Imagine you and your family walk into a rescue center with the intent to make some lucky dog a new member of your family. The kids are bouncing off the walls. Little Tommy, who just turned four, and Sally, showing off her new braces, bounce from kennel to kennel. Finally, the family narrows it down to two dogs.
The first doesn't shed much, is already house trained, knows some basic commands and is great with children, but it costs $100 to adopt. Not as much is known about the other dog, but the shelter does tell you it has been aggressive toward small children and other animals, it isn't house trained, and it likes to chew up furniture and other household items, but this one only costs $30 to adopt.
Which dog are you going to adopt? What if I added, even though it might be considered remote by some, your likelihood of getting cancer while owning dog two for the next eight to 10 years is greater than owning dog one? Well, dog two is Lumber Liquidators (LL).
Alright, so this example may be a bit extreme, but how many people are willing to risk their family's health to save a few bucks? It's the PR Lumber Liquidators is going to have to fight yet again. The CDC is out with a report noting it miscalculated the risks of cancer due to certain products from the company.
Previously, the expectation was the risk of cancer sat at two to nine cases per 100,000. It has now increased that, and the increase has the market worried. The new number is six to 30 per 100,000, which gives us a mean increase of 3.27 times as likely. The odds are still remote, but do you ever want to hear worsening odds and the word cancer in the same sentence? I don't.
The company faced a margin crunch in 2015, seeing margins drop from 40% to 30%. News like this is likely to dampen sales further, after a fall of double digit percentage points over the last year. If we see another fall, I expect margins to shrink even more in 2016.
The company did do a few things right last year, keeping cash flow positive by decreasing inventory and eliminating the buyback, but it did extend its revolving credit line by $20 million, so the increase of $53 million in cash is a bit misleading, as we should read it as $33 million net.
Note much of this came from an inventory reduction of $70 million. While some may view it as a positive, it is a double-edged sword. Leadership blamed the slowdown in sales on stores not having the necessary inventory to meet demand. If LL ramps inventory again, it won't only be EBITDA in the red, but also cash flow.
The company is going to face more PR nightmares after this and will likely see the SG&A expenses elevated yet again. Let's not forget this is a company on probation for five more years due to illegal imports, something often lost in the discussion of the tainted laminate as they are separate issues.
My question here is why? Why be involved? Sure, there may be a bounce play here, but if I were a shareholder, I would be praying for a buyout at the moment. The practices of the company in the past here seem unscrupulous. If buyers do any research on the company beyond price, I think it will be a hard sale.
I don't have a dog in this hunt, but if I did, it would be dog number one rather than dog number two. LL isn't staring bankruptcy in the face, but if we see another year like 2015, you have to bet the chatter will increase at least 3.27 times the current level.