The research division of Raymond James & Associates, Inc. 880 Carillon Parkway, St. Petersburg, FL, released the following information on Ethan Allen Interiors August 13, 1997:
Ethan Allen's origins date back to 1932 when the corporate name was The Baumritter Corporation, the last name of the company's founding family. The company began selling product under the Ethan Allen brand name in 1937, and the concept for Ethan Allen stores developed and expanded under Nathan Ancell, the brother-in-law of the founder, who led the company for many years.
Ethan Allen was public until 1979 when the company was bought by INTERCO, Inc. It operated as an independent division of INTERCO for the next decade until the company's Chairman, M. Farooq Kathwari, and other members of management, were successful in effecting a leveraged buyout. Ethan Allen's current Chairman joined the company after his company was acquired by Ethan Allen in 1980.
Today, Ethan Allen is a major - and perhaps the most recognized - brand name in the furniture industry, an industry that has surprisingly few well known and well respected brand names. At the same time, Ethan Allen is a designer and manufacturer of a broad array of furniture and accessories, an importer of other related product, a retailer of its total product line in 65 company-owned stores, and the operator of a warehousing, distribution, and home-delivery service for its owned and independent retailer network.
The company's product line is distributed exclusively through a gallery network of 299 stores, most of which are free standing. Although a majority of these stores are located in the U.S. and Canada, the company's distribution scope extends intentionally with 12 stores located abroad in Japan, Korea, Mexico, the Philippines, Saudi Arabia, and Taiwan.
Ethan Allen's furniture is manufactured in 20 different facilities and some of its related accessory product is produced and assembled in two additional company-owned facilities. The company's headquarters are located in Danbury, Connecticut, in a 144,000 square foot facility that is owned by the company. Adjacent to the headquarters facility is a large operating store unit and a 199-room hotel called the Ethan Allen Inn. This hotel, which is operated for commercial purposes, also provides accommodations for dealer personnel that journey to headquarters for training programs.
We reaffirm our NEUTRAL (3) rating on the shares of Ethan Allen (Ethan) following the company's release of fiscal fourth quarter and year-end 1997 earnings. In riding the present strength among high end manufacturers, Ethan reported an impressive fiscal fourth quarter operating performance. After-tax earnings per share in the quarter grew to $1.02, nearly twice the profit earned in the comparable period a year ago. While the year-over-year performance was in itself an impressive feat, the fact that the strength was broad based and above recently revised expectations was all the more pleasing. All product categories, including casegoods, upholstery, and accessories, posted double-digit sales gains in the quarter. Additionally, wholesale volume, after backing out intercompany eliminations, advanced by 16.0% to $104.1 million and retail revenues grew 27% to $52.3 million. In all, Ethan registered one of its best quarterly performances in memory, exceeding both our view and the Street consensus by about $0.17 per share, or 20%.
Building off the strong results of the quarter, we recently raised our fiscal 1998 EPS estimate from $3.60 to $3.85. In driving this increase, we have made changes to our operating assumptions both in margins and sales growth. Sales are projected to increase 10.3% to $630.5 million. Our net wholesale operating margin assumption has been raised modestly to 20.6%, and retail operating margins are projected to grow to 4.3% of sales, a modest 10 basis point improvement. For fiscal 1999, we introduced a formal EPS estimate of $4.30 on sales of $680.0 million, up 10.3% from $630.5 million. While we recognize there may be some potential for modest upward revision to these estimates, we also caution that wholesale operating margins are near historical highs. Management avows some comfort with the current level of wholesale operating margins, but does not expect a material improvement in the near-term. Notably, certain species of lumber (e.g., Maple, Birch) have increased in price in recent months, although some moderation is expected. Nonetheless, with lumber representing close to 50% of overall raw material costs, or roughly 17% of cost of goods sold (COGS), investors should be aware of the potential impact of further increases in raw material prices.
Raw material issue aside, Ethan's outlook remains quite good. Recently, management outlined a number of initiatives designed to help sustain the momentum its has achieved in recent quarters. First, expansion into intentional markets remains an important catalyst for future growth. In fiscal 1997, Ethan added six new stores to its international roster in Japan (2), Korea (1), the Philippines (1), Taiwan (1), and Kuwait (1). A joint venture arrangement with an existing retailer in Canada was also further developed, promising additional stores in that region. A 20,000 square foot store in Singapore will open later this year as well. Second, national television advertising will remain an important tool in driving store traffic. It will also help draw new customers to its stores. Finally, with nearly 44% of Ethan's store base in new or improved locations, and with a majority of these stores having undergone major face lifts (82%), management has fumed its focus to the interior of its stores. A host of ideas were introduced at its retail conference in May. An adaptive approach to a concept developed in its 30,000 square foot Stamford, Connecticut store is being modeled in smaller locations, and should be more accommodative to a traditional 15,000 square foot Ethan store. In all, Ethan remains well positioned for strong, visible future growth.
From a valuation stand point, Ethan's shares have appreciated markedly in recent weeks, and are up nearly 60% from the beginning of the year. In light of this strong performance, Ethan's shares now sell at a premium to a select group of peers on the bases of several measures, and have approached our projection of intrinsic net worth. High margins, impressive cash flows and good recent execution certainly justify the premium valuation, but we believe that the easy money in these shares has been made. The potential for a modest pullback seems likely in the near-term, particularly for performance oriented accounts with a value oriented mindset.
We have examined two approaches to valuation of this security, a comparable peer group study and an estimated intrinsic value analysis. The selected peer group in both cases was culled from a larger group of publicly traded residential furniture manufacturers and home furnishings retailers. We intentionally narrowed the group of peers to include those companies that best matched the size and profitability characteristics of Ethan. We also placed a high degree of emphasis on earnings consistency, quality of brands, management, and share liquidity. In all, we were left with four well respected, large cap peers, split equally between retailing and manufacturing.
While boasting the highest profit margins in the group, Ethan also supports the highest valuation. Ethan's shares trade at 16.2 times forward earnings, while the group, on average, trades at just 13.9 times. Measured against our fiscal 1999 EPS estimate of $4.30, Ethan commands a P/E multiple nearly 18% above the group, or 14.5 times compared with 12.3 times. Similar conclusions are drawn from our calculated MEV ratios and price-to-book statistics.
Furthermore, we project Ethan's intrinsic value slightly exceeds $64.00 per share. Our methodology uses estimates of future cash profits versus economic cash capital employed. We have also long been proponents of measuring intrinsic value by using present value of future cash flow EVA techniques.
On balance, today's stock market places a high value on consistency and on exceeding analysts' expectations. We think Ethan has demonstrated that consistency throughout most of its public career.
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