There are few companies that were helped by the pandemic more than Lovesac. This is a company that makes two primary products – an oversized bean bag chair (Lovesac) and a sectional couch (Sactional). Pre-pandemic, the company was largely considered a broken IPO – trading at $12-$14 vs the 2018 IPO price of $16, and never turned a profit in its history. But then due to the home-boom in 2020, comps accelerated to 53%, Gross Margins were up nearly 500bps to 54.5%, and the SG&A ratio improved by nearly 700bps to 33.3%. All in, this two-hit wonder went from a negative (7%) EBIT margin to nearly +5% today. Is this sustainable for another 1-2 years? Yes, probably, given continued strength in the housing market and exposure to a category that is among the most robust in all of retail. But keep in mind that this is a company that makes just two primary products – the Lovesac that is about 12% of sales, and the Sactional, which is the bulk of the remaining 88%. This is not like RH, Williams Somoma, Wayfair, Overstock or even the lowly Ethan Allen where you can buy furniture or accessories for every room of the house. Then can someone explain to me what’s so magical about The Sac that LOVE trades at 3x an RH multiple? Over the course of the pandemic the stock went from $12 to $91 and currently sits at 90x earnings and 45x EBITDA. If anything we’d argue that a better comp is probably La-Z-Boy – which predominantly makes sofas and chairs. For what it’s worth, LZB trades at 14x earnings.
But the problem at LOVE is that its sitting at a 55% Gross Margin and that is only sustainable if a) home demand remains white hot AND b) it does not diversify beyond its current limited SKU offering. If this company wants to gain share of the furniture market (which it clearly does) then it’s going to have to get into bedroom furniture, tables, and meaningfully broaden its accessory offering. Even RH, a company that has literally no peers in the home furnishings industry, has a gross margin that barely touches 50% -- and yet the consensus is straight-lining LOVE’s GM of 55% into perpetuity. For the record, LZB’s GM is 42.5%, and it’s not headed any higher.
This name actually has some factors in common with YETI (a Best Idea Short) where the consensus is not modeling any margin degradation as it blows out distribution and grows into new categories and experiences SKU proliferation. In fact, the stock charts look almost identical – from the 2018 IPO date until today’s all-time highs. Except YETI, which is a more defendable business – trades at 38x earnings – nearly a third of where we see LOVE trading today.
We’re giving this company the sales growth in our model, as it has unit growth to sustain roughly 20% top line growth until its hits its max 200 stores in another 4-5 years. But we’re taking down margins by 500bps in our model as we see the natural deleverage as it moves away from a singular category focus in attempt to comp those stores – especially as the housing boom wanes and compares get ridiculously tough. In the end, we have TAIL earnings power of about $1.25, which is about what the company should earn this year as well. Over time growth and margin should wash each other out. This is massively off of the consensus, which has TAIL earnings of $5+per share, which we think is an absolute pipe dream.
The irony is that even if the consensus is right this stock is beyond expensive. But on our number it’s at 83x earnings, 35x EBITDA, and a sub-1% FCF Yield. This isn’t a Best Idea Short for us today because the company still likely has another 2-quarters of beats ahead of it – but we think that’s in the stock at $91. Ultimately, we think this name is worth a mid-teens multiple on $1.25 in earnings, or about $20. Note that $20 is still 50% above where it was pre-pandemic – though 80% below where the stock is today. We don’t get why short interest was over 30% when this stock was a teenager, but it’s only at 14% today. Sounds completely backwards from where I sit. We’ll almost certainly size this one higher over time as we de-risk near-term strength in the category.
-- McGough
