Research from Water Tower Research, Water Tower Research

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.

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<h2>KEY POINTS</h2>
<div></div>
<ul>
<li>Highlights from 2Q22.&nbsp;HNI reported strong sales and improving profits as price increases began recapturing margin lost to inflation. 2Q22 adjusted EPS of $0.52 compared with $0.40 in 2Q21 and beat our $0.35 estimate. Consolidated 2Q22 revenues of $621.8 million beat our $615.1 million estimate and were ~22% above 2Q21 revenues of $510.5 million. Drilling down to the divisions, Residential Building Products (RBP) sales grew 29%, while Workplace Furnishings (WF) sales rose 18%. HNI’s July 20 sale of Hong Kong-based Lamex for $75 million generated a pre-tax $50 million gain. A DTA adjustment tax benefit was accounted for in 2Q22. The gain versus Lamex’s book value and the balance of tax impact will be booked in 3Q22.</li>
<li>Guidance.&nbsp;Management’s guidance was cautiously in line with a softer macro outlook. 2Q22 RBP order trends gained 14%, but slowed as the new housing market cooled. 2Q22 WF orders rose 4%, but small and medium businesses (SMBs), a proverbial canary in the coal mine, turned decidedly soft. Strong backlogs in both segments will support near-term sales growth. The Lamex sale will have a net negative impact of about $0.08 on 2H22 adjusted EPS,</li>
<li>Our view.&nbsp;HNI has navigated a difficult economic environment nimbly. Nonetheless, slower new home sales and the recession threat/reality is unsettling. We are cutting our 2H22 estimate by 27% to $1.40 ($0.82 in 3Q and $0.58 in 4Q) from $1.94 ($0.93 in 3Q and $1.01 in 4Q). Our new estimates jibe with management’s view that 2H22 earnings will be lower than its 2H/1H normal 70%/30% seasonality.</li>
</ul>
<h2>ESTIMATES</h2>
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<h3>COMPANY OVERVIEW</h3>
<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 manufacture 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>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/289/647/original/image_62457130331659376010179.png?1659376011" class="editor-image img-responsive" data-smartkarma-image-id="289647"></figure>
<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>
<h2>INSIDE THIS NOTE</h2>
<p>Figures 1 and 2 are variance analyses comparing 2Q22 consolidated results with 2Q21 and our 2Q22 estimates. In addition, we show operating income results for the two segments as well as for unallocated expenses.</p>
<p>Our estimates are summarized in “Estimates and Valuation” and shown in detail with our income statements, balance sheet, and cash flow models.</p>
<h2>REVIEW OF 2Q22</h2>
<p>Consolidated sales for 1Q22 grew 21.8% to $621.8 million, above the Water Tower Research estimate of $615.1 million. Organic sales rose 18.9%.</p>
<p>GAAP net income grew 74%, boosted by a one-time tax benefit created by the pending sale of the Lamex division. Excluding the tax benefit and one-time items totaling $1.2 million, pre-tax, net income rose 24.3%. Reported GAAP EPS was $0.72 and adjusted EPS was $0.52. Water Tower Research was modeling $0.35 and consensus was $0.34.</p>
<p>Gross margin percentage compressed by 130 basis points (bps) Y/Y due to higher inflation and lower net productivity, reflecting, in part, costs and inefficiencies with the ramping up of a new plant in Mexico. The rate of gross margin compression improved sequentially from 240 bps in the first quarter. We expect that better price realization, moderating inflation in raw materials, and maturation of the Mexico plant will return the gross margin to a historical rate of 36% to 37% by next year.</p>
<p>SG&amp;A as a percent of sales dropped 150 bps compared with the prior year thanks to leverage on fixed costs due to higher prices and rising volume, partially offset by higher freight costs and higher spending on marketing, branding, and product development.</p>
<h2>Segments</h2>
<p>Workplace Furniture segment sales grew 18.2% to $406.7 million, ~$4.3 million below our estimate. WF adjusted operating earnings were $12.1 million, $3.2 million better than our expectations and up 29% Y/Y. WF’s adjusted EBIT margin advanced to 2.98% from 2.72% a year ago. Sequentially, the segment improved from a loss of 1.8% in 1Q22.</p>
<p>Residential Building Product revenue grew 29.3% Y/Y to $215.1 million and beat our estimate by $11 million. Organically, sales increased 20.5%. Acquisitions in 2021 and 2022 added $14.6 million to segment sales. During 2Q22, HNI acquired an installing distributor in Raleigh, NC, and now owns 27 nationwide. RBP EBIT grew 21% Y/Y, with the margin compressing by ~115 bps to 17.2%. Lower productivity and the impact of acquisitions affected RBP margin. Higher volume partially offset those effects.</p>
<h2>DIRECTIONAL GUIDANCE FOR FY22 – OUR ESTIMATES AND BEYOND</h2>
<p>Consistent with its recent practice, management updated directional guidance for FY22. Below is the summary of the guidance.</p>
<p>Workplace Furnishings.&nbsp;Management expects WF revenues to grow by the low teens for 2022, below its earlier outlook of high teens to the low 20% range. Slower volume growth and the divestiture of Lamex drive the cut in its view. Excluding the Lamex sale and the effects of an e-commerce restructuring (previously announced), price and volume growth are expected to remain in the low 20% range. That full-year outlook implies meaningful slowing in 2H22. We are modeling revenue growth rates in 3Q and 4Q of 9.1% and 0,5%, respectively, reflecting a cautious view.</p>
<p>Residential Building Products.&nbsp;Management continues to expect revenue growth in the high teens, aided by acquisitions and investments in growth. While still strongly up, it represents a sharp slowing from the +29% growth in 2Q and +21% in 1Q. We are modeling growth rates of 16% in 3Q and 9% in 4Q.</p>
<p>Consolidated Results.&nbsp;Management cautioned that investors should not expect the normal earnings seasonality this year. Typically, HNI generates ~70% of its full-year profits during the year’s second half. Consistent with management’s updated comments, we now model ~62% of the full-year profit in the next six months.</p>
<p>Our full models are attached below.</p>
<h2>VALUATION METRICS</h2>
<p>We do not offer specific stock recommendations and/or stock price targets at WTR. Our purpose is to help educate our readers about a company and some factors that we believe can be relevant to their choices about when and if to invest in a particular issue. Below, we offer charts illustrating the valuation of HNI stock today relative to its historical norms. We have chosen two metrics: forward P/E valuation and forward EV/EBITDA. Both metrics require some confidence in the outlook for the firm. HNI remains vulnerable to macroeconomic changes, as the shift in outlook this quarter illustrates. However, the company’s history of execution and adaptability in adverse circumstances bolsters our confidence that the forward view is reasonably reliable.</p>
<p>Below, we show that HNI stock is about 25% undervalued on a consensus forward P/E basis. The median historical forward P/E is about 13.7x versus 10.9x on current forward consensus estimates. On our revised estimates, the stock is about 11.6x our out-year estimate.</p>
<p>On the forward EV/EBITDA, HNI is at about 7.3x versus a five-year mean of 9.2x.</p>
<p>We compare HNI with its peer group (SCS, MLKN, KBAL) on those metrics in the charts on the following pages.</p>
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<h2>REVIEW OF 2Q22</h2>
<p>Figures 1 &amp; 2: Review of 2Q22 vs. 2Q21 and WTR Estimates – Consolidated and by Segment</p>
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<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/289/652/original/image_64185935781659376096844.png?1659376099" class="editor-image img-responsive" data-smartkarma-image-id="289652"></figure>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/289/653/original/image_68728359791659376109284.png?1659376111" class="editor-image img-responsive" data-smartkarma-image-id="289653"></figure>
<p>Figure 3: HNI Corp. Consolidated Income Statement Model</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/289/654/original/image_879349565101659376124141.png?1659376126" class="editor-image img-responsive" data-smartkarma-image-id="289654"></figure>
<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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<h2>DISCLOSURES</h2>
<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 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


Highlights from 2Q22.&nbsp;HNI reported strong sales and improving profits as price increases began recapturing margin lost to inflation. 2Q22 adjusted EPS of $0.52 compared with $0.40 in 2Q21 and beat our $0.35 estimate. Consolidated 2Q22 revenues of $621.8 million beat our $615.1 million estimate and were ~22% above 2Q21 revenues of $510.5 million. Drilling down to the divisions, Residential Building Products (RBP) sales grew 29%, while Workplace Furnishings (WF) sales rose 18%. HNI’s July 20 sale of Hong Kong-based Lamex for $75 million generated a pre-tax $50 million gain. A DTA adjustment tax benefit was accounted for in 2Q22. The gain versus Lamex’s book value and the balance of tax impact will be booked in 3Q22.
Guidance.&nbsp;Management’s guidance was cautiously in line with a softer macro outlook. 2Q22 RBP order trends gained 14%, but slowed as the new housing market cooled. 2Q22 WF orders rose 4%, but small and medium businesses (SMBs), a proverbial canary in the coal mine, turned decidedly soft. Strong backlogs in both segments will support near-term sales growth. The Lamex sale will have a net negative impact of about $0.08 on 2H22 adjusted EPS,
Our view.&nbsp;HNI has navigated a difficult economic environment nimbly. Nonetheless, slower new home sales and the recession threat/reality is unsettling. We are cutting our 2H22 estimate by 27% to $1.40 ($0.82 in 3Q and $0.58 in 4Q) from $1.94 ($0.93 in 3Q and $1.01 in 4Q). Our new estimates jibe with management’s view that 2H22 earnings will be lower than its 2H/1H normal 70%/30% seasonality.

ESTIMATES

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 manufacture 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.
INSIDE THIS NOTE
Figures 1 and 2 are variance analyses comparing 2Q22 consolidated results with 2Q21 and our 2Q22 estimates. In addition, we show operating income results for the two segments as well as for unallocated expenses.
Our estimates are summarized in “Estimates and Valuation” and shown in detail with our income statements, balance sheet, and cash flow models.
REVIEW OF 2Q22
Consolidated sales for 1Q22 grew 21.8% to $621.8 million, above the Water Tower Research estimate of $615.1 million. Organic sales rose 18.9%.
GAAP net income grew 74%, boosted by a one-time tax benefit created by the pending sale of the Lamex division. Excluding the tax benefit and one-time items totaling $1.2 million, pre-tax, net income rose 24.3%. Reported GAAP EPS was $0.72 and adjusted EPS was $0.52. Water Tower Research was modeling $0.35 and consensus was $0.34.
Gross margin percentage compressed by 130 basis points (bps) Y/Y due to higher inflation and lower net productivity, reflecting, in part, costs and inefficiencies with the ramping up of a new plant in Mexico. The rate of gross margin compression improved sequentially from 240 bps in the first quarter. We expect that better price realization, moderating inflation in raw materials, and maturation of the Mexico plant will return the gross margin to a historical rate of 36% to 37% by next year.
SG&amp;A as a percent of sales dropped 150 bps compared with the prior year thanks to leverage on fixed costs due to higher prices and rising volume, partially offset by higher freight costs and higher spending on marketing, branding, and product development.
Segments
Workplace Furniture segment sales grew 18.2% to $406.7 million, ~$4.3 million below our estimate. WF adjusted operating earnings were $12.1 million, $3.2 million better than our expectations and up 29% Y/Y. WF’s adjusted EBIT margin advanced to 2.98% from 2.72% a year ago. Sequentially, the segment improved from a loss of 1.8% in 1Q22.
Residential Building Product revenue grew 29.3% Y/Y to $215.1 million and beat our estimate by $11 million. Organically, sales increased 20.5%. Acquisitions in 2021 and 2022 added $14.6 million to segment sales. During 2Q22, HNI acquired an installing distributor in Raleigh, NC, and now owns 27 nationwide. RBP EBIT grew 21% Y/Y, with the margin compressing by ~115 bps to 17.2%. Lower productivity and the impact of acquisitions affected RBP margin. Higher volume partially offset those effects.
DIRECTIONAL GUIDANCE FOR FY22 – OUR ESTIMATES AND BEYOND
Consistent with its recent practice, management updated directional guidance for FY22. Below is the summary of the guidance.
Workplace Furnishings.&nbsp;Management expects WF revenues to grow by the low teens for 2022, below its earlier outlook of high teens to the low 20% range. Slower volume growth and the divestiture of Lamex drive the cut in its view. Excluding the Lamex sale and the effects of an e-commerce restructuring (previously announced), price and volume growth are expected to remain in the low 20% range. That full-year outlook implies meaningful slowing in 2H22. We are modeling revenue growth rates in 3Q and 4Q of 9.1% and 0,5%, respectively, reflecting a cautious view.
Residential Building Products.&nbsp;Management continues to expect revenue growth in the high teens, aided by acquisitions and investments in growth. While still strongly up, it represents a sharp slowing from the +29% growth in 2Q and +21% in 1Q. We are modeling growth rates of 16% in 3Q and 9% in 4Q.
Consolidated Results.&nbsp;Management cautioned that investors should not expect the normal earnings seasonality this year. Typically, HNI generates ~70% of its full-year profits during the year’s second half. Consistent with management’s updated comments, we now model ~62% of the full-year profit in the next six months.
Our full models are attached below.
VALUATION METRICS
We do not offer specific stock recommendations and/or stock price targets at WTR. Our purpose is to help educate our readers about a company and some factors that we believe can be relevant to their choices about when and if to invest in a particular issue. Below, we offer charts illustrating the valuation of HNI stock today relative to its historical norms. We have chosen two metrics: forward P/E valuation and forward EV/EBITDA. Both metrics require some confidence in the outlook for the firm. HNI remains vulnerable to macroeconomic changes, as the shift in outlook this quarter illustrates. However, the company’s history of execution and adaptability in adverse circumstances bolsters our confidence that the forward view is reasonably reliable.
Below, we show that HNI stock is about 25% undervalued on a consensus forward P/E basis. The median historical forward P/E is about 13.7x versus 10.9x on current forward consensus estimates. On our revised estimates, the stock is about 11.6x our out-year estimate.
On the forward EV/EBITDA, HNI is at about 7.3x versus a five-year mean of 9.2x.
We compare HNI with its peer group (SCS, MLKN, KBAL) on those metrics in the charts on the following pages.


REVIEW OF 2Q22
Figures 1 &amp; 2: Review of 2Q22 vs. 2Q21 and WTR Estimates – Consolidated and by Segment




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 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.

Reviewing 2Q22 Results and Updating Estimates; Strong Sales and Improved Profits Versus 2Q21; Softening Macroeconomy Catalyzes More Cautious Outlook