Lumber Liquidators Holdings Inc (NYSE:LL) is under investigation for potentially violating the Lacey Act related to illegal sourcing of wood for one SKU of hand scrapped hardwood. According to the report published by the Environmental Investigation Agency (EIA), the management of the Lumber Liquidators knew that Xingjia, its Chinese supplier was illegally sourcing logs from protected forests in Eastern Russia.

Lumber Liquidators

Illegal sourcing issue lobbed was overdone

Wedbush analyst Seth Basham believed that the illegal sourcing issue lobbed against Lumber Liquidators Holdings Inc (NYSE:LL) was “overdone,” and it was an isolated incident without major repercussions to the company.

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According to Basham, they spent significant time investigating the operations and suppliers of Lumber Liquidators Holdings Inc (NYSE:LL) and found no evidence of widespread negligence on the part of the executives of the company.

“We found no indication of illegally sourced logs by other top suppliers identified using Port Examiner Import data,” wrote Basham in a note to investors. He believed that the case will be resolved in isolation with minimal outcome.

Lumber Liquidators’ small sales portion representation

He emphasized that if there was illegal sourcing, the potential illegally sourced woods typed only represented a small portion of the sales of Lumber Liquidators Holdings Inc (NYSE:LL) and it is “extremely unlikely” that it was significant driver in the expansion of the gross margin of the company.

Basham explained that Eastern Russian is no longer the largest source of quality logs for the Chinese flooring industry because of restrictions and pricing. According to him, there are abundant sources of the same quality of logs with competitive pricing including the United States and countries in Eastern Europe.

China’s wood demand

He believed that a huge portion of the products of Lumber Liquidators Holdings Inc (NYSE:LL) coming from China does not require high quality logs such as laminate, bamboo, and engineered wood that would be worth getting from illegal areas.

“Scrutiny of logging sources is very high today as are penalties for importing illegally sourced wood. It is not worth the risk for any reputable company to knowingly authorize in illegal sourcing or even turn a “blind eye” on it,” pointed out Basham.

Lumber Liquidators’ gross margins estimation

Basham believed that Lumber Liquidators Holdings Inc (NYSE:LL) will continue to generate higher gross margins of at least 100bps in 2014 based on his detailed analysis from Chinese sourcing operations particularly from its massive 800 bps sourcing mix shift to Asia YTD. He also noted that the sales of the company are still strong because of the housing rebound.

The analysts have an Outperform rating for the stock of Lumber Liquidators Holdings Inc (NYSE:LL) with a price target of $125 per share.

Last month, Whitney Tilson disclosed that he has a short position on the shares of Lumber Liquidators. According to him, he was convinced that the sourcing of large quantities of illegally harvested and imported hardwoods were the main contributors to the “unprecedented margin expansion” of the company.