Bassett Furniture Industries, Incorporated (NASDAQ:BSET), the furnishings manufacturer and retailer, has continued reporting weak earnings as demand for furniture has remained low in the current macroeconomic environment. The company is looking to report its Q2/FY2024 results on the 10th of July after market close. Wall Street analysts are expecting a slight sequential revenue improvement, but as the industry's uncertainty persists, I believe that caution is required.
I previously published an article on Bassett on the 28th of November in 2023, titled “Bassett Furniture: Eyeing A Financial Recovery.” In the article, I noted Bassett’s sale of its logistics business, modest revenue growth, and fluctuating margins. I also noted the company’s weak short-term performance due to the weak furnishings industry. Since, earnings have continued to drop, and the stock has returned -13% compared to the S&P 500’s positive return of 21%.
Bassett’s Financial Pressure Has Continued
After my previous article, Bassett has continued to report weak financials. Led by a -21.7% decline in Q4, the company’s revenues decreased by -19.7% in FY2023. Wholesale to external customers declined by -26.8% in the year, while retail sales performed slightly better with -17.2% as retailers continue to churn excess inventories. Operating income ended up at $0.8 million in FY2023, down from $29.8 million in FY2022, as the lower sales’ negative operating leverage pushed earnings down.
The weakness continued into FY2024 as revenues declined by -19.6% in Q1, led by wholesale weakness but also showing continued weakness in retail sales. Due to lower sales, operating income declined into -$2.4 million from a positive $1.2 million in the prior Q1, now making Bassett’s trailing operating income negative – the furnishings industry has remained incredibly pressured, which Bassett's financials increasingly continue to show.
Margins Should, And Need To, Eventually Bounce Well
Bassett is planning to reduce expenses by implementing a new retail distribution model – the company is looking to eliminate five facilities in primarily the mid-Atlantic region and to consolidate other production facilities. The changes are expected to reduce inventory costs and delivery costs by 200 basis points, aiding the margin level as the changes are slowly being implemented. The company is also looking to reduce costs in other parts of the business as well, but doesn’t seem to have identified very significant cost items, as no other initiatives were mentioned in the Q1 press release.
Overall, margins are looking to have a good bounce eventually with a macroeconomic recovery. Bassett has managed to expand the gross margin well in recent times, increasing the margin to 55.3% in Q1 from 51.1% in FY2023 despite an increasingly challenging retail environment. The cost reductions look to further increase the sustainable margin level.
The trailing slightly negative operating margin level is still weak compared to competitors such as Flexsteel's (FLXS) 4.0%, Ethan Allen's (ETD) 13.0%, Hooker Furnishings' (HOFT) 1.3%, and RH's (RH) 11.3%, making the costs improvements important above just expecting improvements from a macroeconomic recovery.
Upcoming Q2 Results Could Surprise Wall Street Negatively
Bassett is going to report the company’s Q2 earnings on Wednesday on the 10th of July after market hours. Wall Street analysts are expecting revenues of $87.8 million, down -12.7% year-over-year, as weakness in the furnishings industry continues. The adjusted EPS is expected at a negative -$0.10, down $0.24 from the previous Q2.
Comparison levels are starting to come down, making the thinner decline a reasonable assumption. The revenue estimate expects around a $1.2 million sequential improvement. The EPS decline of $0.24 also expects a smaller year-over-year decrease from $0.30 in Q1.
The US consumer sentiment has been better during Bassett's Q2, but I wouldn't expect a great sequential improvement as a base scenario - Hooker Furnishings reported a -23.2% year-over-year decline in the period from February to April with two months of overlap with Bassett's Q2, and continued to echo low faith in a short-term recovery in the quarterly earnings call. RH's Q1 report also communicated an expectation of continued weakness with an incredibly weak housing market.
With the remaining weakness in mind, I believe that the expected Q2 results are fair, but could even be slightly too optimistic. Hooker Furnishings' revenues have performed in line with Bassett's, and the company had a -3.3% sequential revenue decline in the latest quarter compared to estimated sequential 1.4% growth expected for Bassett. The EPS is ultimately a byproduct of sales with a high share of fixed costs, and the adjusted EPS could also miss if revenues end up being weak.
Bassett’s Cash Position is Significant
After Q1, Bassett holds $58.4 million in cash and short-term investments combined – at the current stock price, the cash represents nearly half of Bassett’s total market cap.
It doesn’t seem likely that Bassett is using the cash position strategically, at least in the short term, though - the company has historically held on to a large amount of cash and doesn’t have any very notable M&A in recent history. Bassett has also slowed down significant share repurchases in the past two reported quarters into an insignificant level. The cash is also being held to sustain the turbulence caused by slower demand.
The current dividend yield of 5.22% does require the cash as Bassett’s cash flows are currently weak, but the current quarterly $0.18 dividend doesn’t require such a strong balance sheet.
The Stock's Valuation Isn't Attractive Enough Yet
I updated my DCF model, now anticipating the weakness to persist longer than previously. I estimate revenues to decline by -9% in FY2024 compared to a previous estimate of a slight recovery. And I still estimate the demand to recover, now from FY2025 through to FY2027, with a 6.3% CAGR. Afterward, I continue estimating a 2% perpetual growth.
With the cost measures taken, elevated gross margins, and the new planned distribution model, I continue estimating a long-term EBIT margin of 4.0% despite short-term weakness beyond my previous anticipation. The company has continued with a good amount of capital expenditures, slightly worsening the cash flow conversion.
The estimates put Bassett’s fair value at $15.74, 13% above the stock price at the time of writing. The stock price is starting to get more attractive, assuming the eventual recovery. As the uncertainty still persists, I don't believe that the slight undervaluation represents a very attractive investment case yet, though.
A weighted average cost of capital of 12.40% is used in the DCF model, down from 14.52% previously. The used WACC is derived from a capital asset pricing model:
I continue estimating no long-term debt. To estimate the cost of equity, I use the 10-year bond yield of 4.45% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran’s estimate for the US, updated on the 5th of January. I have kept the beta estimate at 1.62. With a liquidity premium of 0.5%, the cost of equity and WACC both stand at 12.40%.
Takeaway
Bassett has continued reporting weakening earnings as the furnishings industry has remained incredibly soft. The company is soon reporting its Q2 financials, and Wall Street analysts are expecting continued softness but a slight sequential improvement. I believe that the expectation of sequential growth could turn out to be too optimistic as competitors continue to echo weakness, though. The company's eventual likely margin bounce and strong balance sheet make the stock slightly undervalued with my financial estimates, but as the weakness still persists, the stock isn't very attractive yet. As such, I remain with a Hold rating for Bassett.