Note: topics under case studies are for illustration purposes only. They are not investment recommendations. We may or may not maintain active holding at time of publishing and we will make decisions about the investments involved solely on their merits from value investing perspective without any prior updates to this post.
Category: Long term value play
Position Recommended on:
May 13, 2016 at $11.34
Position Currently at:
Sep 11, 2017 at $38.23
Return: approximately pre-tax 237% for 16 Months
Lumber Liquidator was one of the largest flooring retailer with hundreds of locations in the US and Canada and continues to expand throughout North America. They have presence in over 46 States and over 1000 employees. The company was started by its founder Tom Sullivan in 1993.
From 2013 to 2015, the company was the subject to various class action lawsuits accusing certain category of laminate flooring that were sold by LL from 2013-2015 emitting toxic chemicals that would allegedly cause cancer and other serious health issues. Also the company was facing various government regulators’ investigations on their alleged violations with “Lacey Act”. The market feared strongly about the outcomes of those lawsuits, and the share price of LL dropped from a once-all-time-high of $119/share to below $10/share at one point in 2016.
Upon examining their financial statements, this company fit squarely into Ben Graham’s value arbitrage when market priced a company at a book value that implied a 50% mark-down on their inventories. On top of that, the company carried nearly no debt on the balance sheet, which provides a healthy capital structure to fair any upcoming legal storms that were looming.
We spent many hours to dig through almost all their legal proceedings on various fronts. We concluded that there was a relatively low chance on extremely large legal liability, especially given the fact that they had reserved a considerable amount in their earnings statements related to legal settlement costs.
Based on legal situation assessment, balance sheet analysis, belief in management team which was led by their founder, almost no debt on their balance sheet, favorable industry outlook and their leading position in hardwood/laminate flooring market, we concluded that at around $11-15/share range, we have a very good opportunity to buy a good company led by capable management/owner
There are various risks that may negatively impact this investment:
- Various law suits may turn out negatively if we were not accurately assessing the potential liability
- In such a competitive flooring retail market, reputation damage can be potentially fatal
- The price may well go below $10 and stay there for much longer given the fact that the sales were declining significantly back then and the legal proceedings were taking long time to work out an outcome
Follow-up note: Recently the market appraised LL’s share at $38-$40/share, when the company still posted a loss. The new price was solely due to some positive legal development and some improvement in sales. However, we think that at this level this issue becomes a speculation and is no longer suitable to initiate new investment position.