How to Profit from the Lumber Liquidators Fiasco

The blowup in Lumber Liquidators (NYSE: LL)  – as a result of allegations that it knowingly used a Chinese manufacturer to make and distribute flooring with unhealthy levels of formaldehyde – has created numerous opportunities for investors.

The question is: which opportunity to profit from the Lumber Liquidators fiasco is right for you?
Let’s run down all of the scenarios to see which may conform to your personal investment and risk profile.
The first and most obvious question is whether you should jump aboard with the rest of the short sellers, and short the stock here at $36, following Thursday’s 10% jump. The stock gained after the company offered a slideshow presentation and conference call.
In order to short the stock, you first have to believe that either the allegations are true and the company will be on the hook for damages from litigation, or that negative perception will remain with the company for so long that its business will materially suffer.
The stock is already down 60% from its high, so the easy money has been made. Still, there may be more downside to come.
The other side of the trade is that you believe the company’s explanations – that the products are safe, and that perception will improve over time. If you think that’s the case, then you go long.
Or you could instead look to competitors, who may see business pick up if Lumber Liquidators falls apart.
The big kahuna in the sector is probably Mohawk Industries (NYSE: MHK). Mohawk offers carpets, ceramic, laminate and wood flooring under many different names and lines.
Business is booming at Mohawk, with year-over-year EPS increases in the 20% range. The stock trading at 20 times fiscal year 2015 estimates.
Mohawk has $97 million in cash and $1.4 billion in rather expensive debt (7%), with free cash flow in the unimpressive range of $100 million to $160 million annually. While not a cash cow in that respect, it’s a “growth at a reasonable price” stock, and those have been very hard to find.
Armstrong World Industries (NYSE: AWI) is a more diversified flooring company, with three segments.
Its Building Products segment handles ceiling products. Its Resilient Flooring segment manufactures vinyl sheet and tile flooring. Like Lumber Liquidators, this segment also makes laminate flooring products. The Wood Flooring segment is even closer to its now-infamous rival, and offers prefinished solid and engineered wood floors.
Armstrong’s FY15 earnings are expected to be flat, but then pick up 30% next year and 18% annualized total for the next five years. Thus, trading at 25 times FY15 estimates makes it seem a bit pricey, although at only 20 times FY16 estimates, it’s a bit more reasonable.
Armstrong has a billion dollars in debt at 4.6% interest and $87 million in cash, but it barely generates any free cash flow. I think you can do better.
Interface Inc. (NASDAQ: TILE) isn’t a direct competitor for hardwood flooring, as it deals in modular carpet and carpet tile products. If you want to play this company, it is arguably undervalued. It trades at only 20 times FY15 earnings, but it’s growing at 25% annually.
Overall, there aren’t too many choices here. I think Mohawk is the hands-down favorite.

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