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Water Tower Research

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.

Research from Water Tower Research

Equity Research Firm

Equity Bottom-Up

<h3>KEY POINTS</h3>
<ul>
<li>Before market open on October 24, HNI reported 3Q22 results. Non-GAAP (adjusted) EPS of $0.71 on sales of $598.8 million beat our EPS estimate by $0.04 and consensus by $0.06, yet missed revenue estimates for both significantly. A full statistical review of the results is in our attached tables.</li>
<li>GAAP EPS of $1.51 included: (1) a $50.6 million pre-tax gain on the sale of Lamex (Asia); (2) a $3.6 million pre-tax write-down of inventory in the Workplace e-commerce business; and (3) a $5.6 million pre-tax charge for a newly announced cost-cutting program that HNI expects to generate ~$30 million in annual savings (mostly in 2023).</li>
<li>Management noted challenging market conditions in its two segments—Workplace Furnishings (WF) and Residential Building Products (RBP)—and cut guidance.</li>
<li>3Q22 orders in WF fell 15% Y/Y. The current elevated backlog will support near-term sales. Orders from the large market and small businesses have been weak, challenged by a slow return to the office and the specter of recession.</li>
<li>Orders in HNI’s RBP segment are also slowing for repair and remodeling and new home construction channels. Lower permits (-20%) and mortgage applications (-30%+) portend sharply slower new construction orders in the near to intermediate term.</li>
<li>Our revised 4Q22 estimate of $0.46 (versus $0.72) is near the low end of management guidance. We cut our 2023 EPS estimate from $2.55 to $1.52. We believe cost cutting and pricing initiatives will support margins. We think it prudent to assume significant pressure on the top line through 2023, mostly in the first half.</li>
</ul>
<h3>ESTIMATES</h3>
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<h2>IMPLICATIONS ABOUT HNI AS A POTENTIAL EQUITY INVESTMENT</h2>
<p>In the face of the mixed 3Q22 earnings report (EPS beat, revenues miss, and dour guidance), HNI’s share price performance was flattish to modestly positive within a day when the major indices were generally positive.</p>
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<p>For 2022 to date, however, HNI is down 32.7%, underperforming the S&amp;P 500 by 10.4% (the S&amp;P 500 is down 20.3% YTD). Also, the shares are ~$18 below the $46 level they touched in the first half of 2021 and well below their ~$62 all-time high in early 2006. Irrespective, the shares performed better than their peers for 2022 to date. The nearby charts show the performance during 2022.</p>
<p>Recall that operating under a regulatory publisher’s exclusion, Water Tower Research do not make specific recommendations and/or opine about target prices. Yet, we can and do issue estimates and have operating models that clients can, at their request, review. We also can and do include graphics and comments about how the market has valued the equities of our covered companies.</p>
<p>Additionally, we do comment on the investment theses that management and investors can have about their equities. For HNI, the recent investment thesis had several tenets that we addressed in our initiation of coverage. These were: (1) improving operating margin performance within its WF segment, irrespective of whether it grew revenues; (2) growing its revenues within its RBP segment, while maintaining its high operating margin despite investing more heavily in marketing; (3) keeping a strong financial condition; and (4) adhering to high governance and sustainability standards.</p>
<p>Accordingly, while the 3Q22 results were mixed versus expectations and guidance was disappointing due to macroeconomic conditions, management deserves credit for delivering on these tenets. Despite lower revenues, the WF adjusted operating margin advanced. Despite an increasingly challenging housing backdrop, RBP revenues grew in 3Q22 and its 17.7% adjusted operating margin is impressive. HNI’s balance sheet is strong, with debt to EBITDA and net debt to EBITDA at and below 1.0x. Additionally, management, noting the challenging operating environment, committed to additional cost cutting that will maintain that strength during the upcoming periods. Investors, considering the attraction of HNI as an equity investment, can have confidence that HNI leadership will continue to strive to improve long-term operating performance. We note that management did not repurchase shares during 3Q22.</p>
<p>Our revised economic model is attached following the tables that review the 3Q22 operating performance. Moreover, charts comparing the historical valuation of HNI with its commercial/contract furniture peers are attached following the model. We compare the historical valuations on three metrics: (1) Enterprise Value to EBITDA (Forward); (2) Current Share Price versus Forward Earnings Estimates; and (3) Share Price versus Trailing Sales.</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/305/383/original/image_44021152241666736350296.png?1666736351" class="editor-image img-responsive" data-smartkarma-image-id="305383"></figure>
<h2>COMPANY OVERVIEW</h2>
<p>Headquartered in Muscatine, IA, HNI Corporation operates in two distinct and unrelated businesses:</p>
<p>(1) HNI’s Workplace Furnishings (WF) segment manufactures and markets commercial and contract office furniture. Its office furniture includes systems, seating, storage, tables, and architectural products. Previously, WF was labeled as HNI’s&nbsp;Office Furniture Segment.</p>
<p>(2) HNI’s Residential Business Products (RBP) segment is the market leader in the manufacturing and sale of fireplaces and related hearth products. Its fireplace offering includes a broad array of gas, wood, electric, and pellet-fueled fireplaces, fireplace inserts, stoves, facings, and accessories. Previously, RBP was labeled as HNI’s&nbsp;Hearth Products Segment.</p>
<p>HNI was founded in the mid-1940s on the two ideas of treating employees fairly and serving customers with products that they value.</p>
<p>Figure 1: Revenue Comparisons: 3Q22 versus 3Q21 and 2022 versus 2021 YTD</p>
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<p>Figure 2: 3Q22 Operating Results Comparisons</p>
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<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/305/388/original/image_45947867391666736443309.png?1666736445" class="editor-image img-responsive" data-smartkarma-image-id="305388"></figure>
<p>Figure 3: HNI Corp. Consolidated Income Statement Model</p>
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<p>Figure 4: HNI Corp. Segment Operating Income Model</p>
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<p>Figure 5: HNI Corp. Balance Sheet Model</p>
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<p>Figure 6: HNI Corp. Cash Flow Model</p>
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<h3>DISCLOSURES</h3>
<div></div>
<p>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.<br><br>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.<br><br>Budd Bugatch and Rex Henderson, CFA who are the writers of this report, covers the Consumer Hardlines sector for WTR. Mr. Bugatch and Mr. Henderson, CFA including members of their household have no personal or business-related relationship to the subject company other than providing digital content and any ancillary services WTR may offer.<br><br>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.<br><br>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.<br><br>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.<br><br>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.<br><br>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.<br><br>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.</p>

KEY POINTS

Before market open on October 24, HNI reported 3Q22 results. Non-GAAP (adjusted) EPS of $0.71 on sales of $598.8 million beat our EPS estimate by $0.04 and consensus by $0.06, yet missed revenue estimates for both significantly. A full statistical review of the results is in our attached tables.
GAAP EPS of $1.51 included: (1) a $50.6 million pre-tax gain on the sale of Lamex (Asia); (2) a $3.6 million pre-tax write-down of inventory in the Workplace e-commerce business; and (3) a $5.6 million pre-tax charge for a newly announced cost-cutting program that HNI expects to generate ~$30 million in annual savings (mostly in 2023).
Management noted challenging market conditions in its two segments—Workplace Furnishings (WF) and Residential Building Products (RBP)—and cut guidance.
3Q22 orders in WF fell 15% Y/Y. The current elevated backlog will support near-term sales. Orders from the large market and small businesses have been weak, challenged by a slow return to the office and the specter of recession.
Orders in HNI’s RBP segment are also slowing for repair and remodeling and new home construction channels. Lower permits (-20%) and mortgage applications (-30%+) portend sharply slower new construction orders in the near to intermediate term.
Our revised 4Q22 estimate of $0.46 (versus $0.72) is near the low end of management guidance. We cut our 2023 EPS estimate from $2.55 to $1.52. We believe cost cutting and pricing initiatives will support margins. We think it prudent to assume significant pressure on the top line through 2023, mostly in the first half.

ESTIMATES

IMPLICATIONS ABOUT HNI AS A POTENTIAL EQUITY INVESTMENT
In the face of the mixed 3Q22 earnings report (EPS beat, revenues miss, and dour guidance), HNI’s share price performance was flattish to modestly positive within a day when the major indices were generally positive.

For 2022 to date, however, HNI is down 32.7%, underperforming the S&amp;P 500 by 10.4% (the S&amp;P 500 is down 20.3% YTD). Also, the shares are ~$18 below the $46 level they touched in the first half of 2021 and well below their ~$62 all-time high in early 2006. Irrespective, the shares performed better than their peers for 2022 to date. The nearby charts show the performance during 2022.
Recall that operating under a regulatory publisher’s exclusion, Water Tower Research do not make specific recommendations and/or opine about target prices. Yet, we can and do issue estimates and have operating models that clients can, at their request, review. We also can and do include graphics and comments about how the market has valued the equities of our covered companies.
Additionally, we do comment on the investment theses that management and investors can have about their equities. For HNI, the recent investment thesis had several tenets that we addressed in our initiation of coverage. These were: (1) improving operating margin performance within its WF segment, irrespective of whether it grew revenues; (2) growing its revenues within its RBP segment, while maintaining its high operating margin despite investing more heavily in marketing; (3) keeping a strong financial condition; and (4) adhering to high governance and sustainability standards.
Accordingly, while the 3Q22 results were mixed versus expectations and guidance was disappointing due to macroeconomic conditions, management deserves credit for delivering on these tenets. Despite lower revenues, the WF adjusted operating margin advanced. Despite an increasingly challenging housing backdrop, RBP revenues grew in 3Q22 and its 17.7% adjusted operating margin is impressive. HNI’s balance sheet is strong, with debt to EBITDA and net debt to EBITDA at and below 1.0x. Additionally, management, noting the challenging operating environment, committed to additional cost cutting that will maintain that strength during the upcoming periods. Investors, considering the attraction of HNI as an equity investment, can have confidence that HNI leadership will continue to strive to improve long-term operating performance. We note that management did not repurchase shares during 3Q22.
Our revised economic model is attached following the tables that review the 3Q22 operating performance. Moreover, charts comparing the historical valuation of HNI with its commercial/contract furniture peers are attached following the model. We compare the historical valuations on three metrics: (1) Enterprise Value to EBITDA (Forward); (2) Current Share Price versus Forward Earnings Estimates; and (3) Share Price versus Trailing Sales.

COMPANY OVERVIEW
Headquartered in Muscatine, IA, HNI Corporation operates in two distinct and unrelated businesses:
(1) HNI’s Workplace Furnishings (WF) segment manufactures and markets commercial and contract office furniture. Its office furniture includes systems, seating, storage, tables, and architectural products. Previously, WF was labeled as HNI’s&nbsp;Office Furniture Segment.
(2) HNI’s Residential Business Products (RBP) segment is the market leader in the manufacturing and sale of fireplaces and related hearth products. Its fireplace offering includes a broad array of gas, wood, electric, and pellet-fueled fireplaces, fireplace inserts, stoves, facings, and accessories. Previously, RBP was labeled as HNI’s&nbsp;Hearth Products Segment.
HNI was founded in the mid-1940s on the two ideas of treating employees fairly and serving customers with products that they value.
Figure 1: Revenue Comparisons: 3Q22 versus 3Q21 and 2022 versus 2021 YTD

Figure 2: 3Q22 Operating Results Comparisons



Figure 3: HNI Corp. Consolidated Income Statement Model

Figure 4: HNI Corp. Segment Operating Income Model

Figure 5: HNI Corp. Balance Sheet Model

Figure 6: HNI Corp. Cash Flow Model




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 and Rex Henderson, CFA who are the writers of this report, covers the Consumer Hardlines sector for WTR. Mr. Bugatch and Mr. Henderson, CFA including members of their 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.

3Q22 EPS Beats Estimates; Revenues Miss; 4Q22 Guidance Cut Reflecting Challenging Business; Now Implying Lower Earnings for 2023