Whitney Tilson’s email to investors providing an update on Lumber Liquidators Holdings Inc (NYSE:LL); and how it reminds him of SodaStream.
1) It’s really difficult to time the bottom of a stock in decline. Even if you’re (hopefully!) right that its share price will eventually turn around, the odds that you bought the stock at the very bottom are close to zero. That means you’ll have to endure a period in which you’re underwater.
Seth Klarman On Margin Of Safety Investing
This is part nine of a ten-part series on some of the most important and educational literature for investors with a focus on value. Across this ten-part series, I’m taking a look at ten academic studies and research papers from some of the world’s most prominent value investors and fund managers. All of the material Read More
During this time, you have to answer a tough question: Is your investment thesis still intact and you just got in a bit too early, or have you made a mistake and stumbled into a value trap?
In one of my e-mails next week, I'll lay out a framework for thinking about this critical question. But in the meantime, let's look at a real-time example...
Since we launched the Empire Investment Report in April, we've made four stock recommendations: one, Howard Hughes (HHC), is up big, two haven't moved much, and one, Lumber Liquidators (LL), is down quite a bit. I've mentioned both HHC and LL here before.
When I recommended Lumber Liquidators' stock in April, it had fallen from over $40 less than two years ago to around $11. Given that I thought it would easily be worth $20 within a year and perhaps twice that in two to three years, I thought it was unlikely to fall much further.
For the first three months, I was right: even after the Trump administration increased tariffs from 10% to 25% on most of what Lumber Liquidators sources from China, the stock traded in the $10-$13 range. As recently as two weeks ago, it was at $12... but since then, it has been in freefall, losing a third of its value. Today it trades around $8.
This sell-off is really puzzling because there hasn't been any company-specific news at all – it's in a quiet period before it releases second-quarter earnings next Wednesday.
In our regular Empire Investment Report newsletter, published later this month, subscribers will receive a full update on Lumber Liquidators, including our analysis of Q2 earnings and our recommendation of whether to simply hold the stock or buy more of it.
But in the meantime, I wanted to share some insights from my friend and flooring industry veteran, Donovan Royal:
There has been a brutal selloff in LL's shares the last two weeks. Trump's List 4 tariff announcement yesterday further eroded LL's market cap to $235 million, even though none of LL's products is subject to these tariffs (although there could be some broader economic impacts affecting consumers and their home improvement projects).
While LL is facing some significant challenges in housing and the home renovation market overall, confirmed by a weak Q2 Catalina industry report – and Mohawk Industries (MHK) showing significant slowing in its North American flooring segment (down 7% in Q2) – I feel this weakness is more than priced into LL's stock.
Also worth noting is that Floor & Décor (FND) reported strong earnings after the close yesterday, leading to a surge in the stock today, demonstrating that it is possible to grow even in this tough flooring environment.
While LL has underperformed FND for the last five years, it has stabilized its business and I expect it to extract further price concessions from vendors to improve its gross margins (much as FND did).
Looking forward to LL's earnings next week, we should get an update on their sourcing initiatives, CFO position, and hopefully some additional color on the progress of its new expanded showroom format.
Additional reasons to be constructive on LL are that existing home sales comps ease in the back half of 2019, all of LL's legacy issues are behind it, and Q2 should be the first full quarter where we can see how this management team can execute without distractions.
At $8, assuming no changes in legacy accruals, payables, and long-term debt, each LL store is valued at around $1 million (of which 70% is inventory), equal to roughly 40% of sales. That seems very cheap to me.
2) I agree with Donovan that the tariff and housing headwinds are more than priced into the stock.
This story so far reminds me a bit of my experience with SodaStream... It took a huge beating initially before the investment turned into one of my biggest successes ever.
The company's countertop machines turn regular tap water into sparking water with the touch of a button. It has a great razor-and-blade business model because the carbon dioxide (CO2) bottles in its devices need to be replaced regularly – and the company makes something like an 80% profit margin doing so.
But SodaStream had botched its marketing in the U.S. and was also relocating its main factory in Israel, so its sales and earnings were down. I patiently waited until the stock had been cut in half, bought a small position, and pitched it at my Value Investing Congress conference in April 2014, with the stock trading at $35. But it kept on drifting lower, so I pitched it again at $22 at the Robin Hood Investors Conference in November 2014.
Again, I was too early. SodaStream shares kept going down for more than a year, finally bottoming in early 2016 at $12. At that point, I had lost nearly two-thirds of my original investment!
But I didn't panic. I put my emotions aside and focused on the company's fundamentals. As you can see in this slide presentation I developed to teach this case study, the number of CO2 refills – where the company makes most of its money – was rising. This told me that the underlying business remained healthy, so I tuned out all of the short-term noise and bought the stock at various points all the way to the bottom.
I never made it a huge position – as the stock declined, I'd buy it back to roughly a 4% weighting – because I knew that there was always the risk of a permanently bad outcome.
But my position was plenty big enough to give me big returns when the company's revenues and earnings finally turned. In early 2016, the stock took off like a rocket, and less than two years later, it was at almost $100.
And then in August 2018, Pepsi (PEP) swooped in and bought the company for $144 a share, more than four times what shares were trading for when I first pitched the idea.