Lumber Liquidators (LL) appears significantly overpriced now as its stock has increased to around $24 despite the expiration of tariff exclusions. I could understand the case for it being worth $20+ if the tariff exclusions were extended, but the reintroduction of tariffs makes Lumber Liquidators a sell at its current share price.
Effect Of Tariffs
Lumber Liquidators mentioned before that 25% tariffs could create around $56 million in annualized headwinds to operating income. It was able to fully offset $22 million in annualized headwinds (from the 10% tariffs) through mitigation efforts, although it believed that the additional $34 million in annualized headwinds (from the rise from 10% to 25% tariffs) would be much harder to fully mitigate.
The expiration of the tariff exclusions means that after August 7, 2020, around 43% (the percentage coming from China) of Lumber Liquidators’ merchandise receipts are subject to 25% tariffs. This is an increase from the 10% of its merchandise receipts that were subject to 25% tariffs prior to the expiration of the tariff exclusions.
Thus, there may be $26 million in annualized headwinds to operating income as a result of the expiration of the tariff exclusions. This is based on the $34 million in annualized headwinds that it hadn’t mitigated before, less the 23% (10 percent divided by 43 percent) of Chinese merchandise receipts that weren’t subject to tariff exclusions anyway.
If Lumber Liquidators is able to mitigate half of this impact, then the annualized headwinds to operating income would be around $13 million, or a bit over 1% of net sales.
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I noted before that a -20% comparable store sales result for Lumber Liquidators would be pretty solid for Q2 2020 given its -30% comps up to May 23. Lumber Liquidators ended up with -21.3% comps for the full quarter, which indicates to me that its sales results are fine.
Despite the reduced sales caused by store closures earlier in the quarter, Lumber Liquidators delivered a solid 2.8% adjusted operating margin for Q2 2020 as it also reduced SG&A commensurately. Adjusted gross margins remained strong at 38.3%, although the end of the tariff exclusions may push this to around 37% over time despite mitigation efforts.
Notes On Valuation
My previous calculations around Lumber Liquidators’ value indicated that it would be worth close to $20 per share based on a 10x EV/EBITDA multiple and modest comparable store sales growth going forward. This assumed that the tariff exclusions were extended though.
The estimated impact to Lumber Liquidators’ operating income reduces its value by around $4 per share. Thus it may be fairly valued at around $16 per share now assuming that it can deliver around +3% comps going forward. At $24 per share, Lumber Liquidators needs to deliver a lot of growth to justify its value with its lower operating margin potential now.
Lumber Liquidators has performed decently operationally, with its sales largely recovering towards the end of Q2 2020. It has also kept its operating margins in good shape with temporary SG&A reductions that matched up with the temporary sales losses during the quarter.
That being said, the end of the tariff exclusions is a significant blow to Lumber Liquidators. Without any additional mitigation, this may reduce annualized operating income by $26 million. Lumber Liquidators can likely mitigate some of this impact, but it may still see a $13 million hit to operating income while the 25% tariffs are in place.
I considered the stock close to being an outright sell at $23 with the tariff exemptions still effective. It was trading a bit higher than my estimate that it was worth close to $20 at the time, making it somewhat overvalued.
The expiration of the tariff exemptions reduces its estimated value by around $4 (to $16 per share) which makes it appear to be a clear sell when it is trading at $24 per share now.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in LL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.