Flexsteel (NASDAQ:FLXS) is a company that is at its inflection point and has 52% upside to our $42.50 price target, with a booming housing market providing strong tailwinds. The company has just released its September quarter results and the numbers were just out of the ballpark. Flexsteel had a record order jump with a backlog amounting to $89 million, primarily spurred by residential furniture order growth of 60%. The company’s EPS has rebounded, and the stock price is looking to rally with further earnings surprises for investors to look forward to.
The company’s move to exit various commercial businesses (details below) and focus on residential completely cannot have been timelier for investors. As housing continues to surge, likely for another couple years according to housing executives with no signs of slowing, we see Flexsteel as a prime beneficiary. Their very attractive “value” chart offers favorable risk-reward, in our opinion. With that being said, Flexsteel has mounting cash on the B/S with no debt, and a three-year repurchase program in the pipeline, indicating to investors that management is bullish on this stock.
Deep Value Metrics for Flexsteel
For this current FY06/2021 and next FY06/2022 (estimates taken from our model), the FCF yield is an extremely attractive 10.3% and 10.5%, respectively. When taken on EV (Enterprise Value), FCF Yield for FY21e and FY22e is even greater, at 15.1% and 17.1%, respectively. This is because of Flexsteel’s growing net cash position caused by improving business and profit growth.
P/E is an attractive 13.2x and 11.2x for this FY06/2021e and FY06/2022e, respectively. When stripping out net cash, ex-cash P/E yields us a more representative image of Flexsteel’s true value or worth as a company. Ex-cash P/E for Flexsteel for the FY21e and FY22e is a much more undervalued 9.0x and 6.8x relative to what we mentioned earlier. This is due in part to Flexsteel’s abundant 17% to market cap net cash position, more details to follow.
In addition, P/B and P/S are also attractive for Flexsteel and are relatively stable according to our estimates in the near term. Price-to-book (tangible book value) for the FY06/2021e and FY06/2022e is a stable 1.2x and 1.0x. Price-to-sales is 0.5x for the FY21e, and on FY20A actuals, it was 0.6x.
Price Target and Valuation
Source: Bloomberg Terminal
Our price target is $42.50, based on our FY06/2022 estimates, representing 52% upside. At a price target of $42.50, we value Flexsteel based on a P/E of 15.0x (ex-cash P/E of 12.6x) and FCF yield of 6.9% (FCF Yield on EV of 9.2%) on our FY06/2022 estimates, plus the add-back of excess net cash.
At today’s price of $27.92, on FY06/2020 estimates, we have a P/E of 11.2x (ex-cash P/E of 6.8x) and FCF yield of 10.5% (FCF yield on EV of 17.1%). Flexsteel should recover as it is currently at an inflection point, with rebounding earnings, on the back of a strong furniture market.
To arrive at our price target of $42.50, we used a P/E of 15.0x (13.1x ex-cash P/E) for the FY06/2022 based on our estimates. For the FY06/2022, we also have an EPS estimate of $2.50. Multiplying both P/E of 15.0x to the EPS of $2.50, we were able to arrive at $37.50. But we must not forget to add back net cash, which represents added value for the company and must always be factored back in. Therefore, adding back ~$5.00 of net cash, we are able to arrive at our final price target of $42.50.
Stellar September Quarter: Record adjusted EPS and Backlog
Flexsteel had a record-breaking quarter ended September, where EPS was the highest in the past 3 years. Revenues increased by 4.9%, with organic net sales jumping 17.9% YoY, excluding discontinued Vehicle Seating for RVs and Hospitality product lines. The highlight for this quarter was the record backlog of $89 million (driven by 60% growth in the retail home furnishing segment). This backlog represents approximately 3 months of Flexsteel’s sales value.
The exodus from cities to suburbs continues to be a defining catalyst for Flexsteel as record home sales provide a silver lining for furniture during an otherwise bleak sales period due to the pandemic. Work from home continues to trend strong, and because of a resurgence of COVID-19 in the US during the winter months with record cases nearing 200K, consumers will stay at home and furniture spending will go up. Pending home sales also increases our confidence because it is an indicator that most of the homes have yet to be moved into and inhabited by their owners, indicating that furniture sales will continue to be robust going into FY21.
The present backlog is much higher than the past three fiscal years (Source: 10-K).
Source: Bloomberg Terminal
Even though stated EPS is $0.57 for the September quarter, there are adjustable items to be accounted for that when added back lead to a more representative bottom line. Adjusted for one-time items, non-GAAP EPS would have been $0.80. This adjusted EPS of $0.80 would make this September quarter one of the best reported EPS numbers in the last 5 years, clearly demonstrating that the restructuring process for Flexsteel is now nearly complete. In the following paragraph, we will go on to highlight some of the adjustments made.
Increases in retail and ecommerce channels were partially offset by a decline of -$11.1 million (or an impact of $1.40 per diluted share) versus the prior year quarter, due to restructuring expenses related to the exiting of the RV and hospitality business in the fourth quarter of FY20. Flexsteel has reported that it expects restructuring expenses to only amount to $2.5 million for this FY21, which is much lower than the prior fiscal year – indicative that it is nearly complete with the exiting of these businesses. Furthermore, the company recorded additional tax expense of $2.1 million during the quarter (effective rate of 51.3%, expected to drop back to normal levels of 25% to 26% in the following 9 months of the FY21 ending June), or an impact of $0.27 per diluted share.
The company reported stellar EPS, despite the COVID-19-related disruptions, because of effective cost-saving strategies. Flexsteel was able to increase its gross margins by 450 basis points to 21.7% compared to 17.2% YoY. It was able to do this by employing structural cost reductions, operational efficiencies and fixed cost leverage due to higher sales volume YoY. Reduced wages and travel expenses, instilled in the prior fourth quarter of FY20, were also a contributing factor.
The stock has climbed on these earnings, with next day price up +10% at the market close. With housing continuing to surge with no slowdown in sight, we are very optimistic for positive earnings surprises over the next few quarters.
Flexsteel: USP Product, Market Leader and Long History
Source: Company Website
Flexsteel Industries, Inc. is one of the largest manufacturers, importers and online marketers of furniture products in the United States. Product offerings include a wide variety of upholstered furniture such as sofas, loveseats, chairs, reclining and rocker-reclining chairs, swivel rockers, sofa beds, convertible bedding units, occasional tables, desks, dining tables and chairs and bedroom furniture. A featured component in most of the upholstered furniture is a unique steel drop-in seat spring from which the name “Flexsteel” is derived. The company distributes its products throughout the United States through its ecommerce channel and direct sales force. (Source: Company Press Release)
Restructuring: Move to Residential Furniture
Flexsteel has discontinued its RV seating product line and is reducing its footprint hospitality business in order to completely pivot towards its residential segment. As of now, disaggregation of Flexsteel’s business stands at 90% residential and 10% commercial. Getting rid of these two businesses will render Flexsteel’s core businesses entirely towards residential, and this is an encouraging move, given the surging housing market.
The restructuring expense is estimated to run up to $2.5 million over the fiscal year 2021. This is a marginal amount relative to Flexsteel’s net cash reserves of $36.5 million as of the latest September quarter.
17% Net Cash with No Debt on the Balance Sheet
Flexsteel is at a favorable net cash position with zero debt on the B/S. The company has $4.62 per share in net cash (or $36.5 million), which represents 17% of the current stock price. Flexsteel can use this cash as a safety net during this disruptive operating environment caused by the severe impact of COVID-19. This cash can be used to help increase inventory and imports to sustain the run rate of production to meet the $89 million record backlog of orders (fueled by 60% gains in retail home furniture orders).
Along with cash on the B/S, Flexsteel also has a solid FCF yield for this fiscal year and the next. According to our projections from our model, for this FY21e and the next FY22e, the FCF yield is an extremely attractive 10.3% and 10.5%, respectively. When taken on EV, FCF Yield for FY21e and FY22e is even greater, at 15.1% and 17.1%, respectively. Cash reserve and FCF yield will help maintain shareholder value either through improvement towards top-line growth, dividend increases, or buybacks.
Flexsteel Announced a $30 million Repurchase Program
On October 22, 2020, Flexsteel approved a new repurchase program authorizing the company to purchase up to an aggregate of $30 million (or 14% of the current market cap) of the company’s common stock over the next three years. This means that the company sees real value in their stock, and this is likely to lead to a share count reduction. It is especially likely now that they are at the completion point of their restructuring process.
Since FY06/2017 shares outstanding have been relatively flat, despite repurchases being made in the previous fiscal years amounting to $13.7 million (or 6% of the current market cap). So, a large portion of these buybacks went towards compensation to employees in the form of grants and options. While previous buybacks did not reduce shares outstanding, it did nonetheless offset dilution and help maintain a stable share count.
Dividend: Reinstatement Likely to Pre-Pandemic Levels
The company continued its reduced quarterly dividend of $0.05 per share (annualized run rate dividend computed to $0.20 per share, or 0.7% yield on current stock price). Historical dividend prior to 3QFY20 ended March, as can be seen from Bloomberg in the image above, was $0.22 quarterly dividend per share (annualized $0.88 per share, or 3.1% of current stock price). We have strong reason to believe that the company will reinstate their dividend back to their prior levels, as things look to improve during this optimistic period. The record backlogs led by the 1) macro housing boom and 2) company-wide restructuring efforts away from the currently weak contract/commercial markets give way for a positive outlook for Flexsteel. We predict that, by early calendar 2021, the quarterly dividend should be reinstated at $0.22. Record earnings growth and EPS surprise, backed by orders and sales, is the primary factor for the dividend improvement back to pre-crisis levels, in our opinion.
Sourcing from Asia
The US-China trade war had made it harder for Flexsteel to sell furniture. They struggled to deal with the 25% surcharge tax levied on incoming shipments from China mainly in FY19 and FY20 ended June. Roughly 60% of the furniture is sourced in from Asia (China, Vietnam, and Thailand) and Mexico, the rest 40% being manufactured by the company itself in the US. As a result of the tariff on incoming Chinese goods, gross margins took a big hit, but they have recovered since going into FY21.
Current concerns for Flexsteel, when it comes to international sourcing from Asia, are limited availability of ocean containers and inflationary pressures in key materials.
Vietnam Issue: Likely to Dissolve
There has been a recent probe by U.S. Trade Representatives (USTR) into Vietnam’s alleged manipulation of currency and illegal harvest of timber. The manipulation of currency was brought into question when USTR concluded in August that Vietnam had manipulated its currency in at least one case involving the export of light vehicle tires. Vietnam currency was undervalued by around 4.7% last year, according to Treasury, making it easier for US to purchase these goods from the region.
Since Trump took office in 2016, US’s trade surplus with Vietnam has increased steadily rising from $38.3 billion in 2017 to $55.7 billion last year, according to U.S. Treasury data. A large part of this increase is caused indirectly by the increasing trade tariffs and restrictions placed on goods coming in from China, leading many American companies to pivot and look to other regions to relocate their operations. Vietnam became an attractive proxy because of its low labor costs, skilled workforce, and proximity to China.
We are monitoring this issue as we are following furniture stocks Hooker (HOFT) and Bassett (BSET) who also import from Vietnam. We are long on Bassett and Hooker stocks and have written multiple research notes (see Bassett initiation note and Hooker initiation note).
The Trump administration has been stern on the issue of no other country having a trade surplus with US. As a result, there might be a fresh new wave of tariffs imported goods coming from Vietnam. Considering that the investigation into these alleged malpractices by Vietnam has just gotten underway, in our view, any set of new tariffs could take some time to materialize if not at all. Flexsteel is very well diversified with multiple locations to source their furniture from (China, Vietnam, Thailand, and Mexico).
Election Results: Trade tariffs on goods coming in from Asia will be impacted by the next President, post the 2020 Elections. Lot of this might be resolved and cease to have impact, and some tariffs may still persist. It is too early to clearly state. We shall have a clearer answer to this and these pertinent issues for Flexsteel hopefully by January of the next calendar year 2021.
Housing Market Stats – Record Gains
Existing Home Sales
From June to September, there were record existing home sales on an annual basis of 20.7% (June), 24.7% (July), 18.6% (August), and 20.9% (September), respectively, according to CNBC. Demand in the US housing market has outstripped supply as people continue to splurge on buying homes.
Sales could be more robust if there were more homes available. The inventory of homes for sale fell 19.2% annually to just 1.47 million homes for sale at the end of September. At the current sales pace that represents a 2.7-month supply. That is the lowest since the Realtors began tracking this metric in 1982.
Housing starts are also at record highs, beating forecasts in October and growing at its fastest pace since February. In the chart taken from Bloomberg (see below), single-family housing starts as well as backlogs have hit their fastest pace since 2007. The high number of backlogs is an indicator that more orders are yet to be fulfilled by builders. This means homes will only be available for purchase going forward 4-6 months, and then, there will be the further delay associated with paperwork at the time of purchase. Factoring this all in, the housing market looks strong for the considerable future. Given below is a quote from a Bloomberg article, highlighting reasons for builder confidence:
Record-low mortgage rates and the rush to relocate to larger homes in suburbs that double as new workplaces during the pandemic have depleted housing inventory, helping explain why builder confidence stands at an all-time high.
Source: Bloomberg Terminal
Strong Housing Market Continues
The housing market soared from June to September with an average existing home sale growth of ~20% throughout the period. Median home prices surged to record levels.
$89 million backlog (roughly 3 months of sales value) signaling pent-up demand and surge in orders; likely to continue going forward this full year. Flexsteel looks to ramp up production to meet this demand.
Exiting of Commercial Businesses
Will make Flexsteel a residential provider of furniture, and it will help make more out of this housing market. This is good for investors in the medium term who will benefit even more now, given the current optimistic outlook for housing.
Tariffs on Imported Goods
Tariff present on goods from China and Vietnam could lead to higher margins which could hurt Flexsteel’s financials. This could easily dissolve with trade policy changes, as it was the Trump administration who was much more focused on trade issues. However, this is just a generalized view and policy and politics is subject to the unknown.
Flexsteel, having zero institutional coverage by the Street, is a very underfollowed stock relative to its peer group. We believe this provides a unique buying opportunity, as the company is relatively unnoticed and trading well below its 5-year highs (unlike other furniture stocks, like Haverty (HVT) or La-Z-Boy (LZB) which have crossed this mark). We see a 52% upside with a favorable risk-reward scenario. The housing market has a long runway laid out ahead, with no signs of slowing down, and the situation on trade tariffs also looks to be clearing. We are very optimistic that Flexsteel will be a continual beneficiary of housing, and being overlooked and out-of-favor today, creating an attractive investment opportunity at this point of time.
Disclosure: I am/we are long HOFT, BSET. 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.