Ethan Allen's Masterful Q4 Decor

Ethan Allen masterfully managed costs and inventory to preserve EPS despite a revenue decline.

(Companies in article: ETH, FBN, HOFT)

Ethan Allen Interiors (NYSE: ETH), one of the nation’s leading producers and retailers of furniture, reported fiscal fourth quarter results last week, and ETH shareholders collectively exhaled. Despite a difficult operating environment, what with the housing sector in turmoil and all, ETH reported EPS of $0.65, in line with analysts’ consensus and just a penny shy of last year’s result. The company’s shares were up some 8% that day on the news.

While net sales decreased 5% in the quarter, management noted a tough comparable in the prior year, which had grown some 12%. Given its difficult operating environment, we were not surprised to see a revenue decrease. The analyst community may have been though, since ETH’s top line was 3.1% short of consensus expectations, according to Thomson Financial.

Still, the retail division actually grew revenue in the quarter some 1.7%, while the wholesale segment experienced a decline of 8.5%. ETH’s wholesale segment fills the company’s own stores as well as others, so we suspect the wholesale group’s miss reflects inventory cuts across the industry.

Ethan Allen accredited inventory reduction as one factor behind its improving margins. Gross margin expanded 200 basis points over the prior year period, benefiting from an increased mix of retail revenue, to roughly 73% of sales, from 69%. Gross profit also benefited from improved retail operations and margins at the manufacturing level.

The company noted that in its effort to reduce inventory levels to a more appropriate point for the current operating environment, it had reduced operating hours at its plants to 32 hours from a 40-hour workweek. ETH’s plants are now back operating at the traditional level.

Operating margin still narrowed 100 basis points on the lower sales. However, after an improved tax rate and some $16.9 million of share repurchases, ETH managed to satisfy expectations. Furthermore, Ethan Allen’s CEO, Farooq Kathwari, bravely stated his view that the company should drive EPS in FY 08 (Jun.) within the range of analysts’ expectations. On the conference call, one observant analyst noted the current range of estimates forecasts EPS growth anywhere from 3% to 22% in FY 08. Kathwari humorously noted his understanding of that. He reiterated that the operating environment left much out of his control.

However, management also noted positive trends in July, as well as share repurchases during the month of some 700,000 shares. ETH also raised its dividend 10% one day prior, implying some level of confidence. Wall Street Greek likes ETH’s quality focus, and admires its 65% domestic manufacturing and sourcing. With its market position, and trading at 12.4X FY 08’s $2.66 consensus number (down $0.04 since last week), we think the company compares well to peers Furniture Brands International (NYSE: FBN) and Hooker Furniture (Nasdaq: HOFT).

The shares may offer opportunity for selective entry on days of severe market weakness, but this market calls for careful treading within housing related industries. ETH's future is going to be tied to credit availability, employment and consumer strength, three areas we are concerned about. Even so, within industry, we see the company well-positioned to benefit from the troubles of a significant number of weaker peers. Does this mean buy now, eh, probably not. It means put it on your list of things to buy if the market capitulates, if the Fed comes to the rescue or when housing finally bottoms, which could theoretically all happen simultaneously. There are likely better industries for capital on this particular day, but in a well diversified portfolio, there's also likely a place for ETH.

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