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Water Tower Research is a leading equity research firm that provides research on micro, small and mid cap companies.

Water Tower Research was founded by Wall Street veterans after witnessing a fundamental shift in the investment research industry with the result being a declining knowledge base among investors, a lack of awareness and a shrinking pool of fundamental research being conducted on companies across the small-cap and micro-cap spectrum. The same issues are now increasingly occurring in the mid-cap space. This sea change within the investment community is impacting not only the companies themselves but also current shareholders and potential investors. With significantly less active sell-side sponsorship by Wall Street, a substantial information gap has developed between companies and various constituents in the financial community. The net result is fewer channels for insight and information to flow between companies and investors.

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KEY POINTS

2021 was a challenging year for HNI. Like its peers, HNI faced rapid inflation, supply chain bottlenecks, and labor challenges that persisted into 4Q21. Though pressuring overall margins, the challenges were most evident in HNI’s Workplace Furnishings (WF) segment. As a result, price/cost impact was negative for 4Q21. Also, workforce shortages, supply chain capacity issues, and COVID outbreaks pushed some revenue out of 2021.
In response, HNI initiated several price increases across its brands. It expects significant profit improvement in 2022. Though declining to provide specific guidance, management made directional comments about its 2022 outlook on the 4Q21 conference call. It also noted HNI’s strong balance sheet and low leverage, and voiced optimism about the company’s long-term future.
In our view, HNI’s actions, strategies, and investments should improve profitability in Workplace Furnishings and generate longer term growth in its hearth business, the Residential Building Products (RBP) segment. We expect improved profits in 2022.
In WF, HNI’s new seating facility in Mexico gives it access to a new labor pool and relocates some production lines to improve labor dynamics. Digital initiatives and return to work also hold promise to increase segment growth.
In RBP, early results of marketing initiatives seem promising. Also, its 2021 acquisitions, Trinity Hearth &amp; Home and The Outdoor GreatRoom Company, strengthen its logistics position and offer a new product vector for growth.
With its financial strength intact, HNI has a high likelihood of delivering meaningful revenue growth and profit improvement in the upcoming years.

ESTIMATES

COMPANY OVERVIEW

Headquartered in Muscatine, Iowa, HNI Corporation manufactures and markets workplace furnishings and residential building products. HNI operates in two distinct businesses: commercial/contract office furniture, and fireplaces and related products. HNI was founded in the mid-1940s on the idea of treating its employees fairly and serving customers with products that they value.
HNI’s office furniture includes systems, seating, storage, tables, and architectural products; HNI reports results of its office furniture business in its Workplace Furnishings (WF) segment. Residential Building Products (RBP) is HNI’s official segment name for its fireplace business that was previously called “Hearth Products.” Its products include a broad offering of gas, wood, electric, and pellet-fueled fireplaces, fireplace inserts, stoves, facings, and accessories.
INSIDE THIS REPORT
Tables 1 and 2 are variance analyses that compare 4Q21 consolidated results to 4Q20, and to our 4Q21 estimates. In addition, we show operating income results by two segments, and the unallocated expenses.
Our estimates are summarized in “Estimates and Valuation” and shown in detail with our income statements, balance sheet, and cash flow models enclosed in this reporft.
REFLECTIONS ON 4Q21 and FY21
Consolidated sales for 4Q21were $602.9 million, up 7.25% versus 4Q20, and beat our estimate by ~$4.5 million, which brought the FY21 total to $2.184 billion, an 11.7% increase from the prior year. On an organic basis, FY21 sales increased 9.3 percent y/y. For the full year, RBP posted organic sales growth of 25.16%.
4Q21 revenues were driven by improved y/y sales in each segment, with WF reporting sales of $393.9 million, up 7.7% versus 4Q20, beating our estimate of $386 million, and RBP delivering sales of $208.9 million, up 6.5% versus 4Q20, but missing our $212.4 million estimate.
Workplace Furnishings segment orders for 4Q21 grew 6% y/y when excluding e-commerce and normalizing for the extra week in 4Q20. RBP orders increased 4% compared to 4Q20, adjusting for the same parameter as WF. This slow growth, when compared sequentially was attributed to uncertainty created by the Omicron virus variant.
4Q21 gross profit declined by ~$14.5 million y/y to $194.2 million, missing our estimate of $200 million. This decrease was driven by unfavorable price-cost and $7.6 million of charges related to the strategic restructuring of an e-commerce business in the WF segment. The gross margin for the full year shrank by 220 basis points compared to FY20.
WF operating profit margin declined by 360 basis points y/y, and it reported an operating loss of $10.1 million versus estimate of $2.5 million of profit. This segment also recorded $7.9 million of restructuring costs as well as a $5.8 million goodwill impairment charge, working out to 230 bp of margin compression on a non-GAAP basis. However, the entire year GAAP operating margin expanded by 40 bp y/y.
RBP’s operating profit margin reported a y/y compression of 430 bp to $38.1 million, close to our estimate of $37.9 million. The decline in both segments was mainly driven by unfavorable price-cost and reduced volume due to labor and supply chain constraints, partially offset by lower variable compensation.
Although non-GAAP diluted EPS of $0.43 compared unfavorably to the $0.66 delivered in 4Q20, it exceeded our $0.40 estimate by $0.03.
See Tables 1 and 2 for detail.
DIRECTIONAL GUIDANCE FOR FY2022—OUR ESTIMATES AND BEYOND
Given the challenges of 2021 and the uncertainty occasioned by the Omicron variant, management decided to provide only directional guidance for FY2022. Below is the summary of the guidance.
Workplace Furnishings:&nbsp;Management expects “pricing benefits, backlog normalization, and assumed market improvements to drive revenue growth rates in the high teens to low twenties” for FY2022. Our estimate is $1.64 billion, ~14.6% above 2021 WF sales. We are not now forecasting any impact from acquisitions in our WF sales estimates.
Residential Building Product:&nbsp;“Pricing benefits, inorganic revenue from acquisitions closed in 2021, and continued benefits from multiple growth initiatives are expected to fuel growth rates in the high teens for 2022, on top of 25 percent organic growth generated by the segment in 2021” as per management. For RBP, our 2022 revenue forecast is $890.7 million, 18.7% as reported, and 13.6%, organically above 2021 RBP actual revenues. Two acquisitions, one distributor and the Outdoor Great Room, were made in 4Q21and will impact sales primarily in the first three quarters of 2022.
We are not asuming any revenues for acquistions that have not been announced.
Management expects earnings seasonality (diluted EPS) to be more skewed than the recent historical trend of ~70% for the back half of 2022. Our diluted EPS estimates, shown below, conform to that distribution with ~28% of our $2.63 estimate targeted for the first half of 2022. Our diluted GAAP EPS estimates and dituted non-GAAP are, at this juncture, identical:

Management also provided directional guidance for 1Q22, expecting profitability to be below 1Q21 levels. Additionally, the benefit of lower price-cost pressure is expected to be more than offset by continued headwinds from labor availability, supply chain constraints, and COVID impacts, as well as seasonal softness in the e-commerce and International Workplace Furnishings businesses, and investment in additional Workplace Furnishings capacity on a sequential basis.
Finally, HNI’s financial condition remains strong with cash, short-term investments, and long-term investments at $54 million, and outstanding borrowings at $178 million at the end of FY21. Gross leverage ratio remains low at 1.0x. Low debt and continuing free cash flow generation are likely to keep the balance sheet healthy through 2022, allowing for more investment, dividends, acquisitions, and share repurchases.
Our detailed economic models are also attached. We forecast by segment, building into an income statement that conforms to the presentation HNI provides. We also forecast balance sheets and cash flow statements. We project that HNI’s financial condition will remain strong. We have not incorporated any new acquisition assumptions into our model. That said, we are forecasting that free cash flow will be used for the benefit of shareholders in terms of dividends and share repurchases.v
INSIGHTS: OPPORTUNITIES
Margin Expansion
HNI's key margin initiative involves improving operating profitability in its Workplace Furnishings segment. WF offers unrivalled price point, channel access, and market reach, and the company is investing in a number of strategic initiatives to ensure profitability expansions in the future. We estimate that WF will return to mid-single-digit operating profitability by 2024. The Residential Building Products segmentdelivers industry-leading profitability. Announced price increases should aid shrinking the cost-over-price gap that marred WF's 2021 profits. HNI's lean discipline (which it calls “rapid continuous improvement”) should also help drive RBP improvements.
Revenue growth
Two questions frame much of the debate about HNI’s equity: (a) Can it grow its RBP/hearth segment? and (b) If so, can it grow RBP without materially damaging profitability? Over 40 years, HNI grew RBP to control the leading domestic hearth market share. HNI asserts that new marketing initiatives will spark demand in RBP's two channels: new house construction and remodel/retrofit. We project RBP annual sales growth of 10%+ for 2022-2025, even after the 2021 spike. Though added costs will likely limit margin expansion, we estimate RBP's 2025 profit will approach $200 million by 2025, with a still-impressive 17.6% operating margin.
INSIGHTS: CHALLENGES, NEAR-TERM AND LONGER-TERM
Labor constraints, supply chain capacity, and rising input costs.
Unfavorable fluctuations in price, availability, and quality of commodities, raw materials, and other inputs may have a negative impact on sales costs, profitability, and the capacity to satisfy consumer demand. Neither HNI or any of its competitors are large-enough purchasers to withstand raw material input cost increases. Typically, the best that HNI and/or its peers have been able to effect are delays in incurring higher costs. Inputs such as steel have been significantly impacted in recent years by a variety of factors, including changes in global supply and demand, the onset of the COVID-19 pandemic, changes in laws and regulations (including tariffs and duties), changes in exchange rates, and global price levels. Margins could be impacted negatively if commodity, raw material, and component costs continue to rise, and the company is either unable to offset such costs through strategic sourcing initiatives and continuous improvement programs, or is unable to pass along a portion of the increased costs to customers due to competitive market dynamics. Furthermore, the COVID-19 pandemic caused freight disruptions, particularly in ocean rates, that increased costs and delays in meeting customer delivery expectations. All of these headwinds, if continued, can have a negative impact on sales and profitability going forward.
Looking forward to 2022, the company projects its input costs to increase in the range of $220-240 million. Approximately 80%, 85%, or more of that is roughly expected to impact COGS. Steel prices, ocean freight rates and a wide range of other input goods are expected to a have a combined significant effect on costs. Outside of COGS, wage inflation as well as increased shipping costs are expected to impact profitability. The company’s planned price increases are expected to offset the rising costs, and result in $40 million to $50 million of positive price/cost in 2022.
Economic Sensitivity: Not Immune From Downturns and Macro-Uncertainties
Housing starts, housing inventory, general employment levels, interest rates, home affordability, consumer confidence, energy prices, disposable income, and changing demographics are all elements that affect residential construction sales. Residential building goods sector sales are also influenced by industry variables such as technological advancements, health and safety concerns, and environmental legislation, especially indoor air quality regulations. A decline in economic circumstances or a downturn in the homebuilding sector could immediately impact demand for residential building products, affecting operational performance.
The company's operations have also been harmed by the Covid-19 pandemic. Due to limitations placed by many countries throughout the world to prevent Covid-19 from spreading, worldwide sales and transportation have been restricted. It has had a major influence on the workplace furnishings industry. The need for office furniture has substantially decreased as corporate offices closed during the pandemic. The Omicron variant delayed return and re-opening of workplaces. If additional variants emerge with severity, re-openings again may be delayed, raising the potential for higher cancellations and order delays.
HISTORICAL VALUATION METRICS
A hallmark of our research at WTR is that we do not offer specific stock recommendations and/or stock price targets. Our purpose is to help educate our readers about a company and some of the factors that we believe can be relevant to their choices about when and if to invest in a particular issue. The chart below compares HNI’s price performance over the last 12 months to the broad market (S&amp;P 500) and to its peers (Steelcase, MillerKnoll, and Kimball International). The price performance of all of the peers, including HNI, paled versus the broad market. HNI, down 6.5% over the past 12 months, performed better than any of the peers.

We do offer estimates and financial models that underpin those estimates. We also offer data and graphs about how the stock has been valued historically – typically, using conventional metrics – and sometimes, we present data and graphs that juxtapose historical valuations among issues that are believed to be comparable. For HNI Corp., now, we are focusing on historical valuation metrics for the past decade. The first set of graphs show HNI Corp’s enterprise value, historical EBITDA (TTM), and track versus revenues, EBIT, and EBITDA. As noted, the ssource of the data and charts is YCharts. The chart directly below provides a 10-year look back at HNI valuation metrics.


Finally, the chart above compares HNI versus it contract furniture peers, using Enterprise Value / EBITDA as the valuation metric to compare. Currently, on that metric, the public market market is valuing HNI less highly than any of the cited peers.
TABULAR REVIEW OF 4Q21
Tables 1 and 2: Review of 4Q21 versus 4Q20 and WTR Estimates – Consolidated and by Segment




Source: Company Reports; Water Tower Research
EXHIBITS: WTR HNI ECONOMIC MODEL: INCOME STATEMENTS, BALANCE SHEET, AND CASH FLOW
Exhibit 1: HNI Corp. Consolidated Income Statement Model


Exhibit 2: HNI Corp. Segment Income Statement Models


Source: Company Filings, Water Tower Research &amp; Analysis
Exhibit 3: HNI Corp. Balance Sheet Model

Source: Company Filings, Water Tower Research &amp; Analysis
Exhibit 4: HNI Corp. Cash Flow Model

Source: Company Filings, Water Tower Research &amp; Analysis
DISCLOSURES







Water Tower Research (“WTR”) is a professional publisher of investment research reports on public companies and, to a lesser extent, private firms (“the Companies”). WTR provides investor-focused content and digital distribution strategies designed to help companies communicate with investors.  WTR is not a registered investment adviser or a broker/dealer nor does WTR provide investment banking services. WTR operates as an exempt investment adviser under the so called “publishers’ exemption” from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940. WTR does not provide investment ratings / recommendations or price targets on the companies it reports on. Readers are advised that the research reports are published and provided solely for informational purposes and should not be construed as an offer to sell or the solicitation of an offer to buy securities or the rendering of investment advice. The information provided in this report should not be construed in any manner whatsoever as personalized advice. All users and readers of WTR’s reports are cautioned to consult their own independent financial, tax and legal advisors prior to purchasing or selling securities.  Budd Bugatch, who is the writer of this report, covers the Consumer sector for WTR. Mr. Bugatch and members of his household have no personal or business-related relationship to the subject company other than providing digital content and any ancillary services WTR may offer.  Unless otherwise indicated, WTR intends to provide continuing coverage of the covered companies. WTR will notify its readers through website postings or other appropriate means if WTR determines to terminate coverage of any of the companies covered.  WTR is being compensated for its research by the company which is the subject of this report. WTR receives no more than a maximum of $10,500 per month from a given client and is required to have at least a 6-month commitment. None of the earned fees are contingent on, and WTR’s client agreements are not cancellable for the content of its reports. WTR does not accept any compensation in the form of warrants or stock options or other equity instruments that could increase in value based on positive coverage in its reports.  WTR or an affiliate may seek to receive compensation for non-research services to covered companies, such as charges for presenting at sponsored investor conferences, distributing press releases, advising on investor relations and broader corporate communications and public relations strategies as well as performing certain other related services (“Ancillary Services”). The companies that WTR covers in our research are not required to purchase or use Ancillary Services that WTR or an affiliate might offer to clients.  The manner of WTR’s research compensation and Ancillary Services to covered companies raise actual and perceived conflicts of interest. WTR is committed to manage those conflicts to protect its reputation and the objectivity of employees/analysts by adhering to strictly-written compliance guidelines.  The views and analyses included in our research reports are based on current public information that we consider to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy, completeness, timeliness, or correctness. Neither we nor our analysts, directors, officers, employees, representatives, independent contractors, agents or affiliate shall be liable for any omissions, errors or inaccuracies, regardless of cause, foreseeability or the lack of timeliness of, or any delay or interruptions in the transmission of our reports to content users. This lack of liability extends to direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, losses, lost income, lost profit or opportunity costs.  All investment information contained herein should be independently verified by the reader or user of this report. For additional information, all readers of this report are encouraged to visit WTR’s website www.watertowerresearch.com.








Updating Estimates After 4Q21 Report. Strong Market Leader Emerging From a Challenging 2021

United States

HNI Corporation manufactures and markets office furniture as well as hearth products. The Company's products are sold primarily through dealers, wholesalers, and retail superstores. HNI has operations in the United States and Canada.

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HNI Corp (HNI US)

Updating Estimates After 4Q21 Report. Strong Market Leader Emerging From a Challenging 2021

KEY POINTS 2021 was a challenging year for HNI. Like its peers, HNI faced rapid inflation, supply chain bottlenecks, and labor challenges that...

Water Tower Research

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