Published on February 13th, 2018 by Bob Ciura
Every so often, companies need to restructure the way they do business. The simple reality is that things change, and businesses have to adapt. This can cause short-term challenges and reductions of earnings, and stock prices usually suffer as a result.
But we believe this can also create opportunities for long-term investors, particularly if the underlying core business remains strong. In these instances, high-quality dividend growth stocks that are temporarily struggling, can be attractive buying opportunities.
HNI Corporation (HNI) is an example of this. HNI has a long history of growth and a leadership position in its industry. It also has a secure 3% dividend yield. You can see all 747 dividend-paying industrial stocks here.
The company has had to turn itself around, due to changes in its operating climate. As a result, the stock has significantly underperformed the S&P 500 Index in the past one year.
However, we feel HNI is still a strong company, that is simply undergoing some short-term bumps in the road. HNI’s recent fourth-quarter earnings report showed important progress in its turnaround initiatives.
HNI designs office furniture, and also designs and manufactures hearth products. It has an extensive product portfolio. Products include filing cabinets, desks, chairs, wall systems, gas-and-wood-burning fireplaces, inserts, stoves, facings, and accessories.
Source: Fourth Quarter Investor Presentation, page 4
For its 2017 fourth quarter, HNI reported earnings-per-share of $0.47, on revenue of $584.28 million. Both figures beat analyst expectations, which called for earnings-per-share of $0.42, on revenue of $567.83 million.
On a year-over-year basis, HNI’s quarterly results showed modest growth. Net sales rose 0.5%, while organic revenue, which excludes the impact of currency fluctuations and divestments, rose 3.7% versus the same quarter a year ago.
GAAP earnings-per-share came to $0.77 versus earnings-per-share of $0.24 in the same period the previous year. However, the GAAP earnings figure contained many non-recurring items, which should generally be excluded when evaluating the company’s quarterly performance. For example, earnings included impacts from the recent tax legislation, as well as nonrecurring charges related to HNI’s massive restructuring.
Excluding these nonrecurring items, adjusted earnings-per-share were $0.47, a decline of 43% from the same quarter a year ago. As you can see, it was not a strong quarter for HNI, but also not unexpected. The company is undergoing a transformation, to optimize its business portfolio and re-position the company for future growth.
For 2017, HNI had full-year earnings-per-share of $1.97, a 25% decline from 2016. Lower earnings were due primarily to lower-than-expected volumes, higher restructuring costs, and unfavorable business and product mix. 2017 was clearly a difficult year for HNI, but the good news is, a return to growth is right around the corner.
HNI expects 2018 adjusted earnings-per-share of $2.40 to $2.80. This excludes restructuring and transition costs, while including the recently enacted tax legislation impact. 2018 is expected to be a year of substantial recovery for HNI. The company’s previous 2018 forecast called for earnings-per-share of $2.15 to $2.65. The most recent update represents a significant guidance raise, which indicates positive momentum is building.
The expected imminent recovery is based on the fact that industry fundamentals remain healthy. Core drivers of home hearth and furniture sales—specifically employment, small business confidence, and housing starts—are still growing. This is expected to fuel higher demand for hearth and furniture products in 2018 and beyond.
Source: Fourth Quarter Investor Presentation, page 5
Compared with 2017, HNI expects earnings-per-share growth of 22% to 42% growth in 2018. Full year organic sales are expected to be up 5% to 8%. Including the impacts of acquisitions and divestitures, full year sales are expected to be up 1% to 4%.
In addition to sales growth, earnings are expected to grow, thanks to successful implementation of the company’s turnaround initiatives. Restructuring costs were especially high in 2017, at 1.7% of revenue, up 120 basis points from 2016. Now that these charges have been absorbed, earnings will improve in 2018. Looking further out, Value Line analysts expect HNI will grow earnings by 16% per year, through 2022.
Valuation & Expected Returns
At the midpoint of company guidance for 2018, HNI expects earnings-per-share of $2.60. Based on this, the stock trades for a price-to-earnings ratio of approximately 14.5. In the past 10 years, the stock held an average price-to-earnings ratio of 22.5.
We believe fair value for HNI is a share price of $43, which represents a price-to-earnings ratio of 16.5, based on expected 2018 earnings.
A higher valuation is justified, because HNI is an industry leader in its core product categories. HNI’s most important competitive advantage is its leading position in the office furniture and hearth products industry.
The company enjoys high market share, including the #2 position in office furniture, and the #1 position in hearth products. It has a large and diverse brand portfolio, with coverage across virtually all segments of the office furniture and home hearth industry.
Source: Fourth Quarter Investor Presentation, page 8
With a fair value estimate of $43 per share, we believe HNI is undervalued by approximately 14%. If the stock were to trade up to fair value over the next three years, it would add approximately 5% each year. In addition to a rising valuation, HNI will generate shareholder returns through earnings growth and dividends.
ValueLine analysts expect roughly 16% compound annual earnings growth over the next five years. This could be overly aggressive, but we still believe HNI can achieve 10%+ annual returns, through earnings growth and dividends. A potential breakdown of future returns is as follows:
- 4% to 6% revenue growth
- 1% margin expansion
- 1% share repurchases
- 3% dividend yield
Through a combination of earnings growth and dividends, HNI could generate returns of 9% to 11% per year. Plus, returns would be boosted even further, by the expansion of the price-to-earnings ratio. As previously discussed, we believe an expanding valuation can add approximately 5% to HNI’s annual returns. As a result, the stock has potential returns of 14% to 16% over the next three years.
HNI stock has lost 20% in the past one year, since the company entered its current turnaround. The turnaround was necessary, to optimize the company’s portfolio mix, and re-position its brands toward higher-growth opportunities.
But now that the heavy lifting of the restructuring is in the past, investors can look forward to a return to growth in 2018 and beyond. The stock has not yet reflected the successful turnaround, which makes HNI a buying opportunity. In addition, it has a secure 3% dividend yield, with dividend increases each year.