LL - Lumber Liquidators

[KinAlberta]

Just some older reference material for those that are interested... (LL was mentioned last October and the issue dates back to testing done last July.).  The 16x9 documentary was quite interesting.

(Note: I have no position in LL)

 

 

 

 

High levels of formaldehyde found in Chinese-made floors sold in North America | Globalnews.ca

 

http://globalnews.ca/news/1594273/high-levels-of-formaldehyde-found-in-chinese-made-floors-sold-in-north-america/

 

 

 

Think that new hardwood floor is made in Canada? Think again - National | Globalnews.ca

Excerpt:

 

"The problem isn’t so much lower cost competition – at least from the perspective of the consumer, who has benefited from lower prices – but where the flooring is sourced from.

 

And as Chinese wood-based flooring imports continue to grow, there’s also increasing concern about the lax oversight in China over chemicals used in its manufacturing, such as urea-formaldehyde or “UF”, a known carcinogen."

 

http://globalnews.ca/news/1594346/think-that-new-hardwood-floor-is-made-in-canada-think-again/

 

 

 

[Guest roark33]

I would be really interested in anyone's thoughts on what the potential long case is. 

 

My only reasonable idea is that CBS was completely fabricating the results (see Dateline and exploding GM trucks) and LL sues them for some large amount, 5b or so??  Other than that, just the brand damage is huge at this point. 

 

That being said, maybe we are the only ones that know about this stuff...??

 

 

[Green King]

I would be really interested in anyone's thoughts on what the potential long case is. 

 

My only reasonable idea is that CBS was completely fabricating the results (see Dateline and exploding GM trucks) and LL sues them for some large amount, 5b or so??  Other than that, just the brand damage is huge at this point. 

 

That being said, maybe we are the only ones that know about this stuff...??

 

This should be in the too hard pile. You can`t value this until you see the effect of this on same store sales, court proceedings and early settlement results.

 

In terms of management i think they should have recall everything have them tested by a independent party and offer store credit for those who purchased the product if they found it was inadequate. So far they have been disappointment. In terms of brand damage they really messed up in the response there could be significant damage. 

 

In terms of testing. Not passing a standard does not mean it causes cancer in all that have the product. Its more a higher percentage in a population. Also some argue it should be a room air quality test when installed and the standard of that. It could just me harmless or a small standard deviation. I mean a lot of drugs have adverse side effects. Its not if it causes it but more how much and how many. ( they should be compensated) You have think with numbers.

[Pablo12345]

How a 25-Year-Old Sparked Lumber Liquidators’ Stock Plunge

http://www.bloomberg.com/news/articles/2015-03-04/how-a-25-year-old-investor-spurred-lumber-liquidators-plunge

[Guest roark33]

maxvision33 is posting all the legal documents from the CA lawsuit (the original one) on twitter.  In case you are interested....

[JEast]

the reputation of 60-Minutes

 

Just curious if you were referring to the reputation of paying company antagonist over non-union representation to do a hit job on the company Food Lion, or the reputation of a hatchet job they did on a former president indifferent of your political affiliation :)

[Matson125]

I watched the 60 minute piece and also read the short thesis on Seekingalpha. According to 60 minutes the tests they had the labs conduct were done according to the California regulation.  In the 60 minute piece the Lumber Liquidator CEO said the tests were not correct, however he has not released any tests of his own saying they were intact under the appropriate levels.  This is a huge red flag in my opinion.  If I were in his seat and he has the evidence to support his case I would place the results on the front page on my website for all to see.

 

 

[Mephistopheles]

 

This may turn out to be a great short either way because of the reputation damage - but that's not what I want to put money on.

 

My thoughts exactly. In addition, the 60-minutes site has added information and is specifically mentioning the following: "60 Minutes also confirmed with CARB officials that this deconstructive test method is the way they test finished goods for CARB formaldehyde emissions compliance.". It then links to a different CARB document than the one I pulled, which backs up their claim:

 

http://www.cbsnews.com/news/more-on-tests-used-to-investigate-lumber-liquidators/

 

http://www.arb.ca.gov/toxics/compwood/outreach/compwood_sop_fg_decon_091313.pdf

 

So, given this and the reputation of 60-Minutes (they are not necessarily perfect, but have a whole lot to lose by playing fast and loose with the truth, in addition to surely having had to clear CBS-legal before airing), I would be very careful before investing here.

 

Still no position whatsoever.

 

EDIT: I understand where the difference between the 2 documents came from. The section of the CARB website titled "ARB Test Methods / Procedures" where I pulled the original document from also has this mention: "This page last reviewed July 13, 2012".

 

So at a minimum, it seems that the CARB website was not up-to-date. I'm not familiar enough with the applicable legislation, but I would suspect this does not absolve the company from following the up-to-date testing spec.

 

Given the information available at this point, I tend to side with the Tilson/60-Minutes. Your mileage may well vary.

 

Thanks for posting this. I went through this and now I am leaning towards shorting. They claim that deconstructive testing is not the proper way. But the CARB standard blatantly states it is. I emailed the IR about this, but no reply, surprise surprise.

 

If they weren't guilty, this discrepancy would have been addressed asap and front and center.

 

Finally, in the 60 minutes report, the CEO couldn't have looked guiltier. I'm surprised he even agreed to an interview. My gut says that they're toast.

[Guest roark33]

I have changed my mind on LL.  I am still unclear how much consumer reputation damage is out there, but I don't think the deconstructive test is as cut and dry as Tilson and 60 Minutes want it to be.  Follow maxvision33 on twitter for a more complete explanation....

[davidoosnk]

I covered some of the short calls with closer strike prices. I still think this co. is toast long term but the Chapman position could cause a headache for the *shorts in the near term.

 

I do think long term the reputational damage will outweigh any testing ambiguities.

[intothebreach]

Thanks Roark and David for letting us know.

 

At the end of the day, there are 2 aspects to Tilson's short thesis: non-respect of CARB regulations and loss of seemingly unfair cost advantage from illegal sourcing. Regardless of its veracity, the first one will do massive repetitional damage, and the second one, if accurate, leaves them as a non-advantaged supplier in a commodity industry, tainted with a scary story on top. So I guess I really don't understand Champman's thesis... 

[davidoosnk]

Chapman seems to like squeezing shorts. He did it with Herbalife. But when he was out Herbalife dropped back down. Hence my thesis potentially brutal short squeeze but ultimately back down. We shall see...

[Guest Schwab711]

Not buying but I wouldn't short this for anything. Would consider long under $20 or definitely at book (~$14). 60 min piece and future liabilities seem overblown (uneducated guess). Going long in these situations is where the big returns are, just wish it was a better business. Do folks really think this has asbestos potential?

[bookie71]

Not buying but I wouldn't short this for anything. Would consider long under $20 or definitely at book (~$14). 60 min piece and future liabilities seem overblown (uneducated guess). Going long in these situations is where the big returns are, just wish it was a better business. Do folks really think this has asbestos potential?

When you see attorneys coming out of the woodwork and slobbering, it has potential.  ;)

[Guest roark33]

The more I have dug into this, the more I don't believe Tilson.  There are a lot of things wrong with his presentation.    I am honestly too lazy to lay them all out, but here are a few.

 

1. The original short seller used a lab that wasn't CARB certified. In fact, the deconstructive method that Tilson/60 minutes used wasn't even established until almost 6 months after the original short report, so it is unclear what method they used....

 

2. The lab that Tilson and 60 Minutes used is a subsidiary of the domestic hardwood industry association (read: lobbying arm).  In other words, the arch-enemy of LL.

 

3. The second lab that 60 Minutes used explicitly told me that the deconstructive method is not very scientific or precise.  They even posted a video showing the process on their website to show how imperfect it is.  See Benchmark International.  60 Minutes did not test HD or Lowe's products, those tests were only done by the class action attorneys...

 

4. The margin increase that LL might have gotten from sourcing "illegal" products is so minuscule that it makes no sense re: Tilson's "doubling of margins points."  Chapman is actually right on this point (Did I just say that?), but his comparisons to Wal-Mart are idiotic....

 

5. Arb (the regulatory agency in CA that is in charge of enforcing CARB compliance) is very active.  5 or so enforcement actions per month, and they have yet to bring an enforcement action under CARB at all--not one. 

 

6. The deconstructive method is not conclusive of non-compliance but an indicator that leads Arb to investigate further.  However, compliance is determined by 4 factors that occur at the facility.  A) Using CARB certified facility, B) contracts with manufacturers requiring use of CARB materials. C) Document retention requirements. D) Quarterly and annual audits of composite boards--unfinished products. 

 

7. Arb has already proposed draft regulations to amend CARB--see their website.  They are waiting to conform them to the EPA standards expected sometime this year or next.  However, one key point is that they are amending the laminate flooring section in a way that allows them to test without using the deconstructive method--i.e. just leaving the veneer on the composite board.  They don't explicitly say this, but both labs have indicated this is a sticking point in the industry because the deconstructive method is so imperfect. 

 

All of these points indicate that 60 Minutes and Tilson are calling fire when they see smoke.  There may be a fire (i.e. LL may be forging compliance documents, etc), but neither Tilson nor 60 Minutes discovered any evidence of a fire--only smoke.

 

I have bought some LL stock and calls yesterday and today, however, not a very big position because LL's PR response has been so poor, it is almost embarrassing--check that, it is embarrassing.

 

The other problem with the long case is that the stock still isn't that cheap, even now...Anyway, my two cents.

[Picasso]

The more I have dug into this, the more I don't believe Tilson.  There are a lot of things wrong with his presentation.    I am honestly too lazy to lay them all out, but here are a few.

 

1. The original short seller used a lab that wasn't CARB certified. In fact, the deconstructive method that Tilson/60 minutes used wasn't even established until almost 6 months after the original short report, so it is unclear what method they used....

 

2. The lab that Tilson and 60 Minutes used is a subsidiary of the domestic hardwood industry association (read: lobbying arm).  In other words, the arch-enemy of LL.

 

3. The second lab that 60 Minutes used explicitly told me that the deconstructive method is not very scientific or precise.  They even posted a video showing the process on their website to show how imperfect it is.  See Benchmark International.  60 Minutes did not test HD or Lowe's products, those tests were only done by the class action attorneys...

 

4. The margin increase that LL might have gotten from sourcing "illegal" products is so minuscule that it makes no sense re: Tilson's "doubling of margins points."  Chapman is actually right on this point (Did I just say that?), but his comparisons to Wal-Mart are idiotic....

 

5. Arb (the regulatory agency in CA that is in charge of enforcing CARB compliance) is very active.  5 or so enforcement actions per month, and they have yet to bring an enforcement action under CARB at all--not one. 

 

6. The deconstructive method is not conclusive of non-compliance but an indicator that leads Arb to investigate further.  However, compliance is determined by 4 factors that occur at the facility.  A) Using CARB certified facility, B) contracts with manufacturers requiring use of CARB materials. C) Document retention requirements. D) Quarterly and annual audits of composite boards--unfinished products. 

 

7. Arb has already proposed draft regulations to amend CARB--see their website.  They are waiting to conform them to the EPA standards expected sometime this year or next.  However, one key point is that they are amending the laminate flooring section in a way that allows them to test without using the deconstructive method--i.e. just leaving the veneer on the composite board.  They don't explicitly say this, but both labs have indicated this is a sticking point in the industry because the deconstructive method is so imperfect. 

 

All of these points indicate that 60 Minutes and Tilson are calling fire when they see smoke.  There may be a fire (i.e. LL may be forging compliance documents, etc), but neither Tilson nor 60 Minutes discovered any evidence of a fire--only smoke.

 

I have bought some LL stock and calls yesterday and today, however, not a very big position because LL's PR response has been so poor, it is almost embarrassing--check that, it is embarrassing.

 

The other problem with the long case is that the stock still isn't that cheap, even now...Anyway, my two cents.

 

Nice to see you change your view when you quickly realized the case on the short side may not be as clear cut as Tilson laid out.  This reminds me a bit of the HLF situation when Ackman first made his attack.  There was enough room to argue HLF had a viable business at $35 while they could still lever up the balance sheet and generated almost all their profit in other countries.  I tend to stay away from stocks that involve clowns like Tilson or Chapman unless I can clearly see the high probability outcome. 

 

This stock is still in the too hard pile for me. 

[Guest roark33]

Here is the LL presentation.

http://www.sec.gov/Archives/edgar/data/1396033/000114420415015501/v404301_ex99-1.htm

 

They describe well enough why they are right on the legal liability issue (if you understand the deconstructive method), so I think the market will begin to understand that this isn't an asbestos type case. 

 

The question on brand damage and impact on sales...well that's beyond me...But in terms of a beaten down stock that has the potential to go to $0--I think that will become increasingly clear that this isn't the case.

 

I would love to do an interview with Tilson in two years when the cost of his short has eaten away all of his profits....assuming he is still holding out for the stock to go to zero.

 

 

[PatientCheetah]

My thought process is as followed:

 

1) The short case isn't entirely convincing

2) Tilson is holding a weak hand due to his fund's small AUM

3) Chapman has far deeper pockets

 

LL is providing a business update. If the update fails to impress, my downside/stop is $28. if it stabilizes sentiment, short covering and trend chasers can potentially push the stock back to $60+. My risk/reward would be great than 5x and I don't think both cases are equally likely. This situation is more akin to pokers than value investing.

[Picasso]

Chapman doesn't have any significant AUM.  I heard it was less than $10 million.  I don't know why CNBC even lets him on their program as an activist.

[davidoosnk]

Here's my take for what it's worth. LL would have done much much better to admit to at least one major sourcing mistake in their conference call and then call into question the severity of the formaldehyde problem rather than deny any problem. But since they did not do that, they will be seen as liars and the shorts and government agencies will press harder to "get to the bottom" of LL. They and the longs seem to be using a government/shorts/greens are out to get us slant to shirk responsibility. The problem is this narrative is only appealing to maybe 30% of the population. The other 70% wants to know why the 60 minutes tests showed a difference in LL's product compared to that of others.

 

Here is an interesting write-up on the Jack in the Box E coli episode http://www.ou.edu/deptcomm/dodjcc/groups/02C2/Jack%20in%20the%20Box.htm

 

Here is the stock price right before e coli hit and for the subsequent five years.

http://finance.yahoo.com/q/hp?s=JACK&a=11&b=5&c=1992&d=11&e=5&f=1997&g=m

 

It appears it took about four and a half years for the stock to recover. And this is with the company taking responsibility and even hiring ex-government officials to do PR.

 

Of course, formaldehyde is not e coli. , but Lumber Liquidators has not shown the wisdom of Jack in the Box. So I expect their stock to stay somewhat depressed while the controversy rages. Still talking my book. Covered a big chunk at a nice profit but keeping a small part of the synthetic short, a part I believe is safer than the straight short was.

 

I'm curious if the nuance I made is legitimate re. the admission of guilt and how that plays in the eyes of the public and with LL's adversaries. In my mind they are being too warrior like and a little lesson in diplomacy and proper PR would have done them some good. Confrontation breeds confrontation and if this stays a battleground stock it will take years to recover as the shorts accuse LL of lying and the reputational problems they refuse to address linger.

 

 

 

 

 

 

[dwy000]

Here's my take for what it's worth. LL would have done much much better to admit to at least one major sourcing mistake in their conference call and then call into question the severity of the formaldehyde problem rather than deny any problem. But since they did not do that, they will be seen as liars and the shorts and government agencies will press harder to "get to the bottom" of LL. They and the longs seem to be using a government/shorts/greens are out to get us slant to shirk responsibility. The problem is this narrative is only appealing to maybe 30% of the population. The other 70% wants to know why the 60 minutes tests showed a difference in LL's product compared to that of others.

 

Here is an interesting write-up on the Jack in the Box E coli episode http://www.ou.edu/deptcomm/dodjcc/groups/02C2/Jack%20in%20the%20Box.htm

 

Here is the stock price right before e coli hit and for the subsequent five years.

http://finance.yahoo.com/q/hp?s=JACK&a=11&b=5&c=1992&d=11&e=5&f=1997&g=m

 

It appears it took about four and a half years for the stock to recover. And this is with the company taking responsibility and even hiring ex-government officials to do PR.

 

Of course, formaldehyde is not e coli. , but Lumber Liquidators has not shown the wisdom of Jack in the Box. So I expect their stock to stay somewhat depressed while the controversy rages. Still talking my book. Covered a big chunk at a nice profit but keeping a small part of the synthetic short, a part I believe is safer than the straight short was.

 

I'm curious if the nuance I made is legitimate re. the admission of guilt and how that plays in the eyes of the public and with LL's adversaries. In my mind they are being too warrior like and a little lesson in diplomacy and proper PR would have done them some good. Confrontation breeds confrontation and if this stays a battleground stock it will take years to recover as the shorts accuse LL of lying and the reputational problems they refuse to address linger.

 

I'm guessing it plays better with the public but it plays poorly into the hands of lawyers.  As soon as you admit guilt the class action suits come out of the woodwork (no pun intended) and you are now liable for testing and/or replacing floors for everyone who asks.  No admission of guilt and you can bury it in litigation for years while the public forgets about it.

 

I bet you can get a pretty decent price on flooring at LL for the next little while!

[cmlber]

Putting the recent issues aside, the new stores generate 90% pre-tax ROIC in the 1st year.  $280,000 to build plus $300,000 of inventory, $2,600,000 in year 1 sales @ 20% store level margins. 

 

How can that possibly be sustainable?  Is there really that big of a cost advantage for these guys?  Lowe's sells 3x as much flooring, Home Depot 6x as much.  Even if I had half their margins because I didn't have LL scale, I could open up one of these stores and have a pretty nice ROIC at half their level of sales...

[Guest roark33]

Although I don't necessarily like this site, this is a pretty decent write-up of the LL situation.  He gets most of the regulatory issues right re: 60 minutes and Tilson and CARB standards. 

 

http://www.fool.com/investing/general/2015/03/14/lumber-liquidators-holdings-comes-out-swinging-aga.aspx#.VQSgaM1zl_k.twitter

 

 

[Guest Schwab711]

Not buying but I wouldn't short this for anything. Would consider long under $20 or definitely at book (~$14). 60 min piece and future liabilities seem overblown (uneducated guess). Going long in these situations is where the big returns are, just wish it was a better business. Do folks really think this has asbestos potential?

When you see attorneys coming out of the woodwork and slobbering, it has potential.  ;)

 

The very large majority of attorney-led actions for shareholders result in wasted money/time and nothing to show for it for the shareholders (in my experience).

 

Here's my take for what it's worth. LL would have done much much better to admit to at least one major sourcing mistake in their conference call and then call into question the severity of the formaldehyde problem rather than deny any problem. But since they did not do that, they will be seen as liars and the shorts and government agencies will press harder to "get to the bottom" of LL. They and the longs seem to be using a government/shorts/greens are out to get us slant to shirk responsibility. The problem is this narrative is only appealing to maybe 30% of the population. The other 70% wants to know why the 60 minutes tests showed a difference in LL's product compared to that of others.

 

Here is an interesting write-up on the Jack in the Box E coli episode http://www.ou.edu/deptcomm/dodjcc/groups/02C2/Jack%20in%20the%20Box.htm

 

Here is the stock price right before e coli hit and for the subsequent five years.

http://finance.yahoo.com/q/hp?s=JACK&a=11&b=5&c=1992&d=11&e=5&f=1997&g=m

 

It appears it took about four and a half years for the stock to recover. And this is with the company taking responsibility and even hiring ex-government officials to do PR.

 

Of course, formaldehyde is not e coli. , but Lumber Liquidators has not shown the wisdom of Jack in the Box. So I expect their stock to stay somewhat depressed while the controversy rages. Still talking my book. Covered a big chunk at a nice profit but keeping a small part of the synthetic short, a part I believe is safer than the straight short was.

 

I'm curious if the nuance I made is legitimate re. the admission of guilt and how that plays in the eyes of the public and with LL's adversaries. In my mind they are being too warrior like and a little lesson in diplomacy and proper PR would have done them some good. Confrontation breeds confrontation and if this stays a battleground stock it will take years to recover as the shorts accuse LL of lying and the reputational problems they refuse to address linger.

 

I'm guessing it plays better with the public but it plays poorly into the hands of lawyers.  As soon as you admit guilt the class action suits come out of the woodwork (no pun intended) and you are now liable for testing and/or replacing floors for everyone who asks.  No admission of guilt and you can bury it in litigation for years while the public forgets about it.

 

I bet you can get a pretty decent price on flooring at LL for the next little while!

 

Bingo! Most companies do not comment on short sellers (even if it makes 60 minutes). If there were a serious health liability then LL would have been shut down immediately (well before 60 minutes). Most of these pieces are scare tactics that mutually benefit 60 minutes and Tilson. The piece was most likely factual but ultimately fear-mongering. I'm just not that big of a fan of the operating business but this might be too cheap to pass if we can get near $20. I can't see how LL is anything but a commodity retailer with a tarnished (unknown how badly) reputation. Below 10x PM (after-tax) seems necessary before buying for myself.

 

Last comment, the 5x reward/risk comment seems off because of the 'stop' in place. With the stop, your reward/risk calculation has a lot of assumptions built in that you may not be considering. Semantics but the stop always seems like a lack of confidence to me (and a good reason to pass!). I really can't see $0 as possible before litigation is settled. A severe drop in earnings power is the biggest near-term risk in my mind (and the potential over-expansion as a result of lowered ROIC). I think ultimately this will all fade and LL will be back to BAU.

[Guest roark33]

One thing about enforcement is ARB--the Air Resource Board in California, is a very active enforcement agency.

 

http://www.arb.ca.gov/enf/casesett/casesett.htm

 

Here is a link to their enforcement cases.  They have brought cases against Wal-Mart, Dollar General, Luxottica and many more large companies.  They aren't a shy or a agency in name only.  Ironically, since CARB became law, at least Phase 2, there hasn't been one enforcement action in the composite wood area, but there have been in formaldehyde related to hair salons and nail polishes...

 

I have done a lot of research on this issue, but my biggest problem is that LL could still be lying.  I went to a store today in the afternoon, thinking it would be dead, but it was packed.  Really surprised me actually. 

 

Ironically, I went to Home Depot and Lowes to check to see if they were selling chinese laminates also, and it took someone 20 min to help me--even more at HD.  Tilson talks a lot about flooring being a commodity product, but that is one of their strengths, you walk into their store, and they are there to assist you. 

 

I really like Fastenal and although they aren't even in the same universe in terms of comparisons, the stores remind me a lot of fastenal stores--odd off-retail locations (cheaper leases) and bare bones stores.  You can understand how they sell a cheap product....BUT--it could also be the bad chinese stuff:)