CRFT report - Zacks Investment Research



April 4, 2005

Ian Madsen, CFA, MBA ,Editor

imadsen@

155 North Wacker Drive ( Chicago, IL 60606

Craftmade International, Inc. (CRFT – NASDAQ) $21.50

Note to reader: All new comments since last report are highlighted.

Overview

Coppell, Texas-based CRFT was founded in 1985 and designs, distributes, and markets proprietary ceiling fans, lighting products, and accessories. The company sells its products through a network of lighting showrooms and electrical wholesalers. In 1998, the company acquired Trade Source International (TSI), which distributes outdoor lighting fixtures, ceiling fans, accessories, and indoor lighting to mass retailers. Craftmade also has a 50% ownership interest in two entities, Design trends, LLC, and Prime/ Home Impression, LLC (PHI). Design Trends markets portable lamps, floor lamps, chandeliers, and wall sconces, and PHI markets various fan accessories that include down-rods, pull-chains, and ceiling medallions. CRFT distributes its products through a network of 1,600 showrooms and by 65 independent sales representatives. Its website is .

CRFT’s 2Q05 results reflected pressure on both its top and bottom line. Sales continue to suffer from lackluster performance in the Mass retail division, which resulted from the change in buying pattern from one of the prime customers — Lowe’s. Analysts believe this pressure to continue in the upcoming quarters as well despite sales growth in the showroom division (where sales should be aided by new product launches). Margins, however, are under pressure, and that makes earnings visibility clouded. This has prompted brokers to lower their forward EPS estimates.

|Key Positive Arguments |Key Negative Arguments |

|Management expects the Teiber acquisition to be immediately accretive. |CRFT continues to experience lackluster sales due to changes in the buying |

|Outdoor lighting product and the home décor product received positive |patterns of customers. |

|response from the retailers. |Margins continue to remain under pressure. |

|CRFT is slated to launch a new product later in fiscal year 2005. |Earnings visibility is clouded. |

| |Company’s design trends business continues to overhang the shares. |

| | |

| | |

| | |

Craftmade’s fiscal year ends June; all calendar references are to the fiscal year.

Sales

Analysts (SSW and BB&T Capital) project revenue to grow conservatively year-to-year.

Q2 Summary: Net sales for the company were down 2.1% from the year-go period to $28.3 million for the quarter. Craftmade segment sales were down 2.2% from last year to $12.3 million, primarily due to lower sales across most product lines. TSI segment sales were down 2.0% vs. the year-ago period to $16.1 million, primarily due to a $3.7 million decline in Design Trends’ sales (much of it at Lowe’s) and partially offset by increases in other mass retail sales and a $2.1 million charge related to a new product rollout that reduced 2Q04 sales at PHI, a TSI subsidiary.

Management expects the Teiber acquisition to be immediately accretive. CRFT plans to double sales of Teiber products in 16-18 months as it expands distribution from Teiber’s current 300 showrooms to potentially most of CRFT’s 1600 showroom distribution. CRFT sales people already promote Teiber products and are ready to take orders once the deal is closed. The company said customers at the January market were enthusiastic to start adding Teiber products to their CRFT orders. In the opinion of one analyst (SWS), this deal will add substantial earnings power in the next 12-18 months. The company anticipates closing the Teiber acquisition by the end of February. Analysts believe that while Design Trends sales will continue to be soft in 2H05, they believe the visibility is improving. Q205 Design Trends sales decline was due to several items. Sales went down $1.1 million due to Lowe’s replacing Design Trends in 118 stores with another vendor to comply with its desire to have two viable vendors. CRFT previously reported disappointing results in 1Q05 because of a decline in Design Trends sales to Lowe’s, the company’s largest mass retail customer. Management explained that Lowe’s was lowering its inventory position and lead times, which resulted in lower replenishment orders. Management indicated Lowe’s is committed to the program, and 90% of the new stores will incorporate the mix and match lamp program. Analysts believe with the availability of P.O.S. and inventory data near real time, CRFT will be able to better manage inventories at Lowe’s. CRFT can do several different types of analyses to help Lowe’s better allocate products and lower system-wide excess inventory.

Management noted that the company is testing a new product at a mass retailer in April. They believe that the product could potentially provide incremental revenue in FY’06 and beyond.

See the CRFT consensus earnings model for more detail on the analysts’ sales estimates.

Margins

Analysts (SSW and BB&T Capital) expect margins to remain under pressure.

Company-wide gross margins as a percentage of sales were up to 31.1%, compared to 26.4% in the year-ago period. Gross margin was up primarily due to a significant increase in TSI’s gross margin. Craftmade’s segment gross margin declined to 37.5% vs. 38.3% in the year-ago period, due to freight costs, higher product costs driven by a strengthening Taiwanese dollar, and a larger portion of the product mix coming from lower-margin builders’ model fans. The decline was partially offset by the prior import duties accrual. TSI gross profit increased to 26.2% from 17.3% in the prior year. The increase was due to a $2.1 million charge taken in the prior year related to a product rollout to a new customer, the accruing of markdown monies over the entire year rather than in just one quarter, lower freight costs, and a $171,000 benefit from the prior import duties accrual. Analysts expect gross margin to increase in 2H05 as the company implements a price increase in the showroom channel to offset increases in product and freight costs.

SG&A as a percentage of sales for the company was 15.9% for the quarter, down from 17.1% in the prior period, and better than our 16.2% estimate. The Craftmade segment SG&A increased to 21.8% of sales from 20.7% in the year-ago period, primarily due to severance costs associated with the departure of the company’s CFO. TSI’s SG&A decreased to 11.3% of sales vs. 14.3% of sales in the year-ago period, due to a lower overhead allocation from lower TSI sales and decreased wages and relocation expenses related to a California office closure in the year-ago period.

See the CRFT consensus earnings model for more detail on the analysts’ profit margin estimates.

Earnings per Share

The digest averages are $1.55 in FY05 and $1.95 in FY06.

Craftmade reported Q2’05 EPS of $0.33 a year over year decline of 31.8%.

Management is forecasting EPS growth of 10-15% for H2’05, implying total EPS of $0.81-$0.85 for the final two quarters of FY’05.

One analyst (CRFT) has reduced their FY05 estimate due to some additional slack in SG&A expense as the company continues to remediate Sarb-Ox issues.

See the EPS and Recent Revisions tabs in the CRFT consensus earnings model for more detail.

Target Price / Valuation

There are two target prices of $27 and $29 as has been provided by BB & T Capital and Southwest Securities respectively. Both the analysts have valued their target prices by applying a P/E multiple to their forward EPS estimates. Average target price is therefore $27.

Go to the valuation tab of the CRFT earnings model spreadsheet for more detail on the brokers’ valuation methodologies and individual price targets.

Long-Term Growth

Average Long-term growth rate of CRFT is 20.5% as provided by BB&T Capital (21%) and Southwest Securities (20%).

One analyst (First Dallas) believes that with the issue “Design Trends”, the business will continue to overhang the shares over the next six months. They also believe that the issues concerning new accounting regulations and standards, as well as the recent departure of the company’s chief financial officer, have been discounted in the stock. The analyst, however, continues to remain optimistic about CRFT’s long-term business model and believes that the long-term investors will be rewarded over the next two to three years. They further go on to say that the continued success of the mix and match fan programme in Wal-Mart and the new products in the mass retail division will accelerate top-line results over the long-term. In addition, the company is encouraged to promote a new outdoor lighting product line in the lawn and garden category and a new home décor product line with regards to window treatments that are currently not offered by big box retailers. They would encourage the investors to take advantage of any additional weakness as an alternative buying opportunity.

Individual Analyst Opinions

POSITIVE RATINGS

BB&T – Buy ($27) - report date 02/11/05

“We are maintaining our Buy (1) rating on the shares and our 12-month price target of $27, at which CRFT would trade at a multiple of 13.5x our FY’06 EPS estimate, a discount to the company’s 18% three-year growth rate that may be appropriate given the turnaround currently underway”.

Southwest Securities – Strong Buy ($29) - report date 02/11/05

The analyst reiterates their Strong Buy rating and has raised their price target to $29, which is based on 15x FY06 EPS estimate. They add that the company is now focusing on its showroom business, which is a high-margin, stable business. In the showroom channel, CRFT has an impressive reputation, meaningful penetration, and still significant room to grow. In the long run, if the company continues to add products and customers in the showroom channel, they believe it should achieve more stable EPS growth and a higher multiple. Although the mass retail business continues to be volatile, they believe it should stabilize in FY06.

NEUTRAL RATINGS

None

NEGATIVE RATINGS

None

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Research Digest

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