La-Z-Boy: Lagged Market But Shares Are Attractive (LZB)

Overview

La-Z-Boy Incorporated (NYSE:LZB) is a furniture company that designs, produces, imports, exports, distributes, and sells upholstered furniture, accessories, and casegoods in the United States, Canada, and globally. It has four business segments: Wholesale, Retail, Corporate, and Other.

The Wholesale business makes and imports upholstered furniture such as recliners, sofas, loveseats, chairs, sectionals, ottomans, and sleeper sofas, and also imports, distributes, and sells casegoods or wood furniture. This segment sells its products to La-Z-Boy Furniture Galleries stores, independent retailers, and dealers. This is the company’s largest segment.

The company’s next largest segment is the Retail segment which sells furniture, accessories, and casegoods directly to consumers through its 161 company-owned La-Z-Boy Furniture Galleries stores. The Corporate and Other segment sells products through its website. A breakdown of each segment’s 2022 revenue is below.

Performance

Over the past 10 years, LZB has consistently demonstrated robust revenue growth. Last year, the company recorded $2.36 billion in revenue, reflecting an impressive 35.9% YoY increase. Over the last decade, LZB has almost doubled its revenues, with a total growth rate of 85%. The company’s revenue growth has been consistent over this period with only two years of revenue declines.

LZB has also been growing free cash flow over the years as well however in 2022, the company reported just $2.4 million in free cash flow, which represents a decrease of 99% compared to its 2021 free cash flow. This sharp decline in free cash flow was caused by a couple of factors.

First operating cash flow declined almost 75% mainly attributed to the substantial rise in customer deposits in fiscal 2021 due to a surge in sales after retail stores resumed operations, and to a substantial increase in inventory levels in fiscal 2022 to meet increased sales demand.

In addition, capital expenditures doubled primarily because of increased investments towards upgrading the upholstery manufacturing and distribution facilities in Neosho, Missouri, enhancing the retail stores, adding new upholstery manufacturing capacity in Mexico, and upgrading the company’s technology.

LZB has an improving track record of profitability. Over the past decade, the company has averaged a 14% return on equity, but last year the company reported an ROE of 20.7% which is the highest ROE for the company over the period. LZB’s ROE outperform those of its competitors. In 2022, the company’s ROE was 61% higher than the sector median.

Regarding LZB’s balance sheet, the company has effectively increased its shareholder equity, which currently stands at $810 million. LZB has steadily increased shareholder equity, showing an overall growth of 67% over the past decade. The company also enjoys a healthy current ratio of 1.56 and debt to equity ratio of just 0.49. Therefore, the company’s balance sheet is in great shape.

In general, the company has shown a solid financial track record. Unfortunately for investors, this performance hasn’t propelled LZB’s stock to new highs, as it has underperformed the total return of the S&P 500 by a substantial margin over the past five years, leaving investors to ponder if LZB can turn it around.

Outlook

LZB’s strategy is focused on revitalizing its brand by focusing on the comfort message, expanding their omni-channel presence, and finding new growth opportunities. The company will use celebrity ambassador Kristen Bell in their marketing to attract a younger audience while making improvements to its digital platforms for an easier customer experience. This will involve making it easier for customers to browse products, customize them, find stores, or purchase online.

In addition, LZB is expanding the reach of their La-Z-Boy Furniture Galleries and La-Z-Boy Comfort Studio stores. Customers often start their furniture shopping journey online but then visit the stores, where the company can provide the flagship store experience and design services. The company’s initiatives aim to generate growth in their Retail segment by increasing the number of company-owned stores and expanding their proprietary distribution network in the Wholesale segment. The company also plans to upgrade existing stores to new concept designs to help accelerate same store sales.

As a part of LZB’s efforts to grow its ecommerce business, the company purchased Joybird in 2019. Joybird is a leading e-commerce retailer and manufacturer of upholstered furniture with a direct-to-consumer model. LZB plans to grow the Joybird brand by increasing digital marketing, investing in technology, expanding the product assortment, and adding small format stores in urban markets to enhance the omni-channel experience.

LZB also works with over 2,200 other dealers to sell their products through multiple channels, including well-known names in the furniture industry such as Slumberland, Nebraska Furniture Mart, Mathis Brothers and Raymour & Flanigan. The company believes there is a lot of growth potential in these retail channels, so it’s working on making the business stronger and more flexible to support all their consumer brands.

Valuation

To estimate LZB’s intrinsic value, a comparative and discounted cash flow (“DCF”) analyses will be used. The comparative analysis will consist of taking the highest, lowest, and median price-to-earnings ratios the market has paid for LZB over the past five years and multiplying them by LZB’s consensus 2023 EPS estimate of $3.31 per share. As a bonus, the current sector median valuation of 12.39 will also be applied to LZB’s consensus 2023 EPS estimate for an additional scenario.

Scenario	P/E	Next Year Earnings Estimate	Intrinsic Value Estimate	% Change
Bear Case	5.77	$3.31	$19.10	-34.75%
5Y Median P/E	16.75	$3.31	$55.44	89.42%
Bull Case	29.93	$3.31	$99.07	238.46%
Sector Median Valuation	12.39	$3.31	$41.01	40.11%

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On a comparative analysis, LZB has a wide range of scenarios that can play out. Investors could realize an excellent 238.46% return if the market were bullish and applied the 29.93 multiple, seen in 2021, to next year’s average analyst earnings estimate, should those estimates materialize. On the downside, investors could realize a significant -34.75% loss if the market were to value LZB at the 5-year low multiple seen in just a few weeks ago in December of 2022.

The most likely scenario is the base case, which is based on the 5-year median P/E ratio and is the most important. This base case scenario would result in an 89.42% return for investors. The final scenario which is based on the sector median multiple results in an excellent 40.11% gain. Altogether, this comparative analysis indicates that LZB is significantly undervalued at its current share price.

Turning to the discounted cash flow analysis, the starting point will be the average of the last five years of free cash flows, which is $115 million. Then a 7% growth rate will be applied to the free cash flows for the next ten years. This growth rate is based on rule 72 which states a 7% growth rate will take just over ten years to double the original value. This is a reasonable amount of time for LZB to double its free cash flows, based on a combination of the company’s past performance and future growth opportunities. Analysts also predict a similar EPS growth rate over the next five years.

Following the 10th year, a 2.5% growth rate will be used into perpetuity to determine the terminal value. A discount rate of 10% will be used, representing my personal required rate of return. With these inputs, the DCF analysis estimates LZB’s intrinsic value is $49.55, representing an upside of 69% from the company’s current share price.

Therefore, this DCF analysis indicates that LZB is significantly undervalued. However, if you are a bear in regard to LZB’s stock, consider that if a 0% growth rate was used over the next 10 years, then LZB’s intrinsic value would be at $29 per share which is where LZB is currently trading. This demonstrates that LZB is a great deal with a wide margin of safety.

Takeaway

LZB is a leading company in the furniture business. Over the years, the company has put together a decent track record of growing revenues and free cash flow and has made great strides improving its profitability. Moving forward, the company is focused on revitalizing their brand by focusing on the comfort message, expanding their omni-channel presence, and finding new growth opportunities. LZB is investing in new marketing campaigns, opening new stores, upgrading its existing stores, and making further investments in its ecommerce and wholesale businesses.

The company’s stock has lagged the total return of the market in recent years however, based on a comparative and discounted cash flow analysis, shares of LZB are selling at an attractive price. If you believe that LZB’s business will continue to grow into the future, then now is an excellent time to start building a position.

Thank you for reading!