A look at Kimball International after the earnings report (KBAL)
News for Kimball International (KBAL) was mixed on February 3 when they released their fiscal second quarter results. Raw material and labor costs and ongoing logistical challenges from supply chain disruptions put pressure on sales and margins. On the bright side, KBAL ended the quarter with a record backlog and management confirmed previous guidance for fiscal 2022. The intention of this article is to analyze some of the finer points of these matters, se ending with an updated evaluation exercise.
Bottom line-up front: Kimball’s recovery has been and may continue to be slow as concern continues to swirl around COVID, particularly in the hospitality sector. The business model has been compromised by COVID-related lockdowns. That being said, management is working to pivot its product line to more relevant categories reflecting the new environment, in particular work from home and/or hybrid office environments. But even in a slow recovery scenario, Kimball shares are trading cheap enough to present a favorable risk/reward profile. I am bullish on their prospects of providing above market returns.
Here is a table showing critical metrics for this quarter compared to the prior year period and prior quarter:
These reported numbers, however, do not reflect significant events that mitigated the results:
1) Ongoing supply chain issues have affected the in-stock business model of their Poppin line. With inventory stuck on the boats, shoppers who traveled to Poppin to buy something to ship immediately found many out-of-stock items. Instead of being late for possible shipment, these sales are permanently lost. Management discussed this dynamic on the conference call:
…..Poppin’s backlog doesn’t operate like our traditional business. So in our existing Workplace and Health business outside of Poppin, if we get an order and the delivery time is long, we put it in the backlog and produce it when we can.
With Poppin, they have a small backlog, but these are things that would be delivered within 4-6 weeks. It’s very short. So in some cases, if you can’t deliver on demand, it’s a lost sale. They are able to put some projects on hold, but most would be on demand.
Without this issue, sales could have been $1.7 million higher if Poppin had matched this quarter what they had in sales last quarter.
2) Gross margin was impacted by one-time pandemic-related expenses related to encouraging employees to get vaccinated to comply with the federal vaccine mandate. This charge amounted to $2.7 million during the quarter.
Without these items, gross profit would have been $3.2 million, or almost 7% more.
A big bright spot in the quarter was the record backlog of $196.9 million versus $170.8 million in the prior quarter. They expect to recognize $134 million of that backlog in the third quarter.
In the second quarter, they recognized $120 million of their backlog, but net sales for the quarter were $151.4 million. That means KBAL had $31.4 million in revenue that was ordered and shipped more or less immediately for recognition in the quarter. If this is repeated next quarter, third quarter revenue will be in the order of $165.4 million. This will be 19% above the comparable quarter of last year.
KBAL announced that its revenues will be 15 to 20% higher this year than last year. Given the numbers showing in the first and second quarters of this year and what we’ve extrapolated from what could happen in the third quarter, that means that to hit the bottom of their forecast, they’ll need 181 million dollars of revenue in the fourth quarter to obtain a total of 654 million dollars, an increase of 15% compared to last year. A 20% increase would require $209 million. Given that the highest quarterly revenue they’ve ever had was $201.5 million in the quarter ending September 30, 2019, $209 million seems well out of reach. But $181 million is very doable.
To help them achieve this goal, two price increases implemented by KBAL last year. One came into effect on October 1, 2021 and the other was a surcharge they put in place in mid-November to manage “transient” inflationary pressures. With inflation still high and apparently not transitory, they have chosen to make this surcharge permanent and effective next month. Only 33% of the current order book reflects the November overload. As more of their order flow reflects the two price increases, gross margins will increase.
Perhaps the biggest headline in the earnings report was a major goodwill write-off associated with the Poppin acquisition. Between COVID and current labor and logistical challenges, management took a non-monetary hit of $34.1 million. They explain :
….due to the impact of COVID and related labor and logistics issues on Poppin’s near-term results, we recorded a one-time non-cash goodwill impairment charge of $34.1 million associated with the acquisition of Poppin. This charge was partially offset by a corresponding decrease in our earnout liability. These actions in no way change our view of Poppin’s long-term prospects and merely reflect the current COVID-related operating environment. We continue to view Poppin as a key driver of our long-term growth model and are delighted to underline this commitment with investments such as the 3 new Poppin showrooms that will open this fiscal year.
The silver lining is that as a result of this write-down, they were able to reverse a liability for an earn-out provision that they would have had to pay if Poppin had reached certain milestones. This amount was $22.5 million. The net effect on the balance sheet was to reduce shareholders’ equity by $11.6 million.
Forgive me if the following valuation exercise seems a bit rudimentary, but I have found that sophisticated models with fine-tuned and carefully calculated inputs have done no better in helping to determine value than simple methods using reasonable estimates.
My typical timeframe for measuring future value is around five years. Under pessimistic assumptions, let’s say it takes that long for KBAL to recover its revenues back to their pre-pandemic level of $768 million (first recorded in their fiscal year ending June 2019). The company would need to increase sales by just under 6% per year to achieve this. Also assume that KBAL is making an operating margin of 7.4% at that time, a median value for where they were in the five years prior to the pandemic anomalies. Finally, suppose that the current administration raises the corporate tax rate to 28%, a stated objective. Combining all of this and dividing by the current shares outstanding, we would get $1.11 of EPS. At a reasonable P/E of 15, the stock price at this time in 2027 would therefore be around $16.68. Here is the spreadsheet of it all:
Reduced to the present at 12%, my required rate of return, results in a purchase price of $9.46. KBAL is currently trading below that!
All my entries are conservative. I will be shocked if it takes them a full five years to return to pre-pandemic sales numbers. I will also be shocked if the operating margin is only 7.4% given their CEO’s focus on cost savings and considering that they have had such high operating margins than 8.6%. I also don’t think President Biden is likely to find the support he needs to raise the corporate tax rate to 28%. Finally, 15 could be considered a low P/E given how KBAL has traded historically, almost always staying above a multiple of 16:
These are the dream scenarios, where I can achieve my personal rate of return on an investment even if things aren’t going so well.
Kimball International is a fetch game. Many of their end markets depend on the disappearance of COVID: hospitality, education and the workplace. Hopefully we avoid another variant. If KBAL can resume normal operations within five years, buying now would ensure a return of at least 12%. I think they will be back to normal long before.
Their quarterly results weren’t as bad as they first appeared, and a strong order book bodes well for the future. KBAL is a great buy right now.