Lumber Liquidators Holdings Inc Downgraded By Goldman

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Lumber Liquidators earned mixed analyst views from its business update last week, with the initial raft of reports indicating positive views, but they were followed by at least two negative analyst reports. Goldman Sachs downgraded the stock and cut its price target, while Jefferies analysts also slashed their price target and remain on the sidelines.

Goldman downgrades Lumber Liquidators to Neutral

In a report dated March 13, Goldman Sachs analyst Matthew Fassler and his team said they downgraded Lumber Liquidators from Buy to Neutral and trimmed their price target from $40 to $35 per share. They point out that it looks like the flooring retailer’s gross margins are in trouble.

Lumber Liquidators had already begun an expanded marketing campaign for this year, and now it will need to become even more aggressive in its marketing to battle the bad press from the 60 Minutes report. The report alleged that the company’s products do not meet the California Air Resource Board (CARB)’s stringent guidelines for formaldehyde content.

Because of the even greater marketing campaign the flooring retailer will have to follow, its operating margin will likely be “materially lower,” according to the Goldman Sachs team.

Lumber Liquidators’ sales hit by report

Now the debate about whether 60 Minutes used a valid testing method continues. Unsurprisingly though, the company’s sales were hit by the report. The Goldman Sachs team did expect to see a negative impact on sales, but they didn’t expect to see such a big impact on margins.

Because of the lower margins, they cut their 2015 earnings per share estimate from $2.18 to $1.60 per share. Their 2016 estimate moves from $2.35 to $2.05 per share, and their 2017 estimate moves from $2.64 to $2.25 per share.

Questions left unanswered

Fassler and his team said last week’s business update from Lumber Liquidators management did effectively call into question the testing method used by 60 Minutes. They were left convinced that it’s unlikely the company’s products are releasing formaldehyde levels that are unsafe. They also pointed out that what management said was in line with what other participants in the flooring industry told them.

However, they did not answer why the flooring sold by Lumber Liquidators would not pass the news program’s tests even though products sold by competitors did. Also management address the possibility that its suppliers sold it wood that wasn’t properly certified by third-party inspectors. They believe the story has bottomed out but sales probably haven’t.

Worse before it gets better

In their report also dated March 13, Jefferies analyst Daniel Binder and associates John Gugliuzza and Dolph Warburton said they slashed their price target from $52 to $33 per share. They continue to rate Lumber Liquidators as a Hold.

They point out that management’s guidance shows how much the confidence of the company’s customers is shaken. They are staying on the sidelines because of a lack of visibility on earnings per share.

Lumber Liquidators has a long buying cycle

They add that the average 100-day buying cycle for Lumber Liquidators’ products suggests things will get worse before they get better. As a result, near-term comparable sales won’t reveal the entire story and could end up being underestimated. They say the company is different from other retailers because of the longer buying cycle and backlogs.

Currently adjustments and product returns are at around 20 to 25% of gross orders, compared to the average of 11%. One area which isn’t clear is store traffic for customers who are still early in the buying process.

Manufacturing changes may be needed

The Jefferies team said the first 10 days after the damaging news report were more about customers who came through the 100-day process and canceled their orders in spite of the inconvenience to themselves. Those who had not made a purchase yet probably found it easier just to go somewhere else for their flooring.

For this reason, they don’t expect comparable store sales to rebound quickly, and they believe Lumber Liquidators could have to make some changes in its manufacturing process in order to regain customers’ confidence. This is particularly true because of the better test results from flooring products made by competitors.

After closing down 15.33% at $30.55 per share on Friday, shares of Lumber Liquidators rose as much as fell 0.33% to $30.45 per share in premarket trading this morning.

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