Raymond James Brief 7.2.15 – BIFMA: May Orders +2%; Shipments +4%
Raymond James & Associates analysts, reporting on BIFMA’s May 2015 market statistics, noted that “After a series of solid mid-single digit/low-double digit order growth statistics for five consecutive months, May’s ~2% order growth could have investors a bit ‘jumpy’ at first glance. Our observation, as discussed in past notes, is that the contract office furniture industry has become lumpier and May’s slowdown in the order growth rate demonstrates this characteristic. This inherently makes sense given that there has been a shift in the industry toward more project-based business, and the timing of large projects entering the order book can influence the monthly figures. Irrespective, the order and shipment trends reported over the past six months have remained positive, and trailing-12-month growth numbers are encouraging.”
Analysts: Budd Bugatch, Bobby Griffin, David Vargas
>On Wednesday evening, the Business and Institutional Furniture Manufacturers Association (BIFMA) released its market statistics for May 2015. The month’s order and shipment statistics were derived from a sampling of 32 companies in the contract office furniture industry, the combined shipments of which account for ~76% of industry volume.
>BIFMA estimates May orders increased ~2% year-over-year, down from the ~7% reported April order growth. The prior-year hurdle for May was ~600 basis points (bp) more difficult relative to April (May 2014 orders increased 11% vs. a 5% increase in April 2014). Thus, on a two-year stacked basis, May order growth increased ~100 bps to 13%. May orders increased ~1% sequentially, below the normal seasonal trend (the 20-year median April to May percentage change has been +7%). Trailing-12-month (TTM) orders totaled $10.04 billion, ~5.6% above the prior year. TTM orders are ~32.7% above the February 2010 $7.57 billion trough.
>According to BIFMA, May shipments advanced ~4% y/y, down from the ~5% y/y shipment change reported last month. The prior-year comparison for May was ~100 bp easier relative to April (May 2014 shipments decreased 1% vs. flat shipments in April 2014). Consequently, the two-year stacked shipment growth rate for May 2015 was ~3%, compared to ~5% in April 2015. TTM shipments totaled $10.02 billion, up 6.3% year-over-year and ~31.4% above the April 2010 trough of $7.62 billion.
>Thoughts on May and recent BIFMA numbers: After a series of solid mid-single digit/low-double digit order growth statistics for 5 consecutive months, May’s ~2% order growth could have investors a bit “jumpy” at first glance. Our observation, as discussed in past notes, is that the contract office furniture industry has become lumpier and May’s slowdown in the order growth rate demonstrates this characteristic. This inherently makes sense given that there has been a shift in the industry toward more project-based business, and the timing of large projects entering the order book can influence the monthly figures. Irrespective, the order and shipment trends reported over the past six months have remained positive, and trailing-12-month growth numbers are encouraging. In addition and as noted, on a two-year stacked basis, May’s order growth increased ~100 bps sequentially to 13%, reflecting a tough prior year comparison.
>Although May’s orders were below our pre-report expectations (orders of ~$959 million, up 8% year-over-year), we would caution investors not to get too much “agita” on the basis of one month of data. Recall that our pre-report expectations are calculated from a 20-year median of sequential changes. While the methodology seems reasonable as an attempt to predict one month’s orders, it is also highly prone to surprise (and variability depending on the number of years analyzed). In addition, recall in last month’s report we highlighted May’s tough (+11%) prior year order comparison.
>Despite the month-to-month variability, we continue to believe the overall health and fundamentals of the contract furniture industry are improving, and the recent positive BIFMA numbers as well as the F1Q16 commentary and results from Steelcase (+8% North American order growth) support that thesis. In addition, May’s $10.04 billion in TTM orders is the highest trailing-12-month order value since March 2009. Accordingly, we remain positive about the long-term fundamentals of the office furniture industry. Given the shift during calendar 2013 and 2014 toward more project-based business, we are not entirely surprised by some of the month-to-month variability in the BIFMA numbers. We suspect this “shift” will persist in 2015. On that note, some industry participants continue to experience a shift in timing of deliveries, with customers making “more ambitious changes to their work environments”, instead of “refreshing” an existing design or layout. Recall, larger projects typically involve new construction or a significant redesign/reengineering of an existing building/space, each of which is beyond the company’s control. So while the shift to more projects causes monthly volatility and some reduced visibility into quarterly earnings, it does not change our long-term positive view about industry fundamentals.
>So, on balance, we remain positive about the health of the contract furniture industry. Given strong end-of-year orders and shipments, calendar year 2014 was solid, with total orders and shipments growing 3.8% and 4.5%, respectively, vs. 2013. In addition, the accelerating back-half demand in 2014 seems to have jump-started 2015 as year-to-date (January through May 2015) orders and shipments have increased ~7.2% and ~6.5%, respectively. For reference, industry orders increased 7.4% y/y in the second half of 2014, compared to 0.3% growth for the first half of 2014. Moreover, after offsetting improved demand from corporate customers during 2013 and the first part of 2014, federal government demand seems less of a headwind (and may even be a bit of a tailwind near term). Steelcase reported positive federal government order growth in its fiscal first quarter (ended May 2015). We continue to postulate that we are now in the middle innings of a non-residential economic recovery, and calendar-year 2015 will be a year of improved office furniture demand.
>Using our same (admittedly flawed) sequential methodology and looking ahead, the 20-year median change in orders from May to June has been roughly +17%, which would imply June 2015 orders of ~$1,049 million (up 17% year-over-year vs. June 2014 orders of $895 million). The previous year-over-year percentage change in orders for June is -9%. While the 2015 order statistics have been solid, the +17% y/y implied growth seems far too aggressive. We shall see.
>Moving through 2015, real job growth continues to be one of the questions facing the industry. Overall job growth has been positive since October 2010, but the trend has been choppy and the gains modest. Ongoing improvements in employment in 2015 should continue to benefit industry demand. Overall, corporations are experiencing near-record levels of profitability (based on the Bureau of Economic Analysis data). This should also benefit the industry moving forward as long as the macro and geopolitical environments do not drastically deteriorate.
>In addition, while the absolute level of office construction remains depressed, trends have stabilized (following a roughly 50% peak-to-trough decline based on Census Bureau data) and continue to improve. May 2015 office construction spending (not seasonally adjusted) improved ~24.6% year-over-year and the trailing 12-month office construction spending trend improved ~21.6% y/y in May. Trailing 12-month office construction spending has now been positive since December 2013. The Architects’ Billing Index, which we believe leads non-residential construction by 8-13 months, increased in May to 51.9 from 48.8, above 50.0 – the line of demarcation between expansion and contraction. The rolling twelve-month average was 52.2 in May, nicely above the 50.0 line of demarcation.
>According to Reis, net office space absorption was positive by ~32.0 million square feet in 2014 and is forecast to continue to slowly improve going forward (Reis is currently forecasting ~52.3 million square feet of net office space absorption in 2015, followed by ~60.6 million in 2016). Vacancy rates peaked in 1Q11 and have begun to tick lower, but they remain elevated in historical terms. This should support continued office churn as corporations move and/or consolidate space, taking advantage of favorable lease rates and motivated landlords.
>On May 29th, 2015, BIFMA updated its 2015 & 2016 industry forecasts prepared by IHS (formerly the Global Insight forecast). BIFMA expects 2015 orders and shipments to grow by 5.3% and 4.4%, respectively. In addition, BIFMA expects 2016 orders and shipments to increase 8.2% and 7.9%, respectively. Recall that industry orders increased ~3.8% y/y in 2014.
>While we respect the consumption-based methodology used by IHS to develop the current and next-year forecasts, industry participants and observers have been conditioned (by experience) not to put too much weight on the point estimates since the track of the forecasts typically looks significantly higher at the left axis than at the middle or right – at least until we move into the current year. In examining the forecast rationale, we note that the authors refer to the fact that they forecast modest GDP and employment growth near term without much help from price and/or investment in healthcare and/or commercial structures. The IHS model does not account for vacancy rates though the authors note an “upside risk” to the forecast due to the high vacancy rates. In its commentary, the authors also provide pessimistic (recovery stalls) and optimistic (recovery reignites) scenarios (15% probability each).
>We view price-to-earnings multiples for Steelcase, Herman Miller, and Knoll as attractive given our positive longer-term view on the cycle and prospects for higher sales and margins in coming years. In general, industry margins should benefit from favorable mix (normalizing levels of commercial vs. government business), better net pricing/input costs, and improved efficiencies due to more consistent production, partially offset by increasing levels of investment in product development, marketing, and other growth initiatives. Strong balance sheets and positive cash generation also seem likely to benefit shareholders through further deleveraging, dividends/stock buybacks, and tuck-in acquisitions.
>We believe office furniture is a structurally attractive industry for investors. Collectively, the four publicly-traded manufacturers (Herman Miller, HNI Corporation, Knoll, and Steelcase) hold a North American market share of roughly 60%. While the industry is highly competitive, it is largely rational. Furthermore, the industry has historically been successful at passing through pricing to recover input cost inflation. In contrast to residential furniture, office furniture has also been resistant to significant import penetration given the high degree of customization and exacting requirements of architects and building managers.
>In our opinion, each of the companies we cover is well managed and of high quality, boasting solid balance sheets, positive cash flow, attractive operating leverage, individual competitive strengths, and somewhat differentiated strategies. Despite choppy macro conditions, we continue to believe we are in a multiyear revenue and margin recovery, which bodes well for shareholder returns given the high historical correlation between industry volumes and equity performance. Our Strong Buy rating on Steelcase reflects our high regard for management’s domestic market share gains and determination to improve its EMEA performance during the next several years. Our Outperform ratings on Herman Miller and Knoll reflect our long-term bullish view of the industry. Lastly, our recent Outperform rating on HNI reflects the stock’s recent pullback as well as HNI’s valuation discount to its historical ~21x forward EPS multiple.