It is certainly no secret that home furnishing has been a hot group since the bottom back in March, as consumers that were stuck at home spent heavily – and still are – on improving their residences. That led to high levels of spending on everything from couches to patio sets to paint, benefitting countless different companies in the process.
One such company that has seen an enormous benefit is flexible seating innovator Lovesac (LOVE), which has seen its shares nearly 10X from the bottom earlier this year.
Not only have shares recovered enormously from the initial selloff, but they are ~130% higher than they were pre-pandemic, as Lovesac is capitalizing on shifting consumer spending patterns. The stock made a new high off of the truly outstanding Q3 earnings report, but irrespective of whether the next move is up or down, I see Lovesac as a long-term winner.
A disruptive model in an old category
The idea of a company coming in to disrupt an old business model with an innovative approach is certainly nothing new. It has been done countless times, from car retailers, to restaurants, and now, home furniture. Other players like Wayfair (W) have disrupted with online-only models that offer greater selection at lower prices, while traditional players continue to have enormous showrooms with salespeople roaming the floors. Lovesac is altogether different in that it offers essentially one core product that is highly configurable, along with a lucrative line of accessories to attach.
Source: Investor presentation
Lovesac has small stores with very little inventory, and instead of countless salespeople and enormous lead times, it has high-touch technology experiences and the ability to ship its core products very quickly. In other words, in a world where huge, expensive showrooms, months-long lead times, and very high inventory carrying costs are the norm, Lovesac fixes all of those problems.
Since its product is configurable, it doesn’t need endless SKUs and complex supply chains; it just makes its core products well and in high quantities, enabling it to provide additional value to consumers that don’t want to wait three months for a couch. I see this model as highly disruptive and still in the very early stages of potential growth.
The market for this kind of disruption in furniture is obviously huge, and Lovesac reckons it is something like $31 billion annually today, which is about 30% of total furniture expenditures in the US. Lovesac doesn’t compete in other large categories, but given its market share is basically imperceptible at this point, that’s plenty.
Source: Investor presentation
Importantly, this isn’t just a large market, it is expanding. As people create new households, they need furniture, and Lovesac’s core customer is one that is in the 30 to 39 range with disposable income, as Lovesac’s products aren’t cheap. However, the company’s products appeal to anyone that wants a configurable furniture set, so I have a lot of confidence it can continue to take market share over time. With Lovesac’s model being so innovative, and in my own personal experience, the traditional furniture shopping experience being rather unpleasant, I see Lovesac being another Carvana (CVNA), a company that has vastly improved the shopping experience of an otherwise unpleasant task.
Source: Investor presentation
The other thing to keep in mind is that Lovesac is selling what amounts to an ecosystem of furniture products. There are numerous accessories and other products that are related to the core Sactionals, and with roughly a third of transactions from existing customers, Lovesac has not only the tailwind of acquiring new customers, but meaningful revenue from existing customers that either buy another Sactional, accessories, or both. As Lovesac continues to innovate and add new ways for consumers to interact, this tailwind should only grow.
Speaking of growth…
Lovesac has proven it can produce exceptional growth. The company had less than $80 million in revenue as recently as calendar year 2016, but is expected to ~4X that number this year.
Source: Seeking Alpha
All of the tailwinds mentioned above apply for Lovesac in the coming years from product catalog additions to new customer acquisition. I’ve spent considerable time on revenue growth prospects, so I won’t belabor the point. Suffice it to say, however, that I see Lovesac’s revenue runway as very long, and quite steep, which is congruent with its historical performance as seen above.
Apart from that, revenue growth should enable much better earnings because not only will the top line move higher, but it should see sizable margin increases as well. When a growth company produces higher revenue, it has the doubly positive impact of leveraging down things like back office support costs, supply chain costs, rent expenses, etc. This means that, as Lovesac scales, its margins should scale as well.
Indeed, we saw that very thing in the aforementioned Q3 report, wherein Lovesac’s gross margins soared nearly 500bps year over year to 55.3% of revenue. That’s a huge amount of margin expansion for one year, and it was due in part to higher revenue, which also helped it use fewer promotions to acquire new customers. This virtuous cycle of stronger pricing due to higher demand is something I don’t think is done, and the end result should be very strong earnings growth for a long time to come.
Source: Seeking Alpha
To be fair, with all of the growth that I think is coming, Lovesac is priced accordingly. Shares trade for 172 times this year’s earnings, and 123 times next year’s. Those are eye-popping numbers to be certain, but remember that Lovesac is only just beginning to generate profits. We cannot expect a reasonable multiple for a company that is in the very early stages of what I see as a years-long journey to build out its infrastructure, acquire new customers, and deliver on its promises.
Buying Lovesac is a bet that the company’s disruptive model can take significant share over time, transforming an old-world style shopping experience of wandering around a cavernous showroom for hours with a salesperson glued to your side, to a high-tech, quick, highly customized shopping experience and a product that I believe is better as well.
Some risks to consider
That said, Lovesac is not without its risks. It still gets much of the material needed for its products from China, which is in a years-long trade war with the US. The net of this for Lovesac is that its products can be subjected to tariffs, which either crimp margins, or force the company to raise prices. I don’t see this as a significant risk at the moment, but should relations sour further between the two countries, Lovesac could suffer.
Competition is still a huge barrier, not just because Lovesac’s brand recognition is still fairly small, but because consumers are used to the furniture shopping experience I mentioned above at a traditional showroom. That doesn’t mean they cannot be persuaded to try something better, but it will take time.
In addition, and more immediately, short interest is 29% of the float, so shares will likely remain volatile. If you have a shorter-term horizon, or simply don’t want the volatility, Lovesac isn’t for you.
Further, it is clear Lovesac only makes one core product, with that being configurable furniture. It is possible that another competitor could essentially copy the formula, particularly one with the economic might to invest in the supply chain. There are countless examples of companies like this in the market, including recent pandemic winners like Peloton (PTON). Having one great product provides focus and operating excellence because the company isn’t trying to be all things to all people. However, it also means that emulating the company’s success isn’t necessarily that difficult for competitors. Lovesac’s brand certainly appears to be resonating with consumers, so while I consider this a risk, it seems to be a smaller one at the moment.
On balance, however, I see Lovesac as a long-term winner, and one with a very long runway on its modest $568 million market capitalization. I see Lovesac as a buy.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LOVE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.