La-Z-Boy Stock: Margin Recovery & Upside Potential (NYSE:LZB)

Introduction

Shares of La-Z-Boy Incorporated (NYSE:LZB) have risen 25% YTD. Despite the strong movement of YTD shares, I still consider the current level favorable for opening long positions. Thus, a positive change in the channel mix in favor of the retail segment, in my opinion, will continue to support operating profitability. In addition, the growth of brand awareness due to the development of the retail segment, negative net debt, the ability to pass on higher inflation to the end consumer and improving the situation with warehouse constraints will also, in my opinion, support the growth rate and the level of profitability of the business.

Survey of Q2 (fiscal) report

Retail segment: The company’s revenue grew by 31% YoY to reach a record $252 million, while same-store-sales grew by +25% YoY. In addition, due to business growth, operating margins in the retail segment increased from 12.5% ​​in 2Q21 to 16.5% in 2Q22. In my personal opinion, the increase in the share of revenue that falls on the retail segment is a positive factor, as it contributes to an increase in profitability and improves brand awareness. According to management’s comments during the earnings call, the company will continue to grow the share of revenue that falls on the retail segment.

Wholesale segment: revenue in the wholesale segment increased by 2% YoY. Despite higher prices, lower volumes driven by supply delays and warehouse constraints resulted in modest gains. Rising inflation, marketing costs and prices for raw materials led to a decrease in operating margin to 8.6%.

You can see the main details in the chart below.

Gross margin increased from 38.7% in Q2 (fiscal) 21 to 42.7% in Q2 (fiscal) 22. The growth of the gross margin is associated with an increase in the share of revenue in the retail segment, where the gross margin & operating margin is higher. Thus, in my personal opinion, a further increase in revenue in the retail segment is one of the key drivers of market share growth and an increase in business operating profitability. You can see the details of the product mix change in the chart below.

Projections

I decided to build a model of the company’s cash flows in future periods in order to most accurately understand how the operating margin can change due to an increase in the share of revenue in the retail segment, since retail sales are the most profitable, which should contribute to the growth of the company’s gross margin and operating margin in the following periods.

The main assumptions of my model are:

Revenue growth: in my forecasts, I am based on conservative assumptions of single digit growth at the level of 6% in the next quarter, 8% in 2023 and a decrease in growth rates to 5% by 2026.

Gross margin: the increase in gross margin is a key driver due to the increase in the share of revenue in the retail segment. Thus, in accordance with the comments of management, the company plans to increase the share of revenue from the retail segment from the current 34% to about 50% over the next 3 years. Thus, I predict a gradual improvement in the gross margin from 41.2% in 2022 to 42.5% in 2026.

SGA: I predict a modest increase in SGA expenses (% of revenue) from about 31% in 2022 to 31.8% in 2026.

Tax: I’m forecasting at 22% according to management comments.

Quarterly projections

Yearly projections

Valuation

In my opinion, the most effective way to value a company is the DCF method, because:

1. The company operates in a stable market where it is possible to make assumptions about the future purchasing power and dynamics of consumer spending

2. Using DCF allows you to take into account the acceleration of sales and the expansion of profitability when changing the product & channel mix

3. The company has a long public history, and management regularly provides comments and assumptions about future cash flows

The main inputs in my model are:

WACC: 11.4%

Terminal growth rate: 3%

Multiples

Based on my sales & net income forecasts, I calculated current and target multiples, which you can see in the chart below:

Drivers

Revenue growth: new store openings in high-performing locations, successful marketing strategies and a technological approach can drive traffic growth in the retail segment, which can support a company’s revenue in the coming periods.

Product & channel mix: a positive change in the product mix and an increase in the share of revenue in the retail segment may support operating margins going forward. According to management comments, the company plans to increase its retail share to more than 50% in 3-4 years.

Margin: optimization of operating costs (marketing, labor), efficient use of the supply chain, reduction of the backlog and shifting inflation to the end consumer can help improve the level of business profitability.

Macro: a recovery in real incomes and rising consumer confidence could boost consumer spending on furniture, which could have a positive impact on business revenue.

Risks

Margin: rising costs for raw materials, reduced economies of scale against the backdrop of declining sales, as well as rising operating costs can lead to a decrease in the operating profitability of the business.

Macro: an increase in geo- and macro-economic uncertainty could have a negative impact on consumer sentiment, which could help reduce consumer spending on furniture and lead to a decrease in the company’s revenue.

Competition: increased competition could lead to lower revenue growth and market share, as well as increased marketing costs, which could have a negative impact on operating margins.

Conclusion

The company is able to work effectively against the backdrop of unstable macro and geopolitical conditions. First, the company continues to show revenue growth due to the ability to pass on higher inflation to the consumer. Secondly, the company continues to actively develop the retail segment, which contributes to an increase in operating profitability and brand awareness. In addition, the company has negative net debt, which, in my opinion, is especially relevant in the face of rising interest rates and an unstable macro situation. Thus, according to my estimate, the fair price for LZB stock is $63 with an upside potential of 111%.