BASSETT FURNITURE INDS BSET
August 25, 2021 - 10:23am EST by
TallGuy
2021 2022
Price: 21.50 EPS 0 0
Shares Out. (in M): 10 P/E 0 0
Market Cap (in $M): 211 P/FCF 0 0
Net Debt (in $M): -64 EBIT 0 0
TEV ($): 147 TEV/EBIT 0 0

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  • Small Cap
  • Furniture

Description

Executive Summary

Bassett is a vertically integrated furniture manufacturer. We believe current macro tailwinds for housing and furniture demand will persist providing sustainable demand for Bassett’s products. The Company continues to take market share in its wholesale segment driving sales and consolidated operating margins. As an added bonus, Bassett’s Retail division should maintain profitability for the foreseeable future due to changes in its expense base, closure of underperforming stores, and more effective initiatives to drive traffic.

 

On 8/17/21 the Company issued a press release updating the market about multiple supply chain bottlenecks, raw material inflation, and COVID’s impact on its international supply chain (Vietnam partners shut down through middle of September). The main bottleneck is caused by shipping and warehouse logistics rather than production. Bassett slowed down manufacturing to enable their logistics division, Zenith, an opportunity to catch up. Wholesale orders slowed to a 2% increase over July 2020 (29% increase over July 2019), and shipments increased 11% over July 2020 (declined 1% over July 2019).

 

Bassett currently sits on $63.5 million in cash (~30% of its market cap) with no debt. Ex-cash valuations are nice to talk about but unrealistic because Bassett will always have a significant cash balance. This is fair, however, Bassett turned on their buyback increasing the authorization back to $20 million (10% of market cap) while simultaneously raising their regular dividend to $0.14 per quarter.

 

Assuming bottlenecks ease, our base case calls for $525 million in revenue and, depending on your margin outlook, EBIT could be anywhere from $26 million (5% margin) to $42 million (8% margin). The biggest risk to our investment is supply chain issues persisting and/or worsening, compressing margins and limiting revenue growth. 

 

We believe patient investors will be rewarded as time passes and supply chain issues ease. Meanwhile, Bassett will continue to take market share in the wholesale market. To sum it up, good things happen when you combine macro tailwinds, market share gains, and low valuations with buybacks. 

 

What We Expect

  • Backlog
    • Bassett’s backlog, like all its furniture peers, is 4x its normal size given a series of bottlenecks in logistics, manufacturing, raw materials, and labor. We believe backlogs will remain elevated until 2H 2022. However, we do not believe the risk of cancellations is significant because the entire industry is clogged, and consumers have nowhere else to turn. Our estimates put the current cancellation rate below 1%.
  • Sales Growth
    • Written orders (an order for a product in a period) are reaching highs not seen in over a decade. As logistics bottlenecks are relieved, those written orders will flow into revenue. There will be a step change in revenue for this business as supply chains ease.
    • Bassett expanded its custom upholstery capacity by 20% in early June (~$30 million of revenue). This expansion is not yet reflected in the financials due to the bottleneck in logistics.
    • Wholesale sales to independent dealer are growing significantly (see below).
    • Retail – channel checks continue to show strength despite an 18–20-week backlog.
  • Margins
    • Near term margins will be impacted by raw material, labor, and logistics inflation; however, we expect margins to expand above prior cycle highs given the industry’s pricing discipline, consumer demand, and limited inventory.
  • Buyback & Dividend
    • This is an extremely conservative management team. Management regularly references and prides themselves on the strength of their balance sheet. As of May 29th, cash and short-term investments totaled $63.5 million or $6.48 of cash per share.
    • Despite the conservative capital structure, Bassett is in a position to return >90% of net income to shareholders as DD&A will roughly cover capex.
    • The Company bought back another ~$1 million in June (likely around ~$27.50). Assuming $1 million per month over the next 12 months, Bassett will retire >5% of their shares.
      • In May the company bought back $1.8 million of stock at $32.57. Bassett currently trades at a ~40% discount to May prices and, should management return to this pace, it would retire >10% of their outstanding stock.
    • Historically, management has preferred dividends to buybacks and recently increased their quarterly dividend to $.14 from $.12. Given the preference for dividends over buybacks, we take the increased share repurchase authorization and current pace of buyback as a strong indicator of management’s perception of value.

Narrative

Sustainable demand driven by housing 

  • The financial crisis was a formative experience for consumers; it left many viewing an investment in their home as a liability. Then COVID hit. Consumers went through another formative experience of understanding the value of investing in their homes. Like any major life event, we believe COVID will impact consumer purchasing habits for many years to come. 
  • Demand is growing for larger homes away from city centers due to work-from-home and hybrid-work-from-home easing the commuting burden. Larger homes mean more furniture. With 78% of homeowners not refinancing their homes in 2020 there is ample borrowing capacity for home renovations and redecorations.
  • The shift from renters to single family homes further increases the amount of sqft per person driving demand for furniture.
  • Despite massive backlogs – currently an 18-20 week (4-5 months) – consumers continue to order furniture indicative of strong levels of demand.

Market share gains in independent wholesale channels 

  • Bassett is experiencing significant growth in their most profitable and capital light segment – Wholesale. Pre-tax return on assets for this segment are consistently in the low- to mid-teens.

  • Bassett is expanding its production capacity to work through its backlog and support is market share gains (highlighted below). In June, Bassett added 123,000 square feet in manufacturing capacity. The effect of this capacity expansion has yet to hit the financials due to the logistics backlog. Total manufacturing capacity is now over 800,000 square feet. 
    • “Enable us to grow our upholstery business by 20% long term” or roughly $30 million of revenue assuming a previous run rate of ~$150 million of custom upholstery sales. https://www.sec.gov/Archives/edgar/data/10329/000143774921009765/ex_243406.htm 
  • Bassett is growing their wholesale orders to existing independent dealers and adding new dealers as customers (included in the blue bars in the chart above). 
    • 10-Q FQ3’20 – “Wholesale orders from independent dealers increased 61% for the current quarter as compared to the prior year period driven by increases from existing dealers along with an expansion of the dealer base.”
    • 10-K FY 2020 – “Wholesale orders from independent dealers increased 62% for the last six months of 2020 as compared to the prior year period driven by increases from existing dealers along with an expansion of the dealer base.”
    • 10-Q FQ1’21 – “Wholesale orders from independent dealers increased 98% for the current quarter as compared to the prior year period driven by increases from existing dealers along with an expansion of the dealer base.”
    • 10-Q FQ2’21 – “Wholesale orders from independent dealers increased 126% and 93% for the three and six month periods driven by increases from existing dealers along with an expansion of the dealer base.”
    • 8-k June 2021 – “Bassett Furniture Industries, Inc. also announced that wholesale orders for the fiscal month of June 2021 increased by 25% over June 2020 and 39% over June 2019 and that wholesale shipments increased 55% over June 2020 and 21% over June 2019.”
    • 8-k July 2021 – “Bassett Furniture Industries, Inc. also announced that wholesale orders for the fiscal month of July 2021 increased by 2% over July 2020 and 29% over July 2019 and that wholesale shipments increased 11% over July 2020 and declined 1% as compared to July 2019.”
    • Note the differences between shipments and orders is constrained by logistics and supply chains. 
  • Net written orders are the difference between Ending Backlog less Beginning Backlog plus Revenue in the period. A “good” quarter for Bassett’s wholesale segment was $65 million or  $260 million annualized. Current demand is off the charts but not yet recorded in revenue due to supply chain constraints.

 

Massive optionality – Figure out retail 

  • Bassett valuation hit record highs when its Retail segment consistently produced profits between 2015 and 2017. When Retail moves enough product to produce profits, Wholesale sets record margins (driven by fixed cost leverage).
    • Why is Bassett in retail anyway?
      • “We established the retail segment of our business in the late 1990’s to create our own dedicated distribution network for the purpose of protecting our domestic manufacturing facilities and employees from the competition brought on by cheap imported furniture and to maintain our position as a leading wholesale manufacturer and distributor of home furnishings.”
      • “Our Wholesale segment continues to be the foundation of our entire operation and that the majority of our management decisions focus on how to generate wholesale sales volume”
      • “It should be noted that our wholesale sales to all of our customers (internal and external) are generally transacted at the same base price. As a result, our Wholesale segment margins are comparable regardless of the whether they result from intercompany or external customer sales.”
  • From FY 2018 to the middle of FY 2020 foot traffic in Bassett’s stores declined. These trends are seen in declining written sales in the table below. Rob Spilman, Chairman and CEO, summarized the headwinds in the FQ4’19 earnings release.

 

  • “Ongoing deflation in key categories, the seismic shift to digital marketing and online commerce, tariffs on Chinese made goods, evolving generational consumption behavior, and the tight labor market and the aging of the core Baby Boomer workforce are factors that must be dealt with – both for today and for the future.”
    • What has changed?
      • Deflation flipped to inflation – Bassett increased prices four times in FY 2021 each increase coming in around 3-5%.
      • Bassett’s advertising budget is dominated by digital marketing today vs 2018/19 when the majority was TV spend. Bassett’s digital marketing consultant, Emma Battle, joined the board in 2020. 
      • Mitigated tariffs by moving production from China to Thailand. Bassett’s production is 75% domestic (before considering Newton expansion reference above). 
      • Consumer purchasing habits completely flipped due to COVID.
      • Labor market remains extremely tight and is the primary constraint to operations.
  • The retail segment returned to EBIT profitability in FQ4’20. The return to profitability was driven by reworking the operating expense model of stores, closing underperforming stores, and an increase in furniture demand. 
    • The magic number for retail breakeven is a quarterly run rate of ~$950 thousand in sales.
    • Bassett’s written retail orders (i.e., sales made during a period but not yet delivered) have averaged over $1 million per store over the past four quarters.
    • Stores are staffed by design consultants whose pay is typically 100% commission. Bassett cut the number of design consultants from ~400 to ~270. This decision drove up the earnings of the top performers (more customers per consultant > more orders > more pay).
  • E-Commerce
    • Bassett set a goal of 10% e-commerce sales mix. In our discussions with sales associates, traffic from internet booked store appointments converts at a much higher rate than walk in traffic.
    •  
    • ~35% of Bassett’s retail sales involve an in-home consultation. These consultations allow Bassett’s design consultants to offer extensive customization and add on to the ticket. An average ticket is ~$3,000. However, the range is very wide (~$500 to >$100,000). Translating the in-home visit to a digital experience is difficult due to the amount of customization options Bassett offers. 
    • Bassett is launching a re-designed website in 2H 2022 limiting total customization options in an effort to improve the user experience. The website will follow the 80/20 rule highlighting the 20% of the products that make up 80% of revenue.
  • If Bassett is successful in driving higher levels of orders through their existing units and developing a successful e-commerce offering, then our estimates are substantially understated.

Logistics

  • Bassett owns Zenith a shipping and logistical support service uniquely tailored to the needs of Bassett and the furniture industry. Approximately 65% of Zenith’s revenue comes from third parties. This segment is producing record margins due to massive bottlenecks and lack of supply in the trucking industry. 
  • Anyone following any trucking/logistics firm knows how challenging it is to find drivers and warehouse workers. Zenith is the current bottleneck in Bassett’s operations. 

Segment ROA’s

  • To highlight the significance of the transition underway at Basset, take a look at the Pre-Tax Return on Assets for each segment and consolidated results. 

 

 

Capital Investment and Return of Capital

  • Bassett’s investor presentation calls for 40-60% of net income to be returned to shareholders. We believe this number will be closer to 100% unless attractive reinvestment opportunities arise.
  • Capex
    • Over the last six years (FY 15-20) Bassett invested $43 million in its retail segment primarily to expand its retail footprint. This spending came to a halt as Bassett stopped its retail expansion investing only $700k in FY 2020 in retail (i.e., maintenance/renovation level). Going forward, we expect one of two scenarios:
      • a lower capex profile thereby increasing FCF and returns to shareholders
      • more targeted investment in wholesale and logistics to remove bottlenecks and increase capacity – both extremely high ROI opportunities. 
  • Buybacks
    • On 7/15/2021 the board increased the authorization back to $20 million. 
    • In June the Company bought back ~$1.0 million at ~$27.50. At this pace, and given the current stock price, the Company would retire >5% of their diluted shares outstanding.
    • Looking at Bassett’s repurchases over time, the Company has been opportunistic. We expect them to continue to be opportunistic and could potentially return excess cash via a buyback or a special dividend after its fiscal year end in November.
  • Dividends
    • Increased quarterly dividend to $.14 per share from $.12. Bassett typically includes a special dividend at the end of their FY. 
  • The current pace of capital return (dividend + $12 million annual buyback) is $17.5 million or 8.4% of the current market cap and fully supported by FCF. In other words, the pace of capital returns is sustainable and does not comprise the strength of the balance sheet with $63.5 million of cash ($6.48 per share).
    • Cash and investments bottomed at ~$30 million and averaged $50 million since FQ1 2011. The Company is overcapitalized, and this is unlikely to change. Given the cheap valuation an optimized capital structure is not critical to earn a good return. 
  • M&A
    • Bassett bought Lane Ventures for $15.5 million in cash in 2017 and the remainder of Zenith in 2015. We do not have insight into any M&A plans, but management appears to be prudent in executing their M&A.

Forecast and Valuation

  • Historically, Bassett trades at an average P/Sales (punitive for cash balance) of .6x. 
    • We believe Bassett can do ~$525 million in consolidated revenues (see below). Using the average .6x p/s multiple translates to $32 per share.
      • Retail ~$260 million in written orders
      • Wholesale ~$215 million in written orders (net of intercompany)
      • Logistics ~$50 million (net of intercompany)
    • We believe that margins will be higher than prior cycle once Bassett resolves its supply chain issues. This should result in a higher P/S multiple. BSET traded as high as 1x P/S while LZB and ETD (industry highest margins) have traded in excess of 1.2x P/S. in an upside case with continued market share gains and expanding margins we could see Bassett trade for $53. 

 

Pushback

  • Furniture manufacturing is a commodity industry with significant competition from overseas manufacturers. The industry is at peak earnings/demand given COVID benefits.
    • Only time will tell on peak earnings, but we firmly believe there are legs to housing and in turn legs to furniture.  
    • If we are wrong on demand, then there is plenty of cash on the balance sheet to buffer any significant impairment of capital.
  • Raw Materials Inflation
    • Every single furniture company is calling out inflation. What is interesting is Lazyboy (LZB) leading the industry in repricing their backlog to cover various inflationary pressures in their business. Should other furniture companies follow then margins will be steady as the industry demonstrates pricing discipline. Given the level of demand and consistent supply constraints then furniture manufacturers should have pricing power.
  • Container inflation is driving demand to onshore manufacturing which will recede when shipping/logistics bottlenecks are resolved.
    • This is possibly the greatest risk to our “market share gains” thesis however macro tailwinds remain robust and international supply chains are affected by various COVID variants. Vietnam is locked down effecting the furniture industry supply chain. It is worth watching closely going forward. Bassett’s 75% domestic production is an asset in the current environment to capitalize on strong demand given bottlenecks in the import process. 
  • You can’t net out the cash balance in your valuation because the Company is conservative and will hold it.
    • See capital return section above. Minimum cash balance was ~$29.1 million amid COVID. The current pace of capital returns is purely from current earnings and not coming from the significant cash balance on the balance. The presence of the large cash balance will weigh on potential returns however takes significant downside off the table.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

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