Lumber Liquidators-A Stock Without A Ceiling?

By Will Ashworth | April 26, 2013 AAA

Flooring retailer Lumber Liquidators (NYSE:LL) reported strong earnings April 24. By every financial metric it was a big winner in the first quarter. In addition to good earnings in Q1, it sees an excellent year for the remainder of 2013. Flooring businesses of all kinds are doing well in this environment. With Lumber Liquidators stock at an all-time high, it seems its stock has no ceiling.

How should you play this extremely hot industry? Here are a few ways to ride the momentum without getting burned.

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Lumber Liquidators
The first and most obvious option is to buy the stock itself. Net sales increased 22.5% to $230.4 million in the first quarter while operating profits jumped 91% to $25.6 million. Same-store sales increased 15.2% in Q1; they're expected to grow in the high-single digits for 2013 in its entirety. Meanwhile, Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) had comps in the most recent quarter of 7% and 1.9% respectively. Lumber Liquidators' business is clearly in growth mode. I just don't know if you want to pay $20 in enterprise value for each dollar of EBITDA.

Here's why.

Lululemon (Nasdaq:LULU) has an enterprise value of $9.3 billion. That's 22 times EBITDA. LULU's EBITDA margin is 30.6% compared to 10.9% for Lumber Liquidators. You're paying essentially the same EV/EBITDA multiple for a company whose margins are about one-third those of the popular lifestyle brand. I know we're talking about different types of businesses but investing is a lot like the NFL draft: you pick the best athlete available regardless of position. Lumber Liquidators, although a great business, isn't the best stock at this time. I'd wait for some retrenchment before buying.

SEE: Understanding The Income Statement

Flooring Peers
Your three choices are Armstrong World Industries (NYSE:AWI), Mohawk Industries (NYSE:MHK) and Shaw Industries Group, which is owned by Berkshire Hathaway (NYSE:BRK.B). Mohawk and Shaw both had revenues of approximately $6 billion in 2012 while Armstrong World's sales were much smaller at $2.6 billion. Of the three, Armstrong's stock performed the best over the best five years with an annualized return of 15.2% compared to 8% for Mohawk and Berkshire Hathaway pulling up the rear at 4.8%.

Mohawk's been very busy this year when it comes to acquisitions. It's closed two deals worth $1.65 billion and announced a third for $168 million. The biggest of the deals was a $1.5 billion cash-and-stock deal for the Marazzi Group, an Italian manufacturer of ceramic tile. Between the time it announced the deal in December to the closing on April 3, Mohawk's share price appreciated by 25%, reducing the number of shares issued to Marazzi's former owners by 1.7 million shares. Sometimes you have to be lucky to be good.

Of the two pure plays, Mohawk is the better call. As Berkshire Hathaway, you can't go wrong earning its stock.

The Entire House
The final way to play Lumber Liquidators is to buy the SPDR S&P Homebuilders ETF (NYSE:XHB), which is an equal weight fund that invests in 35 stocks related to the housing industry. Lumber Liquidators is the number one holding at 3.89% with Mohawk at 3.34% and Armstrong World at 3.27%. At 0.35%, its annual expense ratio is certainly reasonable, if not cheap. The big concern with the XHB is that it's been on a tear the past year up 47.6% through April 24 compared to 17.7% for the S&P 500. It's bound to cool off. In fact, it probably already has. Year-to-date it's up 12.8%, just 140 basis points higher than the index.

SEE: 5 Must-Have Metrics For Value Investors

Bottom Line
If you really want to own Lumber Liquidators, the XHB makes an abundant amount of sense because it reduces the specific company risk associated with owning a single stock. Not to mention you get Mohawk and Armstrong World thrown in for good measure.

On the other hand, if you buy Warren Buffett's stock, you also get some exposure to the flooring business while also getting investments from all kinds of different industries. Best of all, there is no management fee. Given Berkshire Hathaway is starting to perform better--up 33.8% in the past 52 weeks--I'd be inclined to forego Lumber Liquidators in favor of BRK. But that's just me.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

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