Exclusive: What Will Lumber Liquidators Hold?

This is the third of a three-part series.

To get caught up, read Part 1 and Part 2. For alerts on all news about Lumber Liquidators, add it to your portfolio watchlist here.

It’s been a rocky first quarter with Lumber Liquidators Holdings Inc LL.

An unfavorable “60 Minutes” report made the stock plummet 50 percent to $30. The report claims the company is selling non-CARB compliant laminate with unsafe levels of formaldehyde from Chinese manufacturers, and has been accompanied by short sellers like Whitney Tilson making public statements about the company and its practices.

Lumber Liquidators did provide a business update for Q1 earlier this month, so there may not be too many surprises in store for the earnings report. But analysts and investors are divided on the issue, and there are a few key things that everyone needs to keep an eye on from the first quarter of 2015: 

Aggressive Sales

Sales will be the most important thing for Lumber Liquidators from a near-term data point perspective, Wedbush Analyst Seth Basham told Benzinga.

The business update stated that there was a 12.8 percent decrease is year-over-year sales for the month of March. But, overall sales for the first quarter were up 5.6 percent over the first quarter of 2014.

Basham said a bounce back in the last few weeks of the quarter was probably driven by aggressive advertising and discounting.

Rand Strategic Partners Co-Founder Todd Sullivan also told Benzinga the company has been aggressive with pricing.

“If you look at their website, they’re slashing prices left and right,” Sullivan said. “I’m seeing incredible sales that they are dishing up to people.”

Basham noted that Lumber Liquidators will probably give an update on sales for the month of April, but it’s unclear whether or not they will provide guidance for second quarter or the full year.

Investor Sentiment

What’s important about the bounce back in sales is that it shows there’s still a level of appetite for Lumber Liquidators products, Basham explained, adding that a consumer who’s afraid of formaldehyde probably wouldn’t go near the company, let alone buy anything from them.

“So there’s still a level of demand out there. People are making their judgement and even if they don’t want the Chinese laminate they might think their other products don’t have any problems,” Basham said.

A Piper Jaffray homeowner survey of 404 participants regarding the Lumber Liquidators brand and recent 60 Minutes segment yielded better-than-expected results. Only one-third of the respondents said they had seen or heard about the 60 Minutes report.

Related Link: 8 Damning Quotes From The 60 Minutes Exposé On Lumber Liquidators

When asked about brand perception on a sale of 0-10 (with 10 being the best rating), those surveyed gave an average rating of 5.0. Respondents who had watched or heard about the 60 Minutes report gave an average of 4.0 rating, while those who had not seen or heard about the report averaged a 5.9 answer.

Piper Jaffray also conducted a social media analysis of websites like Twitter, Facebook, Instagram and Wikipedia. According to Piper Jaffray’s research, consumer interested in the lumber liquidators interested in the Lumber Liquidators scandal appears to be slowing and negative social media comments have been declining since mid-March.

The Piper Jaffray report saw the survey and social media analysis results as “modest positives.” The firm has a neutral rating on the stock with a price target of $37.

Cantor Fitzgerald recently initiated coverage of Lumber Liquidators with a Buy rating and a price target of $45, saying that the recent controversy has created an investing opportunity in a “differentiated, growth-driven business model t an attractive valuation.”

Margin Pressure

Sullivan, a long/short hedge fund manager, thinks that the big number for Lumber Liquidators is margins. He pointed out that the company’s business update showed margins fell. Gross margin for Lumber Liquidators is expected to be in the 35.5 - 36.5 percent range, whereas gross margin for the first quarter of 2014 was 41.1 percent.

Sullivan said that the fall in margin prices was probably due to either Lumber Liquidators purchasing CARB-compliant laminate from China and paying more for it, or enticing customers with slashed prices that cut into margins.

In a recent preview for Lumber Liquidators earnings, Basham margin headwinds will remain. “While we believe the fact that customers are not abandoning Lumber Liquidators is more important than margin pressure, gauging stock reaction to this set of facts is difficult,” he said.

Basham’s price target for Lumber Liquidators is $33.15 with a neutral rating.

Regulatory Risk

The formaldehyde issues will continue to haunt the stock, Basham said.

“I think it wipes out a significant set of potential institutional investors who won’t touch this because of those overhanging issues, and it’s really hard to size of the liabilities associated with them,” he said.

Because of those issues, Basham doesn’t see the stock bouncing back to $60 (the level it was at the very beginning of 2015). In addition to falling margins, Sullivan mentioned that there’s potential for costs due to lawsuits, settlements and any regulatory action.

He added that even if regulators don’t act on Lumber Liquidators, specifically, they could act on the industry in general and ban the import of the laminate, which Sullivan said would be a huge blow to Lumber Liquidators and its margins.

“I think there is a tremendous risk to purchasing it here or thinking that over the last year it was fairly valued,” Sullivan said.

That doesn’t mean the stock won’t trade like crazy on any news blurb or anything coming out, Sullivan noted.