December 02, 2013
Lumber Liquidators' oak flooring in China. Courtesy of EIA
Speaking at the Robin Hood Investors Conference on November 22, Whitney Tilson, the founder of Kase Capital Management, said Lumber Liquidators' stock price may be inflated due to purchases of illegally sourced timber from Russia, which is less costly than legitimately-sourced wood. He set a two-year price target of $53 for the stock, which was trading at $115 at the time. The stock plunged 12 percent after the presentation.
Tilson's remarks were based on a recent report published by the Environmental Investigation Agency (EIA). A multi-year undercover investigation by the green group found that Lumber Liquidators (NYSE:LL) has been buying illegally logged timber smuggled from Russia into China. EIA said the practice violates the Lacey Act, which holds U.S. buyers criminally responsible for buying illegal forest products.
Nonetheless, Tilson expressed skepticism about Lumber Liquidators' claims, noting that U.S. authorities raided the company in response to the investigation.
"[Lumber Liquidators] has yet to provide even one fact to rebut the report, which I found to be an extremely impressive piece of investigative work – and 100% consistent with everything we know about the wild-west business environment in Russia and China: widespread corruption, weak rule of law, little concern for the environment, etc," wrote Tilson in a comment posted on Hardwood Floors Magazine. "Federal authorities obviously think the EIA report is credible, as agents from the Department of Homeland Security's Immigration and Customs Enforcement and the U.S. Fish and Wildlife Service on September 26th raided LL’s headquarters, executing sealed search warrants 'which relate to the importation of certain of the Company's wood flooring products.'"
"I’m skeptical that this is an isolated problem limited to one rogue supplier. Rather, the combination of a) the evidence in the EIA report, b) the unusually rapid increase in Lumber Liquidators’s margins to unprecedented levels immediately after acquiring a Chinese supply chain company, and c) the hugely corrupt business environment in both Russia and China lead me to believe that Lumber Liquidators has a big problem on its hands. Though I can’t prove it, the evidence I see, combined with common sense, makes me think it’s highly likely that what EIA has uncovered is a pervasive problem across Lumber Liquidators’s Chinese supply chain."
Tilson said Lumber Liquidators would likely have to immediately clean up its supply chain, potentially increasing the company's timber-sourcing costs.
"Specifically, I think Lumber Liquidators will have to: 1) immediately stop sourcing from suppliers they even suspect are trafficking in illegal wood; 2) find replacement suppliers; and 3) ensure their entire worldwide supply chain is pristine. Doing all of these things is likely to be very costly and disruptive to the business – not to mention management being distracted by having to deal with the authorities for the foreseeable future."
The fund manager added that given these issues, and the sharp jump in Lumber Liquidators's stock price, the company is currently overvalued from an investment perspective.
"These things might not matter if the stock were cheap, but it’s not: after a 7x run-up in less than two years, it trades at 40x trailing earnings and 22x trailing EBITDA," he wrote. "My two-year price target is $53 (and I think I’m being generous)."
Impact of logging in the Russian Far East. Courtesy of EIA
- Maureen Farrell (2013). Lumber Liquidators Fights Back Against Tilson WSJ Nov 25, 2013
- Hardwood Floors Editors (2013). Fund Manager Feuds with LL Over Illegal Logging Accusations Hardwood Floors Magazine November 27, 2013
- EIA (2013). Liquidating the Forests: Hardwood Flooring, Organized Crime, and the World’s Last Siberian Tigers Oct 2013.
|AUTHOR: Rhett Butler founded Mongabay in 1999. He currently serves as president, head writer, and chief editor.|