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Furniture Brands: Gurus Sitting on Paper Losses

January 28, 2013 | About:
Furniture Brands International, Inc (FBN) is a leader in designing, manufacturing, sourcing and retailing home furnishings. FBN markets products through a wide range of channels, including company owned Thomasville retail stores, as well as through interior designers, multi-line/independent retailers and mass merchant stores. It serves its customers through some of the best known and most respected brands in the furniture industry, including Thomasville, Broyhill, Lane, Drexel Heritage, Henredon, Pearson, Hickory Chair, Lane Venture, Maitland-Smith and La Barge.

Guru AlertsSince the third quarter of 2008, Chuck Royce has been accumulating shares in FBN for 18 consecutive quarters, he added to his position in FBN again in the fourth quarter of 2012 with a purchase of 86,748 shares at an average price of $1.08. Three guru investors/investing firms Chuck Royce, Howard Marks and Hotchkis & Wiley Capital Management LLC own 3,979,745, 2,600,000 and 1,761,500 shares in FBN at average purchase prices of approximately $4, $4 and $5 per share.

Valuation

FBN currently trades at a P/B of 0.66 and a P/NTA of 2.04. Its current P/B valuation is at parity to its five year average P/B of 0.65; while its current P/NTA is nearly double that of its five year average P/NTA of 1.04. FBN's current tangible book value share is only slightly more than one-tenth of what it was ten years ago, reflecting the amount of value destroyed in the past decade.

FBN Historical P/B and P/NTA Valuation1359372798520.png

FBN Book Value and Tangible Book Value Comparison1359373101412.png

Since 2007, FBN has reported five consecutive years of losses, but it managed to generate positive operating cash flow in four of the last five years. However, even operating cash flow is turning for the worse, with negative operating cash flow recorded in 2011 and for the trailing twelve months as at the third quarter of 2012.

FBN Earnings-Cash Flow Comparison

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FBN Profit Margins Analysis1359373680972.png

Financial and Business RisksFBN is highly geared with a gross debt-to-equity ratio of 72% and a net gearing of 59%. It has geared up considerably in the past two years; FBN's gearing remained below 45% prior to 2011. As at Dec. 31, 2011, the projected benefit obligation of FBN's qualified defined benefit plan exceeded the fair value of plan assets by $165.4 million.

FBN Cash-Debt-Market Capitalization Comparison1359373722651.png

FBN faces potential risks of inventory write-downs or write-offs. Prior to 2006, DBN's inventory days were in the mid-to-high eighties. In contrast, from 2010 until now, inventory days have hovered around the 100-day mark.

FBN Historical Inventory Days1359374711043.png

The residential furniture industry is highly competitive and fragmented, with a large number of competitors such as manufacturers, retailers and other large retail furniture dealers who offer their own store-branded products. It is increasingly difficult for FBN to differentiate its products through styling or finish, in view of the large number of competitors and consequently a wide range of product offerings.

In 2002, FBN launched a program to open more single-brand stores, where it provided either lease guarantees or sub-leases to independent operators of Lane, Broyhill, Thomasville or Drexel Heritage stores. FBN typically takes the role of either prime tenant or guarantor of many leases of company-branded stores operated by independent furniture dealers, which exposes it to the risk of business failures of large dealers. FBN will become responsible for payment under these leases, if any of these dealers default. Furthermore, FBN would still be required to pay store occupancy costs, even if it decided not to operate these stores. FBN abandoned the Lane/Broyhill retail concept in 2007, but remains liable for 21 “dark store” leases with a remaining net expense burden of approximately $13.4 million.

Business Quality and Capital Allocation

Despite operating in a large fragmented industry, FBN has two advantages over its peers. First, it has a broad portfolio which spans different price tiers. Secondly, based on a 2010 survey provided by FBN, it has four of the top 11 most recognized brands: Thomasville, Broyhill, Lane and Drexel Heritage.

FBN is capitalizing on continued vertical integration opportunities. In terms of back-end integration, FBN is setting up a new manufacturing plant in Indonesia and a new cut-and-sew facility in Mexico. The new Indonesia plant blends modern equipment with traditional craftsmanship - the modern conveyor system improves efficiency in operations, while intricate hand carving is a hallmark of the Indonesian operations. The Mexico facility is located strategically in Yucatan (20 miles from modern container port), a sewing area for many industries such as furniture, automotive, clothing and benefits from a highly skilled local workforce and various government incentives for training.

On the other hand, FBN is implementing front-end integration through disciplined retail store expansion and leveraging high-end brands in designer showroom format. These best-in-class designer brands include: (1) Hickory Chair, a leading manufacturer of high-end furniture for over 100 years with best-in-class custom finishing and quick-ship capabilities; (2) Lane Venture, a leading high-end outdoor furniture brand; (3) Pearson, a high-end upholstery furniture brand with unique custom fabrics; (4) Drexel Heritage, an updated and contemporary furniture leader; (4) Maitland-Smith, a ;eader in unique hand-crafted custom furniture; and (6) Henredon, a leader in high-end case goods and upholstery.

FBN is actively engaged in optimizing manufacturing and cost reduction. It continues to implement lean manufacturing with the aim of increasing facility utilization through the removal of waste and inefficiencies, increasing first time quality, reducing accidents and material costs. FBN has also moved from a holding company model to a operating company model. While FBN used to comprise of siloed operating companies with separate organizational structures prior to 2008, it now has an operating company model with common processes and streamlined service delivery. FBN also has the option to renew existing lease at lower market rates, move to a smaller store in a comparable location or close underperforming stores as legacy store leases expire.

FBN stopped paying dividends in 2009.

Conclusion

FBN's transformation, which began in 2008, has improved gross margin from 18% to 24%, and reduced reported SG&A by $120 million, with strong improvement in quality, safety, and delivery metrics. However, FBN is still swimming in the red and its current market capitalization is about one-tenth of what it was in 2008, reducing it from a half billion dollar company to a micro-cap. This is a classic turnaround investment opporunity which promises great rewards, when and if FBN does return to profitability.

FBN Improvement In Gross Margin and Reduction In SG&A1359376588877.png

DisclosureThe author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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