Stanley Furniture (STLY): Cheap Price Ignores Multiple Catalysts

Stanley Furniture represents the opportunity to purchase a company for less than its Net
Current Asset Value (current assets minus TOTAL liabilities, or NCAV for short). Warren
Buffett’s mentor, Benjamin Graham, devised the strategy of purchasing companies for less
than their NCAV, and found that it returned more than 20% from 1926 to 1956. Stanley
Furniture represents a similar opportunity trading at less than its NCAV, but with the distinct
possibility of being worth even more as a going concern. Since 1924, Stanley Furniture has
made furniture for the middle to higher end price point for American homes.

Situation:

Stanley Furniture is currently undergoing a major restructuring. They are moving the
operations for their Stanley Furniture Brand (the adult furniture line) abroad and will begin
sourcing their products from a number of foreign suppliers. Secondly, they are (oddly
enough) moving their other product set—the Young America line (primarily high quality
cribs)—back home to Virginia. Now, what could possibly be the rationale for these
seemingly contradictory moves? Why would a company move one product line abroad while
bringing another back onshore?

The explanation has to do with quality. Simply put, Stanley Furniture wants the Young
America line to produce the highest quality crib on the market. They have partnered with
Intertek, a company that applies their seal of approval on products that “meet rigorous
safety and quality performance guidelines at every step in the design and manufacturing
process.” More notably, Stanley has also partnered with GREENGUARD to obtain their
certification, which “focuses primarily on the indoor air quality of a child’s living space.” As
the CEO told me, that kind of quality is simply not possible when you are sourcing your
products from half a world away.

The story about the adult line of furniture is more clear-cut. In this macroeconomic
environment, where sales have fallen 50% over the past four years as consumer-related
housing demand has evaporated, Stanley Furniture can no longer afford to maintain
factories and employees in Stanleytown, Virginia and make their furniture profitably.
Margins have been eroding (especially compared to their competitors, who did move
operations offshore) for years, while they have tried to stand by their eponymous town. At
this point, they can no longer remain a profitable enterprise and source their products in
America, so they have decided to move their operations offshore, much like a comparable
company, Hooker Furniture (HOFT).

Competitors:

Because of a sourcing transition and a precipitous fall in demand for anything related to the
housing sector, Stanley Furniture’s operational results have been, frankly, abysmal.
Earnings have been consistently negative, and they have been losing cash for the past
several quarters. The Stanley Furniture of the recent 2 years has posted results in stark
contrast to the steady, profitable results the older Stanley Furniture produced before the
housing downturn.
The question that I have tried to answer is “Are Stanley Furniture’s poor operating results a
product of a lousy product or of a more general lack of demand related to macroeconomic
forces?” Without trying to quantify the benefits that outsourcing would have on Stanley
Furniture’s current operations and risk getting absorbed in overly aggressive, and overly
optimistic assumptions, is the Company in a much worse position than its competitors? The
charts which follow1 suggest, “No, Stanley Furniture is suffering more or less the same as its
competitors.” Furthermore, these charts ignore many of the possible benefits that could
accrue from Stanley Furniture’s outsourcing. They only compare the current unprofitable,
domestically-sourced Stanley Furniture to its other, larger (many of which have been
sourcing their products abroad for years) competitors. As the Valuation section illustrates,
Stanley Furniture stock is priced to ignore any improvement in the business.

Sales History
$3,000

$2,500

$2,000

$1,500
n M
ilo
s

$1,000

$500

$0
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09

HOFT BSET STLY FBN LZB ETH

1 STLY, BSET, and HOFT have been graphed a second time, separate from FBN, LZB, and ETH,
because of the difference in size.
 SalesHistory
$400
$350
$300
$250
$200
n M
ilo
s

$150
$100
$50
$0
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09

HOFT BSET STLY

(FreeCash Flow / Sales) Margin

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09
(5.0%)

(10.0%)

FBN LZB ETH HOFT BSET STLY

 (FreeCashFlow/ Sales)Margin
25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

(5.0%) 31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09

(10.0%)

HOFT BSET STLY

Case Study:

From 2003 to March 2007, HOFT underwent a transition similar to Stanley in which they
transferred all their domestic manufacturing from their Virginia plants to companies abroad.
Stanley Furniture has the benefit of their experience on their side so the transition ought to
be smoother, though HOFT was not operating under the same macroeconomic environment
or financial pressures that Stanley finds itself in today.

The Net Income Margin is muddled during this time by extraordinary write-offs and one time
charges (which amounted to an average of about 15% of pre-tax income), but the
improvement in Gross Margins and Free Cash Flow to Sales clearly improves until the
economy begins to decline in 2008. Though the timing is different for Stanley, the
improvement in operations should be similar.
 HOFTOperatingMargins
35.0%

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

(5.0%)

Gross Margin Net Income Margin Free Cash Flow / Sales Margin

HOFT Sales History

$400.0
$350.0
$300.0
$250.0
$200.0
$150.0
$100.0
$50.0
$0.0

Sales
Valuation:

Value of Business
Free Cash Flow Multiple Equity Value Shares Value Per Share
$5.0 12.0x $60.0 13.677 $4.39
Net Cash on Balance Sheet Shares Cash Per Share
$12.0 13.677 $0.88
Target Price
$5.26

If Stanley Furniture can return to a point where it is a fraction as profitable as it was in the
past, and earn $5 million in free cash flow (less than 1/3 the average amount of free cash
that it generated from 2000-2008) the equity should be worth about 12 times that or 60
million dollars.

After the rights offering dilution, there will be about $27 million of cash sitting on the
balance sheet, and, if all the rights are exercised, there will be an additional 3.333 million
shares outstanding. Adding the additional shares to the 10.344 million shares, which were
outstanding prior to the offering, results in 13.677 million total shares, or a target price of
$4.38 per share ($60 million/13.67 million shares) for just the operations of the business.
The net cash on the Balance Sheet of about $12 million ($27 million pro forma cash minus
$15 million in debt—all of which is maturing in one year) adds another $0.87 to the per
share count ($12 million in cash divided by 13.677 pro forma shares) for a $5.25 target
price.

Possible Catalyst:

Furthermore, this analysis does not take into account the Continued Dumping and Subsidy
Offset Act (CDSOA) payment that Stanley Furniture has reported that they are due to
receive from the government. The CDSOA was a tariff on those that imported Chinese-made
furniture. Stanley Furniture has received “$9.3 million, $11.5 million and $10.4 million in
2009, 2008 and 2007, respectively, from CDSOA payments and other related payments, net
of legal expenses.” Taking the ratio of these payouts to the total industry payouts, Stanley
Furniture expects “to receive approximately $36 million of the funds set aside by the
government” of the “approximately $137 million of CDSOA funds that otherwise would have
been available for distribution to qualifying domestic producers of wooden bedroom
furniture.”

The most recent 10Q reads “In May 2010, the U.S. Supreme Court denied a petition for
certiorari concerning that case. Numerous other CDSOA-related cases before the U.S. Court
of International Trade and the Federal Circuit have been stayed in light of this litigation. The
resolution of these cases will have a significant impact on the amount of CDSOA funds that
may be distributed to qualifying domestic producers of wooden bedroom furniture.” Though
Stanley Furniture provides no guidance on the timing of this payment (they noted on the
2010 Q3 earnings call that they were skeptical they would even receive it in 2011) there
seem to be far fewer impediments to this catalyst occurring.

So, how do the CDSOA funds matter to Stanley?

Already, Stanley Furniture Stock is trading below Net Current Asset Value (NCAV). If STLY
trades up to that value, the increase of $6.342 million in market cap would be a return of
18.12%. Ultimately, Stanley Furniture stock is trading at such a discount that it represents a
nice opportunity as a going concern or if it liquidates.

In thousands:
1. Total Liabilities from most recent 10Q: $44,905
2. Current Assets from most recent 10Q: $76,247
3. Plus $10,000 in Cash that they raise from rights offering.
4. Plus the $36,000 of Cash from CDSOA payment.

Including all $36 million from the CDSOA payment is suspect, and it might be overly
aggressive to include all of a payment not-yet-received in a calculation related to liquidation
value, but nevertheless:

(76,247+10,000+36,000)-44,905 = 77,342
At $35 million market cap, Stanley Furniture is trading at 45.25% of NCAV.

But in the interest of conservative analysis, let’s give STLY credit for half of the cash that is
due to them:

(76,247+10,000+18,000)-44,905 = 59,342
At $35 million market cap, Stanley Furniture is trading at 59% of NCAV.

And what if STLY gets no payment? Let's take a look:

(76,247+10,000)-44,905 = 41,342 (in thousands)

At $35 million market cap, it is 84.65% of NCAV.
Sources:

SEC Filings

Earnings Call Transcripts

http://www.businesswire.com/news/home/20101010005051/en/Young-America-
Host-Product-Safety-Panel-Discussion

http://www.furnituretoday.com/article/528803-
Court_ruling_backs_antidumping_petitioners.php

http://www.furnituretoday.com/article/533349-
ITC_report_looks_at_furniture_antidumping_settlements.php
Additional Charts:

NetIncome Margin
20.0%

10.0%

0.0%
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09
(10.0%)

(20.0%)

(30.0%)

(40.0%)

FBN LZB ETH HOFT BSET STLY

NetIncome Margin
10.0%

5.0%

0.0%
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09
(5.0%)

(10.0%)

(15.0%)

(20.0%)

HOFT BSET STLY

 GrossMargin
100.0%
90.0%
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09

FBN LZB ETH HOFT BSET STLY

GrossMargin
60.0%

50.0%

40.0%

30.0%
20.0%

10.0%

0.0%
31-Dec-04 31-Dec-05 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09

HOFT BSET STLY