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Amid shaky market conditions, when investing in small and mid-cap stocks it’s best to lean in companies that have already demonstrated strong profitability and improving margins. And though this sometimes means eschewing more exciting growth stories, companies with solid earnings and valuation support are protected from substantial downside in case the broader market goes south.
Lovesac (NASDAQ:LOVE) falls into this category. The maker of modular, upper-end furniture has seen pressure in its share price, falling roughly 10% year to date. Its recent string of earnings releases have been mixed, with profit rising but growth decelerating.
Appealing valuation and rising margins help to offset slowing growth
I last wrote a neutral article on Lovesac in December, when the stock was trading closer to $27 per share. Since then, Lovesac has fallen to the low $20s, while also releasing Q4 results in mid-April and an updated outlook for the remainder of FY25 (the year for Lovesac ending in January 2025). With all of these factors taken together, I remain neutral on Lovesac going forward.
The biggest disappointment this stock has shown is its lack of growth. We’ll discuss in greater detail in the next section, but the company’s top-line growth decelerated sharply in the most recent quarter, despite having more weeks in the quarter than the prior-year compare. Furthermore, it seems that whatever growth the company is achieving is through store expansion. It continues to add more showrooms (hence burdening itself with added cost) with seemingly very little incremental growth.
Meanwhile, Lovesac’s outlook for FY25 is calling for only $700-$770 million in revenue, which would represent 10% y/y growth at the high end of that range (albeit against a tough 54-week year compare in FY24): but the possibility of not growing at all despite all the added showrooms is daunting.
Lovesac outlook (Lovesac Q4 earnings release)
On the flip side to all of this: Lovesac is generating decent profit growth despite a slowdown in top-line metrics. Gross margins are expanding sharply, which is helping to defray additional operating costs from opening more stores and investing more into sales and marketing. And most relevant of all, Lovesac trades at a diminutive valuation relative to its profit expectations.
At current share prices just under $24, Lovesac trades at a market cap of $364.0 million. After we net off the $87.0 million of cash on Lovesac’s most recent balance sheet (with no debt), its resulting enterprise value is $277.0 million.
Against the midpoint of Lovesac’s guidance ranges for the current year, Lovesac trades at:
- 4.4x EV/FY25 adjusted EBITDA ($53 million guidance midpoint adjusted EBITDA)
- 18x FY25 P/E, or 14x “ex cash” P/E ($1.32 guidance midpoint pro forma EPS)
Lovesac is certainly not a stock to bet the farm on. But with a very modest valuation, popular high-margin products and an expanding showroom presence that will hopefully reinvigorate revenue growth, there’s enough justification to take a small stake here.
Q4 download
Let’s now go through Lovesac’s latest quarterly results in greater detail. The Q4 earnings summary is shown below:
Lovesac Q4 results (Lovesac Q4 earnings release)
Lovesac’s revenue grew 5% y/y to $250.5 million, notably missing Wall Street’s expectations of $265.4 million (+11% y/y) by a wide six-point margin.
Two more disappointing things to note: first, growth decelerated sharply versus 14% y/y growth in Q3; and second, this deceleration came even with the benefit of a fourteen-versus-thirteen fiscal week compare. Lovesac did not disclose its estimate of revenue without the impact of the fourteenth week in Q4, but if we applied a simple 1/14 adjustment to the company’s revenue for the quarter (assuming even linearity throughout the quarter), revenue in Q4 would have been $232.6 million and would have declined -2% y/y instead of growing 5% y/y.
Note that this is in spite of the fact that Lovesac opened one net-new showroom in the quarter to end with 230 total showrooms, up 18% y/y. The fact that Lovesac has invested into double-digit y/y showroom growth and landed at only single-digit top line growth (or negative, accounting for the fourteenth week) is disappointing.
Lovesac channel metrics (Lovesac Q4 earnings release)
As shown in the snapshot above, comparable net sales (which strips out the contribution of new stores) declined -4.1% y/y, versus 2.0% comp sales growth in Q3.
Yet the company has no plans to stop growing its footprint. It plans to nearly double its store count within the next five years, and will grow its fleet by ~30 locations this year. Per President Mary Fox’s remarks on the Q4 earnings call:
Secondly, our omnichannel experience, and we have become a true omnichannel retailer through a combination of our physical touchpoints and digital platform. For the physical aspect of omnichannel, I discussed our strong showroom economics when I covered brand health. And we’ve seen year-over-year occupancy cost reductions as we lean into our real estate strategy and shift to a higher percentage of non-mall locations and improved deal structures.
In terms of our showrooms, we continue to see opportunity to roughly double our current showroom fleet from 230 to more than 400 locations over the next five years, and we’ll continue exploring productive opportunities to bring our products and our services to our customers. For fiscal ’25, we expect to open approximately 30 net new showrooms as we continue to leverage our predictive analytics tool and consistently optimize our fleet and our site selection model with industry leading paybacks.”
The positive highlight to the quarter was margins. Gross margins rose 360bps y/y to an astounding 59.1%, sky high for a consumer products company. This improvement was largely driven by an improvement in inbound shipping costs. The company also improved its operational capacity and planning procedures that allowed it to reduce inventory by 18%. Adjusted EBITDA also rose 4% y/y to $48.4 million.
Key takeaways
Lovesac continues to be a mixed bag, with a strong showing on the bottom line and a cheap valuation helping to offset a more meager growth story. Hopefully, the company’s plan to expand its store footprint will help to drive a return to meaningful revenue growth. Though hardly a home run stock, I do think Lovesac has modest potential to re-rate upward.
