Kimball: 75% Upside On Strong Margins, Orders And 13% FCF Yield (NASDAQ:KBAL)


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Kimball (KBAL) had a pretty satisfactory quarter despite major Covid-19 disruptions leading a -27% sales decline YoY. Despite concerns, we think the company has a favorable risk-reward ratio. The stock is beginning to price in upside, and think there is limited downside risk in the medium term. Our price target is $18.00, with a total return potential of 75%. As orders pickup, margins consolidate, and free cash flow continues to be encouraging – we are optimistic on this price target being met.

Data by YCharts

Kimball reported EPS of $0.24 [beats consensus estimates by 65%, or $0.09] and revenue of $148 million [slight beat by $0.44 million]. The stock has reacted positively to this earnings news, with Kimball up as much as +8% at the market open. This 1QFY21 was on balance decent for Kimball despite Covid-19, with higher margins, order pickup, the acquisition of Poppin and introduction of the Interwoven Brand under the Health segment to better take advantage of the growing space. The company witnessed 15% higher order rates this quarter than it did in the prior fourth quarter, an incredibly encouraging sign that contract furniture is on the rebound. Order backlogs are now $139.5 million, of which $70 million is expected to be shipped by the company in the 2QFY21.

The company is on target to achieve expected cost savings of $20 million this fiscal year [$26 million cost savings were made in fiscal year 06/2020] as a result of their robust and ongoing transformation plan. Their cost savings totaled $4.8 million this quarter, which were split between COGS and administrative costs. This helped Kimball achieve their eighth consecutive YoY quarter in gross margin improvement. Gross margins improved by 50 bps YoY, at a solid 35.4%, which during the months of July-September in a pandemic-induced business environment is strong.

The company generated a strong $27 million in cash from operations, with a CapEx of $4 million [down from a CapEx of $7.4 million YoY]. This resulted in FCF of $0.62 per share for the quarter, which is an incredible FCF yield of 5.9% just for the quarter. Kimball, additionally, continued its quarterly dividend at $0.09 [an annualized dividend of $0.36 or 3.4% yield] and also an effective resumption of its share repurchase program as of this quarter. The company has a history of buybacks for the last 3 fiscal years and have bought 7% of their shares outstanding, so a resumption is a very good sign for shareholders – see further in the article.

Poppin Company SnapshotSource: Company Presentation

Kimball is set to acquire Poppin, Inc., a tech enabled, market leading B2B commercial furniture company with a focus on design. The company has been an industry disruptor and prior to the pandemic was growing at stellar CAGRs of 40% from 2014 to 2019. With urban showrooms in located in major cities, Poppin’s unique design and business model is tailored towards the new hybrid workspace, a combination of commercial and work-from-home retrofitting, which companies are going to look to in the future. Poppin’s B2B or contract is currently segmented at 75%, whereas the residential line is 25%. This acquisition will align well with Kimball’s Connect 2.0 strategy, helping the company expand its market-share, curtail on costs, and enhance digital capabilities, some of which CEO Kristie Juster has brought to light in her comments on the acquisition:

The acquisition of Poppin, provides Kimball International with an important growth engine that fully aligns with our Connect 2.0 Strategy, designed to drive increased long-term revenue growth. It represents an important step toward realizing our long-term vision to create a leading omnichannel commercial furnishings design powerhouse supported by a robust manufacturing and sourcing infrastructure. Specifically, Poppin greatly accelerates our eBusiness strategy, bringing a digitally native platform that we can leverage across our portfolio of brands. Additionally, we will see near-term opportunities to adapt Poppin’s proprietary products to our target verticals, to develop a complementary Poppin Pro dealer program, and to scale Poppin’s playbook into secondary markets, where Kimball International has long-standing relationships.

Kristie Juster, CEO of Kimball International, 1QFY21 Press Release

Kimbal Poppin AcquisitionSource: Company Presentation ; Benefits of Poppin for Kimball

The Poppin acquisition comes at a price of $110 million initial cash payout plus contingent payments of up to $70 million, based on achievement milestones segments over the next three years to 2024. Kimball currently has $116.5 million in cash with no debt [excluding operating lease liabilities] so they have ample liquidity, along with growing FCF to meet these obligations. This $116.5 million represents 30% of the stock’s market cap – a big number. Yet, they have made the decision to extend into their credit facility, which they have increased to a total borrowing capacity of $125 million. Kimball has been eyeing this transaction for some time and seeing how it fits in well with the company’s business model, with Connect 2.0 and the whole restructuring drive, we will have to give the benefit of the doubt and see things with a longer term horizon, even though there might be a slight risk-factor involved. We have not yet modelled these acquisition results for Kimball, as the quarterly results have just been made available to us.

Kimball & Poppin Complementary BusinessesSource: Company Presentation ; Kimball and Poppin are complementary businesses.

Target Price and Valuation

Seeking Alpha Kimball [KBAL] Price ChartSource: Seeking Alpha Kimball Price Chart – YTD

Kimball is a great stock to invest in, from our viewpoint, as it represents minimal downside risk and great upside of 75%. We see the stock reaching near to pre-pandemic levels of $20.00, with our price target of $18.00 [75% return potential], and potentially even further with our medium-term price target of $23.50 [127% return potential]. Since April, Kimball’s stock price has been stagnating; even though the company has accumulated $116.5 million cash reserves [30% of the market cap], increased FCF [run-rate of this quarter’s FCF gives us a robust-looking annual FCF per share of $2.48 for this fiscal year 06/2021], has an undervalued P/E and a steady dividend yield of 3.4%. Kimball did a buyback over 3 years of 2.7 million, or 7% of shares outstanding, and looks to effectively resume its share repurchase program this quarter.

The new acquisition of Poppin Inc. can be financed by the company and it ties in well with the company’s strategies, as we had mentioned with a quote from the CEO before. We have to give the benefit of the doubt on this acquisition move on part of the company, because anyone looking to acquire during a pandemic has obviously given much forethought before jumping in. Whatever may be the result, we think this stock has been stagnating for a while looking at the chart, and we think there is only upside for this company looking ahead. Therefore, we have not decided to revise our valuations and price target, and we continue to stick to our short-term price target of $18.00, or 75% total return potential, and a long-term price target of $23.50, or 127% total return potential – see section below.

Short-Term Price Target: $18.00

On today’s current stock price, the stock is trading at 7.3x P/E and a 13% FCF Yield based on our 06/2022 estimates. Our short-term price target of $18.00 with net cash of $3/share is based on our ex-cash P/E of 12.7x (regular P/E of 15.9x); and FCF Yield on EV of 9.6% (7.6% on market cap) on our steady-state FY2021e. As is evident from the valuation metrics being similar for 2021est with 2019 actuals, our steady-state/normalized estimates as things recover in FY21 are reasonable and within range of our FY19 actuals. Our short-term price target of $18.00 represents a +75% total return potential.

Long-Term Price Target: $23.50

Our medium-term target, based on a 2 to 3 years view, was $20.50, but adding in $3 net cash per share for this year as aforementioned, we arrive at a revised price target of $23.50. This target of $23.50 is based on an ex-cash P/E of 17.8x (regular P/E of 20.8x) and FCF Yield on EV of 6.9% (5.8% on market cap) on FY2021e. Our medium-term price target of $23.50 represents a 127% total return potential as the stock tries to recover back to pre Covid-19 highs.

The current price is down -49% YTD, which is a very attractive entry point, in our view. Investors should note that Kimball stock traded as high as $21.67 as recently as January this year and before the Covid-19 disruptions. Kimball has attractive valuations on P/E and FCF yield, and the company is also aggressively buying back its own stock. It also has a strong balance sheet with good cash.

Background on Kimball’s “Connect 2.0” Strategy

Kimball is running at full capacity with all facilities operational, since early May. It has acted quickly, this quarter, to develop products and solutions that would assist clients in adhering to social distancing and workplace safety requirements, both from an office and work-from-home setting. This will help increase sales for Kimball as most businesses will look to retrofit their offices.

“Connect 2.0” will focus on workplace, health, hospitality and ecommerce verticals. This will help streamline its operations, improve sales, and improve costs. Specific interest would fall on its ecommerce where the goal would be to achieve online presence across all brands and end markets. Diving into this ecommerce channel will create great scope for scalability and opportunity in this operating environment, even for bigger ticket and contract orders that is Kimball’s domain. A large part of their efforts will be focused on work-from-home retrofitting, which Poppin will greatly help to achieve greater scalability towards.

Kimball Connect 2.0

Kimball’s Connect 2.0 will focus on re-organizing the entire company into four new business units – workplace, health, hospitality and eBusiness. This new plan is designed to facilitate growth going in the next fiscal year. It will help the company’s core strategy to strive towards a more focused market expertise, pivoting to adapt to a post-Covid marketplace. This is an incredibly good sign from Kimball, and the company is thinking one step ahead already – with eBusiness to take particular note of. CEO Kristie Juster briefly explains the 4 major ways that this new go-to-market plan will benefit the business in the company’s earnings call:

“First, it will bring vertical product and brand expertise to the new workplace, including building a new work from home portfolio. Second, it will enable our build of additional expertise in health. Third, it will give us the ability to expand our hospitality business into broader direct commercial sales environments. And fourth, it establishes a new dedicated eBusiness unit, which will be responsible for developing ecommerce across our brands in end market. Our eBusiness unit is a clear signal of our commitment to make ecommerce a meaningful revenue contributor over the next several years.”

Kristie Juster, CEO of Kimball International, 4QFY20 Press Release

Buying Back of Shares

The company has continuously been buying back shares over the last three FYs in order to offset dilution and make use of its excess utility to satisfy greater share market gains. Its current authorization stands in at 2.7 million shares, or 7% of shares outstanding. We expect this to be a continuing trend to come, with the exception of a few one-off circumstances during Covid-19. Buybacks will play in good favor amongst shareholders and will be seen positively by potential investors.

Attractive Dividend Yield of 3.4%

Kimball offers investors a steady Dividend Yield of 3.4% [12 months trailing], and it has been doing so for the last 67 years. We expect the dividend, given our forecasts, to steadily increase to approximately 42 cents/share (on FY22e) given the firm’s growing linear payout cycle. We have reason to believe that the company will offer Special Dividend payouts factoring in its ample cash reserves. In aggregate, the Company returned $15.9 million to shareholders in the form of dividends and share buybacks in FY06/2020, and a further $3.3 million in 1QFY06/2021.

Catalysts

Poppin Acquisition

The acquisition could help the company’s overall business model, increasing efficiency and their transition to a more digital enterprise. Complementary nature between both Poppin and the new Kimball, seen through the transformational restructuring phase, should be a catalyst for the business in the near term. Plus, Kimball has enough money to finance the acquisition with $116.5 million [no debt, excluding lease liabilities], or 30% of the entire market cap

Restructuring: “Connect 2.0” Revamp

Reorganization of the entire business to tailor to post-Covid marketplace. “Connect 2.0” re-organization structure will help the business grow into new marketing channels, catering to the demand of work-from-home settings. This will be a catalyst in ensuring future growth and profitability for the business.

Cost Control: Managing Margins

The company is on target to achieve expected cost savings of $20 million this fiscal year [$26 million cost savings were made in fiscal year 06/2020]. This has helped gross margins improve by 50 bps this quarter which is big given Covid-19, and bottom-line EPS has improve 65% or by $0.09 per share.

Strong Order Backlog: $139.5 million

The company has a strong order backlog of $139.5 million this quarter, of which $70 million is expected to ship out in the second quarter of FY21.

Diversified Business: 6 Verticals

Kimball’s diversified business model of 6 distinct verticals, will mitigate the risk stemming from having only few vendors in one particular vertical. By being overdiversified, the company has greatly reduced its chance of losses and potential downside risk.

Kimball KBAL 6 Vertical Sales MixSource: Company Presentation

New CEO: Good for Company Direction

The newly appointed CEO, Kristie Juster, has been running the company for over 10 months. She has joined Kimball Int’l having previously worked at a well-reputed company, Newell Brands (NASDAQ:NWL), and this could help bring new direction and scope for Kimball in the long term.

Strong FCF Generation on Steady-State

On a normalized account, Kimball has an attractive and high FCF Yield. In FY19 its FCF Yield stood at 14% on EV, which is very impressive. This quarter to FCF per share was $0.62, which over the stock price is an very attractive 5.9% for just the quarter.

Healthy Cash Reserves Act as a Safety Net

$116.5 million or 30% of the market cap.

Dividend Yield Increase

Dividend Yield is at 3.4%, but we believe there is potential for steady growth as the CAGR payout cycle increases 9% year over year. Additionally, special dividend is always an option, as the company’s surplus FCF is evident.

Buyback of Shares

Kimball has been buying back shares over the last three years, partially in order to increase share market gains. It has bought back 7% of shares outstanding, and this is a positive outcome for shareholders of the company.

Risks

Coronavirus: Bottoming out is hard to predict

The coronavirus has definitely left a felt mark on the economy and business, especially the manufacturing and purchasing sector, globally. Kimball will have to comply with state laws such as social distancing, and the impact on the supply chains, customers and logistics is not fully known. The marketplace is currently very volatile trying to grapple and come to terms with a third wave of coronavirus.

The commercial and hospitality sector, when combined, contribute almost 1/2 of Kimball’s income. These might be further affected.

Margin Pressures from Freight and Distribution

Increase in demand for shipping services have been created by the Covid-19 pandemic, which has led to port congestion and pressure on freight and distribution costs.

Heavy Competition: Dominated by Many Players

Kimball operates in a highly competitive environment. Its competition is a threat to sales and market share, including Steelcase Inc. (SCS), Herman Miller (MLHR), Knoll (KNL), HNI Corporation (HNI), etc. Competitors also encompass a large number of other smaller, privately-owned furniture manufacturers, both domestic and foreign-based in nature.

Working Capital

Delays in receivables and bad debts could be on the rise as businesses remain cash-strapped and payments fall on the backburner. Inventory adjustments are being made, according to order demand, to working capital requirements.

Conclusion

To conclude, we think Kimball has had decent quarter despite the Covid-19 disruption. The company has made a big acquisition, but they have a cushion of liquidity without having to rely on too much leverage. The company must have mulled it over quite considerably, because acquiring a company during the pandemic is a quite the undertaking. So, Kimball must really feel that Poppin is a worthy investment. Given the synergy and the way the company has talked about Poppin, we are optimistic that this will be an accretive deal for the company. Amongst other things, margins are improving, healthy backlogs are still present, and orders are picking up. The company is sitting on $116.5 million in cash, has a high FCF per share reported for the quarter of $0.62, and their share repurchase program has resumed – a definite sign that things are improving. We expect upside of $18.00, or 75% total return, on Kimball’s limited downside risks given the stagnant stock price since mid-March.

Disclosure: I am/we are long KBAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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