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Gurus Locking Horns: Lumber Liquidators' Incipient Saga

February 05, 2014 | About:

On the Nov. 22, standing at the Robin Hood Investors Conference, hedge fund manager Whitney Tilson (Trades, Portfolio) gave a widely followed presentation where he announced a short position in hard-wood flooring company Lumber Liquidators (NYSE:LL).

-The short thesis was based on his analysis of LL’s gross margin: He claimed that it expanded rapidly beyond its competitors at the same time as they started working directly with some mills in China. The 300 basis-point increase in margin was therefore suggesting LL might have been acquiring product for much less since.

Since a London-based NGO released a document linking LL purchased timber to illegal logging in Eastern Russia, the company has come under investigation by the U.S. authorities.  The stock plunged promptly since the presentation, reaching a low of $86.88 yesterday from $115 at the time.

The interesting twist came today when both SAC and Lone Pine disclosed significant stakes in LL. SAC’s stake is believed to be close to 13% of the company, held through multiple subsidiaries and using various financial instruments. At the same time, Lone Pine bought 2,189,839 shares of LL, which would give it more than a 7% stake in the company.  So a combined stake of more than 20% announced on the same day by two of the most prominent hedge fund managers is certainly worth looking into.

Is this another repeat of the Herbalife saga? There are some clear similarities: A hedge fund manager going very public on a short position, and two prominent funds mounting a public contrary position. As in the Herbalife situation, this could result in other people crowding the stock and squeezing the short-sellers for a quick profit (Loeb and Icahn on Herbalife).

We can certainly ask ourselves how sound is this short thesis, and what about value? Well by Tilson’s own admission, the fine is not expected to amount to much, and the amount of timber sources from any particular mill is insignificant, so sources of supply won’t suddenly dry out. It might have to ultimately buy more costly timber, but this will not affect its results overnight.

So what does that leave us in terms of value? While the stock is not necessarily cheap by classic measures, it is exhibiting incredible and consistent growth:

  • Revenue growth of 22% annually for a decade.
  • 2013 EPS growth of 58% and 2014 estimated growth of 26%.
  • A very decent 45% ROC for a retailer and leading operating margins.

The way I see this playing out is the following: The company will continue to exhibit strong growth as it is adding constantly to the number of stores, and the results might even surprise to the upside given the strength of homebuilding in the U.S. and that expectations have now  been managed. Even if there is operating margin shrinkage, it is unlikely to come soon as any effect on changing its supply chain will take time to manifest.  

Now that confidence in the stock has been somewhat restored by the credibility of legendary investors like Mandel and Cohen, a short squeeze on results is likely, and this could be an interesting trade for the short to medium term. I’m siding with the longs on that one. Let’s see how it plays out.

Rating: 3.0/5 (3 votes)


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