QEP Company manufactures and distributes flooring products such as hardwood floor materials and installation tools.
Despite operating in an absolutely horrid housing market, the company is firing on all cylinders. Revenues, earnings and EBITDA are all at record highs. The balance sheet is solid and improving. Even with all of these positive factors, the company trades at a depressed multiple and could reward investors handsomely once the market eventually recognizes the company’s success.
First, a look at the company’s recent income and cash flow trends:
Beginning in 2007, the company was hit hard by declining sales, resulting in losses and goodwill writedowns. The company responded with vigorous efforts to cut costs and reduce debt, resulting in greatly improved margins and profits. Net income and revenue over the trailing four quarters are the highest in company history! Free cash flow has soared as well.
Improving profitability and cash flow has gone hand in hand with a strengthening balance sheet:
QEP Company’s share price was hammered during the financial crisis as investors fretted over the company’s excessive leverage and poor liquidity. Since then, the company has succeeded in nearly doubling its current ratio and has cut total liabilities by 37.1%. By gradually paying down liabilities and retaining earnings, the company has increased equity to greater than 50% of assets, more than double 2007’s figure. By any measure, the company’s present balance sheet is less levered and more flexible than at any time in recent history.
At a recent bid/ask midpoint of $17.73, the company’s market cap is $60.18 million. Enterprise value is $65.76 million. Trailing earnings of $11.57 million give a P/E of just 5.20, while EV/EBITDA comes in at only 3.14. Trailing free cash flow yield is 17.02%.
QEP’s process of deleveraging by using free cash flow to reduce debt is coming to an end. Future free cash flows can be used to make acquisitions, reinvest in the existing business or distribute to shareholders via dividends or repurchases. At some point, the market will recognize QEP company’s earnings power, growth potential and balance sheet strength and reward it with a higher earnings multiple. A normalized housing market would only provide an additional tailwind for the company.
QEP does face risks. A stronger US dollar would reduce the value of the earnings of the company’s foreign operations. Another US recession could cause decreased revenue and pinch margins. Most significantly, Home Depot accounted for 63% of sales in fiscal 2011. The impact of losing Home Depot’s business would be devastating. However, the company’s relationship with Home Depot goes back to 1983 and QEP works very hard to maintain the partnership, even offering support to the Home Depot customers who buy QEP Company products.
I’ll be adding QEP Company to the Idea Tracker page tomorrow. In my view, QEP offers a chance to buy a good business with improving finances at a large discount to earnings power.