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Whitney Tilson and the Saga of Lumber Liquidators

- By Robert Abbott

Whitney Tilson (Trades, Portfolio), one of the high-profile investors followed by GuruFocus, has dramatically reversed his opinion about Lumber Liquidators Holdings Inc. (LL).


Tilson famously shorted Lumber Liquidators twice in the past five years but now thinks it may have potential as a long name. He hasn't said a lot on the subject, but this slide from Robin Hood Investors Conference on Nov. 29, 2016 shows his history with the stock and makes it clear where he stood at the time of the conference.

Tilson Lumber Liquidators

Note that Tilson had not at that point (last November) bought or recommended Lumber Liquidators but had at least decided to no longer short it. In his words, the company "might be a good acquisition candidate" now.

Should investors take a second look at a stock that not long ago traded for more than five times its current price?

Who is Whitney Tilson?

Tilson founded and manages the Kase Fund through Kase Capital Management of New York City (formerly T2 Partners LLC).

He graduated from Harvard College in 1989 and later earned an MBA at Harvard Business School. That was followed by two years as a consultant at Boston Consulting Group.

According to the Kase Fund Annual Letter for 2016 (published on Feb. 1), he held 11 long positions and four short positions at the end of the year.

The long positions were:

  • Mondelez (MDLZ).
  • CSX (CSX).
  • Howard Hughes (HHC).
  • Berkshire Hathaway (BRK-B).
  • Fannie Mae (FNMA).
  • Reading International (RDI).
  • Pershing Square Holdings (PSH).
  • Platform Specialty Products (PAH).
  • Spirit Airlines (SAVE).
  • SodaStream (SODA).
  • Grupo Prisa (PRIS.B).



The short positions were:

  • Wingstop (WING).
  • Exact Sciences (EXAS).
  • Herbalife (HLF).
  • World Acceptance (WRLD).



Tilson reported in the Fund Letter that he made significant changes to the portfolio in September 2016 after soul searching about the fund's poor performance, trouble finding bargains, a feeling he was out of sync with the market and a cautious view of the macro environment. That rethinking of the portfolio is continuing in 2017.

As this table (and disclaimer) from the Fund Letter shows, Tilson had reason to be disappointed with the results in 2016:

Tilson Kase Fund

As to his investing philosophy, Tilson says, "On the long side, I seek to construct a portfolio that is both highly concentrated yet also diverse in terms of industries, types of value, catalysts and risk." On the short side, he limits his comments in the Fund Letter to the individual stocks: he's pessimistic about two of them because of underperformance and with the other two he uses the word "predatory."

Tilson has co-authored two books, "The Art of Value Investing: How the World's Best Investors Beat the Market" (2013) and "More Mortgage Meltdown: 6 Ways to Profit in These Bad Times" (2009); he has also written for or contributed to a number of prestigious financial media. (Biographical information from Wikipedia.org)

What is Lumber Liquidators and what happened to it?

The company operates a chain of more than 380 retail stores plus an online sales platform that specializes in hardwood flooring. It was started by building contractor Tom Sullivan in Stoughton, Massachusetts, in 1993. Growing steadily since inception, it listed on the New York Stock Exchange in 2007.

2013 was a pivotal year, with annual sales reaching $1 billion for the first time and the first hints of class-action lawsuits. They emerged after release of a report by the Environmental Investigation Agency, which claimed indiscriminate and poor sourcing practices in Eastern Russia led to destruction of critically endangered tiger habitats and forests. The company subsequently pleaded guilty to the illegal importation of hardwood flooring and was fined $13.5 million.

In 2015, there was new trouble, this time involving the level of cancerous formaldehyde in Chinese-made laminate flooring, a claim magnified by an accusatory episode of the TV series "60 Minutes." The following year, the U.S. Consumer Product Safety Commission wrapped up a probe into the claims, without issuing a product recall. However, Lumber Liquidators did settle with California for importing flooring that exceeded the limits for formaldehyde.

Through 2016, the company has engaged in other damage resolution and adopted new quality and compliance criteria for its imports. Over the past two years, it has also made sweeping changes at the top; founder and Chairman Tom Sullivan has been replaced by an independent chairman, and the company has a new CEO and a new chief financial officer.

Sources for this section include Wikipedia.org, ClassAction.org and Reuters.com.

For more background on the company, see my January 2015 article, Lumber Liquidators: Fearful or Greedy?

What's ahead for Lumber Liquidators?

Tilson isn't the only one with a more positive outlook.

Schaeffer's Investment Research said on Feb. 21, "Lumber Liquidators Holdings Inc. short sellers may find themselves increasingly under water."

And Hellen Ng'endo Gachuhi at Seeking Alpha writes that investors should be reassured by the recovery plan that's being executed, and a new emphasis on compliance should reassure both investors and customers. However, another SA contributor, Josh Arnold, sums up his feelings about the company in the title of his article, "Lumber Liquidators Continues To Struggle But Nobody Cares."

Among the analysts followed by Nasdaq.com, the 12-month consensus price target is $17, below the $18.19 close on Feb. 27 (a day in which the stock climbed nearly 5%), and almost all of them have a hold rating:

Lumber Liquidators analysts

Two of the investing gurus followed by GuruFocus have positions in Lumber Liquidators: Chuck Royce (Trades, Portfolio) and John Rogers (Trades, Portfolio). In the last quarter of 2016, Royce increased his position by 63.5%, to nearly a half million shares. Rogers reduced his position by almost 4%. The former now has a 1.75% stake in the company while the latter has a 1.65% stake.

The fundamentals

As this GuruFocus chart of EPS (earnings per share) shows, it wasn't just the share price that fell off a cliff:

LL Earnings Per Share

Seeing this chart helps explain why Lumber Liquidators' Predictability rating also fell, to 1-Star (from 4-Star in January 2015).

The same story holds for free cash flow:

LL free cash flow

Because of the churning share price and earnings, the price-earnings (P/E) ratio makes no sense at this time. This chart tells that tale:

Lumber Liquidators P/E

The GuruFocus system lists four warning signals: a low Piotroski F-Score; a long-term decline in the gross margin; a high proportion of short sellers (34%); and assets growing faster than revenues.

It should also be noted the company has a negative return on invested capital (ROIC) of -26.76%.

Against all this, though is the 10-year revenue profile:

LL Revenue

Revenue has taken a hit but not as much as might have been expected from seeing the earnings and cash flow results. The top line profile suggests the company retains most of its customers and market share, and that it will show substantial bottom line results once it stops (or if it stops) paying legal bills and associated costs.

Conclusion

In November 2013, before its various troubles began, Lumber Liquidator Holdings flirted with the $120 mark. Now, it's a fraction of that price, bumping up and down in a range between $10 and $20.

Will it break out of that range and head back up again, seeing that it has dealt with many of the issues that bedeviled it? New management has control of the company, and some observers are optimistic. Importantly, Tilson, the short seller who helped bring the company's shortcomings to public notice no longer has a negative outlook.

For most investors, the response still will be, "Show me!" Perhaps prices above $100 are possible again, but earnings and cash flow will have to start catching up to the top line first.

Aggressive value investors may jump in again once the price breaks out above the current range. However, for most investors, this is what Warren Buffett (Trades, Portfolio) might have called a "cigar-butt" stock, and they have little reason to take a position now.

Disclosure: I do not own shares in any of the stocks listed in this article, nor do I expect to buy any in the next 72 hours.

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This article first appeared on GuruFocus.