The former hedge-fund manager Whitney Tilson reveals what may be the 'most shocking stock pick' of his career
- The former hedge-fund manger Whitney Tilson says Lumber Liquidators is a "buy."
- Tilson previously exposed fraud at the company, making $4 million from his short bet.
- The recommendation marks a "rare reversal" for Tilson. He has only made five long recommendations on stocks he was previously short.
- Watch Lumber Liquidators trade live.
The former hedge-fund manager Whitney Tilson has made a recommendation that he says may be the "most shocking" of his career.
Tilson, who helped uncover fraud at the flooring firm Lumber Liquidators, now says the stock is a "buy." He points to a discussion he had with former CEO Rob Lynch back in 2015 as the reason for his "rare reversal."At the time, Tilson was short the stock based on his belief that management knew the flooring it bought from China was toxic, but didn't care because they just wanted to buy the product at the lowest price possible. He believed that was the reason why Lumber Liquidators' operating margin doubled during the first 18 months that Lynch was CEO.
But Lynch told him that wasn't the case, and that the middle man in China was taking an extra six percentage points from the company.
"You see, Whitney, one thing you really got wrong in your analysis is that this is a 6% operating margin business," Lynch said. "Run properly, it's really double that."
That's when Tilson knew he had to close out his short bet, locking in a $4 million profit.
"In the past week, I've received information (I can't reveal the details at this point) which leads me to believe that it's likely that senior management of Lumber Liquidators: 1) Wasn't aware that the company was selling Chinese-made laminate that had high (non-CARB2-compliant) levels of formaldehyde; and 2) Made the decision to continue selling the product even after the 60 Minutes story aired in large part because they genuinely believed that the product was safe and compliant," Tilson said in a Seeking Alpha blog post.
"If this information is correct, then the company was sloppy and naïve, but not evil."Over the next two years the stock rallied by more than 200% to more than $40 a share, which would've resulted in a $7 million loss, according to Tilson.
Flash forward to Wednesday, and in the debut report put out by his new research firm Empire Financial Research, Tilson says for only the fifth time in his career he is going long a stock that he previously recommended to short. The other cases were Fairfax Financial, General Growth Properties, Wells Fargo, and Netflix - all of which led to big gains.
"My recommendation to buy Lumber Liquidators may well be the most shocking stock pick of my career, given that I'm largely responsible for taking the company down," Tilson wrote. "But in doing so, I got to know the company well."
He says Lumber Liquidators is a buy for a number of reasons:
- The executives responsible for the scandal have left the company.
- Lumber Liquidators recently settled its remaining lawsuits related to the scandal.
- It has a great business.
- He sees margins tripling over the next three years.
Tilson says the company's share price, which is now near $11, is out of whack with the fundamentals. He notes that operating margins were only 1.9% in 2018 because of the high legal costs related to the scandal. Now that the scandal is in the rear-view mirror, Tilson says operating margins could reach 6% over the next two years, causing shares to double or even triple.
"The following graphic explains why earnings should more than triple to $1.74 in the next couple of years, due to reductions in other costs and salaries, partly offset by increased advertising expenses and a smidge of taxes," Tilson wrote (Note that due to losses since 2014, the company won't pay full taxes for a while.) "Multiply 15 times earnings by $1.74 and you get a $26 stock, almost two and a half times today's level."
While Tilson is bullish on the stock, he's still aware there are some risks. Mainly, he sees the company's debt level climbing from $65 million to $90 million over the next year due to settlements relating to the scandal."If I'm right and management can execute, then margins should at a minimum revert to the low end of historical levels, which should lead to the stock doubling - or more - over the next two years," Tilson concluded. He recommends the position not commanding more than 3% to 5% of a portfolio.