One of my favorite things about investing is looking at the financial statements of different companies to find really good businesses. To save time, I usually start by looking at the standardized financials on sites like Yahoo Finance, Morningstar, or GuruFocus, and I typically start with the cashflow statement first. Recently, I came across a company that demonstrates the danger of solely using these standardized financials in making an investment decision.
Stanley Furniture (STLY) is a maker of wood furniture for both adults and children (under the Young America brand name). Given the economic sensitivity of furniture makers, the stock has taken a beating over the last several years, falling from a high of $28 in March 2006 to around $3 recently. Market cap is $37M.
From 1999 through 2008, STLY was able to generate both positive free cash flow and net income, before turning negative in FY 2009. I found it astonishing that the business could endure all of the ups and downs of the last decade and decided to take a closer look. As a quick first step, I downloaded the financials into my valuation spreadsheet (I use a modified version of Jae Jun’s incredible intrinsic value spreadsheets). After quickly scanning the standardized free cashflow statement (downloaded from Morningstar) and balance sheet, checking some key ratios, and making some minor adjustments to normalize margins, the spreadsheet came out with a value range of $5-$10. I thought for a moment that I had found a true diamond in the rough and asked myself :Why is it undervalued?”
Well, an answer came quickly to mind- this is a company in an industry tied to the housing market, facing enormous competitive pressures, and likely holding little to no competitive advantages. But, even those types of companies can be excellent investments for value focused investors like us- if they can be bought at the right price.
Digging deeper into the financials directly from the SEC, I read that STLY received $35.6M since 2006 from the Continued Dumping and Subsidy Offset Act, a government program that distributes cash to US furniture makers hurt by lower priced foreign competitors who “dump” their furniture at very low costs. The CDSOA is currently being challenged, and future payments are being held by the government in the meantime, so going forward, payments will be slower to come, if they happen at all (STLY did receive approx $2M in payments in December and believe they are owed another $30M).
Backing out the CDSOA payments drastically changes the picture. Although, FCF (free cash flow) was still positive until 2009, historical FCF margins were much lower and net income would have been negative from 2007 onward. Coupled with another negative year in 2010 and a recent stock offering of another 4M shares (diluting the overall per share value), the value of the company as an ongoing entity likely falls somewhere in the $2-$4 range. Simply not enough margin of safety for me.
I wrote this piece to demonstrate the importance of actually reading and evaluating the 10-Ks and 10-Qs (among other filings) of a company versus relying on Morningstar, GuruFocus, Yahoo, or other sites with standardized financials. Often as value investors we focus so much on the cashflow statement and the balance sheet, but it is just as important to review the income statement (the CDSOA payments showed up as non-operating income) and footnotes as well. Only through this discipline of reading and thinking about the company, its competitive position, and its financial history can we ascertain a range of fair values.
One final note on STLY and the importance of reading the financials- I reviewed this stock as an ongoing concern. A reasonable case could be made that STLY could be a good investment from an asset based standpoint. I’ll review that in a later post.