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No Respite For Stanley And The Furniture Industry

Posted: Jul 21, 2008 09:43 AM by Eric Fox

Tickers in this Article: STLY, LEG, HOFT, FBN, ZZ

While some investors may feel that the time is right to buy into the furniture sector, thinking that years of restructuring will finally start to improve the bottom line, it appears the industry may still be facing a slew of issues aside from weak demand, including rising raw material costs and transport costs, and a weakening dollar.

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The latest example of the industry's woes came when Stanley Furniture (Nasdaq:STLY) reported a loss of 1 penny per share in the second quarter of 2008; unfortunately, analysts had expected that penny to fall on the positive side.

Stanley's Q2 Wrap-Up
Revenue for Stanley Furniture was $59.1 million, which beat revenue estimates of $55.2 million, but fell 12.7% from the same quarter last year. The company also lowered guidance for the rest of the year. Stanley Furniture's president and CEO Jeffrey Scheffer said, "Historically low levels of consumer confidence, housing activity and personal disposable income has led to an industry-wide weakness in consumer demand for residential furniture not seen since the early '80s."

Guidance is now for a loss of 25-46 cents per share, and revenue of $230-237 million for 2008. The abrupt fall in revenue and earnings guidance has been stunning, as just one year ago, analysts were estimating 2008 revenues at $ 318.25 million. (For more on revenue predictions, check out Earnings Forecasts: A Primer.)

Familiar Refrain
Stanley management repeated the familiar tag line of "weak demand and higher costs". Virtually every domestic furniture manufacturer and retailer over the past year has cited the same two problems. It's almost as if a generic press release template exists somewhere and companies just fill in the blanks.

The day after Stanley reported earnings, competitor Furniture Brands (NYSE:FBN) revised its guidance downward and announced an acceleration of its strategic plan to reduce costs and improve efficiencies. The report noted that company actions were taken "in the face of unusually weak economic conditions". The strategic plan includes expanding company-owned manufacturing capacity in Indonesia.

Hooker Furniture (Nasdaq:HOFT) reported disappointing earnings for its second quarter. CEO Paul Toms Jr. said on its conference call on June 11, that the company was being buffeted by "the continuing and significant decline year-over-year in sales in this difficult retail environment." The company also said it expects "retail conditions to be sluggish for the rest of the year".

Slowing retail traffic is not the only problem the industry faces. Last week, Larry Rogers, interim president and CEO of North America for Sealy (NYSE:ZZ), said that in addition to weak consumer demand for bedding, Sealy expects significantly higher material costs due to "rapidly growing inflation on core materials". The company mentioned steel, foam, and fuel in particular.

During a furniture industry conference in June, an executive at Leggett and Platt (NYSE:LEG) said that the cost of steel had doubled in one year from $600 to $1200 a ton, leading him to raise prices. Another CEO Todd Wanek from a private company Ashley Furniture said it was the worst price inflation in 20 years.

Outsourcing Gone Wrong
Manufacturers have spent years outsourcing production to offshore locations to take advantage of low cost labor.

This strategy may backfire. As the price of oil continues to rise, it increases the cost of shipping products from Asia. The weekly newspaper Furniture Today reports that "ocean shipping rates from Asia were estimated to have risen $200-$250 for 40-foot containers shipped to the West Coast and $300-$350 for containers shipped to the East Coast."

The Chinese currency has started to appreciate in value versus the U.S. dollar, moving up about 20%. This has the effect of raising costs as well to domestic manufacturers.

Industry participants are starting to raise prices to compensate for increased material and transport costs, but these increases are coming at just the wrong time for the industry as demand weakens due to the housing downturn, slowing economic activity and restriction in credit availability in general. (For more on the credit crunch see The Fuel That Fed The Subprime Meltdown.)

The Perfect Storm
It is not clear if the furniture industry is an attractive investment opportunity. There are several external risks, including: rising material costs, weakening demand and diminishing credit availability to customers. Finally investors should be aware that the once profitable outsourcing model is starting to backfire as the industry has seen increasing manufacturing costs due to an appreciating currency and higher transport costs in China and other offshore manufacturing locations.

For more on outsourcing and global trade, read The Globalization Debate.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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