal customer base.
The business environment created by the COVID created a substantial demand for greater customer service, as branch sales are replaced by online and phone. Customer complaints about inaccurate pricing data online not only confuse customers but also point to a poor CRM system.
While dividends are attractive and fully covered by net income, the need to invest in customer service and CRM systems, as well as the cyclical nature of the business makes the risk/reward profile unattractive.
Flexible cost structure helped furniture manufacturers face the current economic disruption. Low leveraged companies will be able to generate higher shareholder value in this environment, holding all other things constant.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.