Ethan Allen Cashes in on New Looks
Take a cold, hard look at that red plaid chair you inherited years ago. Its proper home now is your curb. Of course, once you’ve set your sights on a new velvet armchair to replace it, the rug, lamp and sofa will need to be updated, too.
And like a home, companies also sometimes need a remodel. Some businesses lend themselves to constant innovation. Software companies, for example, are always issuing fixes for bugs or updates with new features. Other companies, like furniture or durable-goods manufacturers, need a major spring cleaning to make room for a new product line.
Ethan Allen (NYSE: ETH) is sprucing up its house. The 80-year-old furniture maker and retailer has been revamping its designs to attract new customers: Stodgy colonial maple headboards are out and modern, curved-glass tables are in.
Ethan Allen’s earnings are starting to see the benefits. Despite a small 5% increase in revenue, net income in the December quarter exploded 50% thanks to improving profits for new products and also lower interest payments.
Earnings are expected to grow 30% this fiscal year (ending in June). Conservative estimates pencil in only 5% revenue growth and 12% earnings growth for fiscal 2017, numbers that look too low considering the improvements expected from the new products.
A continuation of improving profits would allow Ethan Allen to grow earnings at least 20% next year, leaving the stock sitting pretty in the mid $40s, versus the $29 it currently trades for.
Its new four-part product cycle is in its final and most important phase. The new furniture lines to be delivered this spring are described as “classics with a modern twist.” They are a continuation of evolving designs that place Ethan Allen squarely in the mindset of millennials.
This generation is ditching its skateboards and skinny jeans for airy condos in Brooklyn. Millennials not only outnumber baby boomers, but also show a greater desire to spend on brand names.
The most recent line to be introduced will move Ethan Allen’s furniture along the style spectrum to casual, urban chic. Most important, these new products are meant to be mixed and matched for an eclectic effect. That matching pine bureau, bed and nightstand is so 1980.
Ethan Allen has invested heavily in interior designers who work with customers to choose products. The anxious leap of spending $6,000 for a sofa that might not match your rug is alleviated with the help of one of these 1,500 consultants. Customers don’t pay for this service, something that would cost well upward of $100 an hour if you hired a professional designer.
The payoff from this service shows in the increase in custom-upholstered products that the company sells. Why buy the same blue chair your neighbor has when you can cover it in a custom fabric to highlight your wallpaper? The increase in highly profitable accessories (lamps, mirrors and artwork) is partly due to the suggestions of these designers, who plan a room from top to bottom for Ethan Allen customers.
Stores, or “design centers,” as they are extravagantly called by management, are shrinking to fit in the urban centers where customers shop. While most stores are still 15,000 to 25,000 square feet, newer ones are less than half that size. The stores are equipped with flat-screen monitors that show off fabrics or furnishings not on the floor.
Just Moving In
These products have a super-long cycle from design to delivery. Management began discussing them in April 2014, and the first batch of newly designed lines hit Ethan Allen stores in November 2014. Georgetown Classics and Romantic Classics were delivered during the last nine months of 2015. The final line, which is expected to have 15% more units than the previous ones, will be delivered this spring.
Once the new lines hit the stores, earnings do not improve immediately. First, because Ethan Allen makes 80% of what it sells, its factories must be retooled for new designs. Early runs of new product are typically quite expensive, as each piece must be inspected and adjusted to meet design specs. Now that all of the new lines have been through this process, manufacturing efficiencies should begin to shine and improve profits.
Second, new products must replace old, discontinued lines. As Ethan Allen does not operate factory outlet stores, these remnants must be sold from the retail floor. When this clearance merchandise shrinks to represent a smaller portion of overall sales, profitability should increase.
Under the Floorboards
Ethan Allen’s makeover is much more than cosmetic. We know from personal experience that splashing a new coat of paint over cracked plaster is not a long-term solution. Besides introducing new products, the company has been fortifying its balance sheet and investing in manufacturing plants.
Debt has been steadily paid down, from $132 million last year to $58 million in the recent quarter. Naturally, lower debt levels correspond to lower interest payments, boosting net income. Interest expense is one-quarter the level it was a year ago.
What’s more, once the changeovers in the production lines are complete, the plants will become more efficient and produce higher profits.
Chairman and CEO Farooq Kathwari has led Ethan Allen since 1985 and is its largest shareholder. He is a strategic and conservative planner who resurrected the company from two years of losses after the financial meltdown. A previous product revamp in 1994 propelled revenue and profits for more than 10 years. We expect his magic touch to bring the swag back to Ethan Allen’s profits.
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