Flexsteel Stock: Recent Q3 Top-Line Growth Of 8%+ Will Be Difficult To Maintain (FLXS)

Intro

We wrote about Flexsteel Industries, Inc. (NASDAQ:FLXS) in October last year when we rated the stock a ‘Hold’ despite the established bullish technical trend. Our reservations revolved around forward-looking margin uncertainty and bearish EPS revisions. As we see below, however, Flexsteel Industries emphatically nullified these concerns over the past nine months returning well over 66% since our October 2023 commentary.

The one disclaimer concerning the stock’s return over the past 9 months is that shares have declined approximately 20% since early April. Therefore, let’s go to Flexsteel’s recent quarterly earnings report to get a solid read on the company’s standing regarding profitability & valuation trends. Technicals aside, the relationship between Flexsteel’s profitability & valuation trends is the most important driver when it comes to investor interest all things remaining equal.

Sales Growth Of 8%+ In Q3 Of Fiscal 2024

Incoming CEO Derek Schmidt reported top-line growth of 8.2% in Q3, which was an accelerated number given the 7.5% sales growth in the second quarter. Although the upholstered furniture space continues to be a challenging space for participating providers, the above trends demonstrate that Flexsteel continues to outperform the average growth curve in this space which is encouraging.

Whether this growth can last is another question altogether but Flexsteel continues to double down on value-adding propositions (through its product line) resulting in sustained market-share gains. The incoming CEO also pointed to new markets, innovation & improved marketing strategies as means of driving sustained top-line growth. How much legs these strategies have however remains to be seen.

Flexsteel Will Remain Under Pressure To Grow Top-Line Sales

From an investors’ standpoint, a lot was going on in the report and this is where our first concern lies from a long-term perspective. For example, Schmidt touched on how the budget Charisma brand continues to grow its offerings and how this should appeal to more buyers over time from this age subset. Then we also learned about the expansion of Flex & the Zecliner sleep chair into new fabrics and how the company must remain relentless in its pursuit of market-share gains over the upcoming years.

Given the above growth trends, the pertinent question here is how long can Flexsteel continue to grow its sales in an industry that is still clearly struggling from an external demand standpoint. To this point and from a long-term standpoint, the company needs a sustained industry tailwind for long-term share-price gains to ensue.

Another area, investors should ponder is the lack of ‘repeat business’ from end-customers in its business model. Customers buying at retail outlets & big-box outfits in the main are most likely brand-new end-customers every time. Furthermore, it should be noted (as this point is linked to the unique customer pointed out earlier) that despite the overall 8%+ top-line growth rate in the third quarter this year, e-commerce sales for example fell by double digits in Q3.

We state these concerns because it is evident that Flexsteel needs production scale to grow its margins & business accordingly. To increase the company’s return on capital (which comes in below 5% at present), it needs to turn over its capital faster than it has been doing. The company’s trailing net-profit margin for example only comes in at a mere 3.87% which is still too low for the stock to be a convincing ‘Buy’ in our opinion.

We acknowledge that new products, improved supply chain dynamics, & more volumes going through the system have helped grow margins but again, we would pose the following question. When the squeeze comes (in terms of external less demand), how much of the above measures will be able to be maintained? Would they have the capacity to hold up in a more difficult trading market? Time will tell on this front but we have already seen

Valuation

This brings us to the company’s valuation. As we see below, with the exception of cash flow, Flexsteel’s trailing 12-month sales, assets & dividend yield are all not as attractive as their respective 5-year averages. Furthermore, Flexsteel’s current debt-to-equity ratio comes in at 56.24% compared to a 5-year average of 39.74% for the same multiple. Flexsteel’s below-average trailing return on capital of 4.56% also is a key valuation driver and raises questions about whether the company will be able to consistently generate higher returns off its capital than the comparable cost.

Suffice it to say, given the reasonable valuation & growing profitability, investors seem to be buying the growth story here in FLXS. Bottom-line earnings are expected to jump by 140% this fiscal year followed by a 45%+ increase over fiscal 2024 in the following year. However, our take here is that these lofty projections have already been priced into the share price of FLXS which means that if there is any contraction from these expected growth rates, the share price could indeed fall as a result.

To this point, given the weakness of the intermediate histogram in the technical chart above and the fact that an intermediate death cross (crossing over of the stock’s 10-week moving average below its 40-week counterpart) is a distinct possibility over the near term, we believe the right rating in FLXS in a ‘Hold’. Remember, the technical chart always gives a succinct picture of what is happening in Flexsteel from a fundamental standpoint so given this stock’s cyclical history, it makes sense not to Buy FLXS stock at this juncture.

Conclusion

To sum up, we are reiterating our ‘Hold’ rating in FLXS despite the company’s recent topline growth & profitability gains. Higher sales, a growing order book, improving gross margin & upcoming cost savings from the Dublin Plant closure all give weight to the bullish case here. The stock’s valuation however is not cheap enough in our eyes and the technical chart may indeed be pricing this in. Let’s see what the fourth quarter brings for Flexsteel. We look forward to continued coverage.