Important disclosures appear on the last page of this report.
April 13, 2012 Investment Recommendation: UNDERWEIGHT
Henry Fund Research
OFFICE FURNITUREMFG.(USBased)
Ryan Jennings
ryan-d-jennings@uiowa.edu
Source: Google Finance
Key Industry Statistics (Averages)
Pure-play Public Companies
4
P/E Ratio (LTM)
18.30
P/E Ratio (FWD)
11.97
Growth (Next 5 Years)
3.2%
Beta (3 Year Monthly)
1.23
1-Yr % Change
-18.6%
Constituents % of Industry Rev. Mark. Cap (B)
Herman Miller (MLHR) 6.8%
1.30
HNI (HNI)
6.1%
1.26
Steelcase (SCS) 6.9%
1.21
Knoll (KNL) 4.6%
0.78
Primary Public Co.’s (qty. 4) 24.6%
4.55
Other/Private
2
(qty. 3,693)
75.6%
N/A
Total 100.0%
N/A
INVESTMENT THESIS
(-) Overvalued relative to S&P 500: The officefurniture
manufacturing industry is OVERVALUED relative to the S&P
500. This is based on the industries lower growth rate, higher
beta, and higher price to earnings (P/E) ratio as compared to
the S&P 500. The current industry P/E is 18.3 versus the S&P
500’s P/E ratio of 14.0.
(-) Strong competitive forces: The officefurniture
manufacturing industry is mature with low company
concentration, which puts pressure on pricing and profitability.
Over 3000 manufacturers exist in this industry, 70% of which
have less than 20 employees and serve local communities.
The top four public companies represent only 25% of the total
revenue. We do not expect significant change to this
landscape over the next 5 years.
(-) Negative historical revenue growth: Industry revenues
declined by 4.5% per year over the last 9 years. US plants
have been shut down or consolidated at a rate of 1.1% per
year over the last 5 years.
(-) Pressure from low-cost imports: Less expensive imports
from China have taken 0.8% market share per year from US
office furniture consumption over the last 15 years. This trend
is expected to gradually weaken, until 2018 when import’s
market share stabilizes due to higher Chinese wages.
(+) Small but positive future growth: We expect positive
trends in key industry drivers such as unemployment rates
and GDP growth. This will provide annual industry revenue
growth at 3.2% over the next 5 years and 3.0% thereafter.
(+) Input prices to stabilize: Steel is a major input cost of
office furniture, and the price of steel has dramatically
increased since 2004. However, we expect steel prices to
level off at their current price for the next 3 years due to
China’s weaker than normal GDP growth of 7.5%. China is a
major user of steel, and a decrease in their usage provides
relief to other users of steel.
(+) Emerging market growth opportunities: Opportunities
for industry growth exists in emerging markets. Currently
emerging markets is estimated to constitute only 10% of the 4
public companies’ revenue sources, although they all have
strategies to pursue this region. Growth of 5 - 8% is expected
in key emerging market regions, such as China and India,
over the next 5 years.
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
2
EXECUTIVE SUMMARY
We propose to UNDERWEIGHT the US officefurniture industry
based upon its current overvaluation relative to the S&P 500.
The officefurniture manufacturing industry bears strong competitive
forces that minimize profitability.
6
There are more than 3000
businesses in the US that supply office furniture, of which 70% have
less than 20 employees and supply local communities. There are 4
major public competitors, which make up 25% of the industry.
2
The industry has seen steady declines in revenue, averaging -4.5%
growth from 2003-2011.
3
Many factories have shut down or
consolidated, reducing capacity by 1.1% per year over the last 5
years. In addition, low cost imports (primarily from China) have
continued to eat away at existing market share at a rate of 0.8% per
year over the last 15 years.
4
Despite the gloom of recent years, we expect there to be moderate
revenue growth of 3.2% for the next 5 years, and 3% growth
thereafter. This growth is a function of positive trends in key
economic drivers for the industry, which includes employment rates,
GDP growth, commodity prices, manufacturing utilization, and office
construction spending.
VALUATION
Industry Valuation
The officefurniture industry is a slightly overvalued industry. The 3
primary factors in valuation are growth, risk, and profit. We averaged
these metrics for the 4 public competitors, Knoll, Herman Miller, HNI,
and Steelcase, and find that each industry metric is worse than the
S&P benchmark.
Source: Data from Yahoo Finance as of April 13, 2012 (5 yr. growth figures are
consensus projections of sell-side analysts. The beta is based on 3 years of
monthly data.)
Peer Valuation
Although we feel the industry in general is overpriced, some firms
within the industry are more attractively priced than others. The
following analysis shows the drivers of valuation (profit, growth, and
risk) for each of the 4 public officefurniture manufacturers. Out of the
group, Knoll appears to be the greatest investment opportunity, as its
profit and growth are above average, while the price reflected in the
P/E ratio of 11.1 is relatively cheap. Note that Knoll is the smallest of
the 4 competitors, although the small company risk is already
accounted for within the beta.
Source: Profit data from FactSet, Other data from Yahoo Finance (Note: growth
data is from Yahoo Finance’s sell-side analyst consensus)
INDUSTRY DESCRIPTION
Background
The US officefurniture industry dates back to the 1800’s. With the
invention of the telephone it became efficient for companies to have
their manufacturing and administrative work separated, giving birth to
the modern-day office.
1
Since that time, the US office manufacturing industry has matured. In
2011, there were over 3000 officefurniture manufacturers
headquartered in the US. The industry has low company
concentration, and has 4 large public companies (Steelcase, Herman
Miller, HNI, and Knoll), which account for only 25% of the 2011
industry revenues.
Products
Products sold by this industry include chairs, desks, cubicles,
conference tables, bookshelves, filing cabinets, and more. We
separate the products into 5 categories, as follows.
2
Seating: This is the largest category, which includes chairs (made of
plastic, metal, wood, and fabric), and constitutes 1/3
rd
of industry
revenues. Within recent years there has been growth in this segment
due to customer appreciation for the benefits of proper ergonomics.
Office chairs now commonly have adjustable back supports, heights,
and armrests. We expect this ergonomic trend to continue, as
businesses continue to provide comfort and safety to their
employees. Seating replacements (due to innovations in ergonomics)
will cause this segment to grow faster than other product segments,
with a 5-year CAGR forecast of 4.5%.
Office systems: This is the 2
nd
largest product segment, constituting
27% of revenues, and includes standardized office desks and
cubicles. The office cubicle was invented in 1965 by Herman Miller,
and is still popular today. We expect that the cubicle will continue to
be a staple in this industry, and will grow at 4% annually over the next
5 years, highly correlated to white-collar job growth in the US.
Case goods: This is the 3
rd
largest segment, constituting 22% of
revenues, and includes furniture that is un-upholstered and solid
wood (such as executive desks, conference tables, and
bookshelves). Typically, case good sales benefit from substantial
positive corporate cash flow. As cash flow and profits increase,
companies provide their executives with better office furniture.
However, over the last 2 years, companies have been stockpiling
their cash. As economic tensions reduce in the next 5 years, we
expect a gradual increase in spending in line with GDP growth of 3%.
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
3
Storage: This category is the smallest, and includes filing
cabinets/office document and supply storage. We expect this
segment to decline relative to other product segments, as fewer filing
cabinets are needed due to the increasing prevalence of electronic
document storage.
The following graph summarizes the product segments, drivers, and
growth forecast:
Source: 2011 data from
http://www.ibisworld.com/industry/default.aspx?indid=870
Customers
The customers of officefurniture manufacturers are rarely the end
users. Currently, only 7% of officefurniture is sold direct to the
customers. The following section provides the revenue breakdown by
customer, along with our projections for the future.
2
Wholesalers and Custom Outfitters: The most common way to
distribute furniture is to sell through wholesalers, which represents
45% of industry revenues. Wholesalers include companies like
United Stationers, who sell a wide variety of furniture and office
supplies in bulk to corporations and the government. Manufacturers
also sell to custom outfitters, who work with corporate clients to
develop and implement office remodeling plans, and makes up 30%
of industry revenues.
Retailers, End Users, and Exports: These customers constitute the
remainder of industry revenues. While these segments currently
represent a small portion of overall revenues, we expect them to
grow, as officefurniture manufacturers will attempt to take out the
middle man, and sell direct to its end users, both local and abroad.
Source: 2011 data from
http://www.ibisworld.com/industry/default.aspx?indid=870
Historical Revenue and Projections
Declining Revenues: Officefurniture industry revenues have declined
on average 4.5% per year over the last 9 years.
3
This is primarily due
to the economic crisis of 2008/2009 and the continued high
unemployment rate. The industry also gradually lost a portion of their
US consumption market share, at a rate of 0.8% per year, due to
lower cost imports (primarily from China).
4
To cope with declining revenues, officefurniture factories have been
closing down operations in the US at a rate of 1.1% over the last 5
years. For example, in 2011 Herman Miller closed a plant in
Wisconsin, while Steelcase announced it will close 3 plants in North
America by 2012.
2
Revenue Projections, Minor Growth: The following graph shows
industry revenues and our projections for the future. We expect
revenues to stay relatively stable in 2012, while increasing in 2013
along with the GDP and the employment rate, providing a 5-year
CAGR of 3.2%. By 2018, we expect growth in the industry will be in-
line with long term US GDP growth.
Continued…
Products, Drivers, and Growth Forecast
Customers, Drivers, and Growth Forecasts
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
4
Source: Historical data from FactSet
Industry Profitability
The OfficeFurniture industry has had poor return on invested capital
(ROIC) over the last 9 years, which is consistent with its poor revenue
growth. Negative economic profit was also common. However, as
the industry drivers improve and revenue growth trends positive, we
expect that by 2013 the industry will once again regain breakeven to
barely positive economic profit.
Industry Profitability
Source: Data from FactSet
International Playing Field:
Small but Growing International Exposure: The 4 public office
furniture manufacturers headquartered in the US gain most of their
income from the US market. A small portion of their sales (estimated
on average about 10%) come from international markets.
3
Along with reducing manufacturing capacity in the US, the industry
has simultaneously developed overseas plants in search for both
cheaper labor and a larger market for their products. For example, in
2006 HNI acquired the largest officefurniture manufacturer in China.
We expect this globalization trend of the 4 public companies to
continue, as they search for growth, which will primarily be found in
emerging market countries such as China and India.
Imports: Due to the space required, internationally shipping finished
goods is costly. Customization and installation is also a benefit that
cannot be obtained with imports. This is a primary reason why office
furniture imports have not grown at the drastic rates seen in other
industries, such as electronics.
The following graph shows the gradual increase of officefurniture
imports into the US over the last 15 years. While the market share for
US manufactures has been reduced by 0.8% per year over the last
15 years, we expect that this trend will subside to 0% market share
depletion by 2018 as Chinese manufacturing costs increase.
Source: http://www.bifma.org/statistics/index.html
Limited innovation
The industry has not recently developed innovation with the potential
to ignite growth. The cubicle was invented by Herman Miller in 1968,
but since then there have not been significant innovative
breakthroughs. Within the last 4 years, a technology called “laser
edgebanding” was developed, which allows an edgeband to be put on
non-solid wood desks, making the desks appear to be constructed of
solid wood. However, we do not foresee this technology as
significantly impacting long-term industry revenues.
Attractiveness of Industry (Porter’s 5 Forces)
Porter’s 5 Forces is a model used to determine the competitive forces
within the industry. Strong competitive forces put pressure on the
industry constituents, and reduce industry profits. As shown in the
following model, the officefurniture industry has below average
attractiveness due to moderately high competitive forces. The
strongest competitive force comes from industry internal rivals, which
compete heavily on price in addition to quality and delivery.
Continued…
Office Furniture Industry Revenues ($B)
Effect of Imports on the OfficeFurniture Industry
US Manufacturers have lost 0.8% US market
share per year over the last 15 years. This
trend is expected to halt by 2018.
Industry Average ROIC – All 4 Public Companies
Expected to return to 8.5% by
2013 and level off, just above the
average cost of equity of 8%.
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
5
ECONOMIC OUTLOOK
The health of officefurniture manufacturing is closely tied with
general economic factors, such as GDP, unemployment rate,
commodity prices, industrial utilization, and office construction. In the
following charts, we provide historical data for each driver, and
forecasts, and projections of how this will affect the officefurniture
industry.
US GDP growth is returning positive after its negative results 2008
and 2009. Henry Fund consensus estimates 2012 GDP growth of
2.8%. For 2013 onward, average GDP growth is expected to be
consistent with historical averages of 3.1%. This is a positive sign for
earnings growth within the officefurniture industry.
Source: http://www.tradingeconomics.com/united-states/gdp-growth
US Unemployment
A highly correlated driver of officefurniture demand is unemployment
rate (or inversely, the “employment rate”). As shown by the following
chart, as the historical US employment rate trends, so trends the
office furniture industry revenue.
Source: http://www.ibisworld.com/industry/default.aspx?indid=870
Currently, unemployment is close to 9%, and we forecast this will
continue to reduce to the 22-year average of 6.4% by 2018. As jobs
are added, businesses will purchase new officefurniture to
accommodate their new employees.
Source: http://www.tradingeconomics.com/united-states/unemployment-rate
US Industrial Utilization
US manufacturing utilization can be used as a proxy for office space
utilization, since manufacturers typically try to match their
manufacturing capacity with their office capacity. To meet constantly
changing product demand, manufacturers do not operate at 100%
capacity. The following graph shows that by 2013, US manufacturing
will reach the pre-recession utilization resistance level. Therefore, in
2013 we expect there will be solid office capacity expansion,
supporting short-term revenue growth in the officefurniture industry.
Continued…
US GDP Growth Rate (% Change YOY)
Expecting moderate
growth of 2.8% for
2012.
We expect unemployment to drop
to 8% in 2012, leveling at the long
term average of 6.4% by 2018.
Long term average is 6.4%
US Unemployment Rate
US Employment % and OfficeFurniture Industry Revenue
Porter’s 5 Forces
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
6
Source: Federal Reserve Bank of St. Louis,
http://research.stlouisfed.org/fred2/graph/?id=MCUMFN
US Office Construction
The US office construction index is typically a trailing index, which
does not provide foresight into officefurniture demand. This is due to
the long-term nature of construction. Nonetheless, it is useful to see
that the US office construction market appears to have hit the bottom
of the valley and is poised for cyclical growth.
Source: YCharts.com,
http://ycharts.com/indicators/us_total_office_construction_spending#series=typ
e:indicator,id:us_total_office_construction_spending,calc:&zoom=10&startDate
=&endDate=&format=real&recessions=false
US Commodity Costs
Commodity costs play a significant role in the profit margins of office
furniture manufacturers. Due to the competitive officefurniture
environment, when input costs increase, the entire cost cannot
always be passed onto the customers. Large customers such as
Wholesalers and Retailers have significant power to reject price
increases not accompanied by an increase in delivery or quality. The
following graph shows how prices have consistently risen for steel,
which is a primary industry input (other significant inputs include
labor, wood, and fabric). We expect steel prices to remain
approximately level at current prices in the next 3 years. This is
primarily due to the expected reduced GDP growth in China of 7.5%
in 2012 versus approximately 10% in recent years.
Source: US Department of Labor, Bureau of Labor Statistics,
http://data.bls.gov/pdq/SurveyOutputServlet
INVESTMENT POSITIVES
(+) Small but positive future growth: We expect positive
trends in key industry drivers such as unemployment rates
and GDP growth. This will provide annual industry revenue
growth at 3.2% over the next 5 years and 3.0% thereafter.
(+) Input prices to stabilize: Steel is a major input cost of
office furniture, and the price of steel has dramatically
increased since 2004. However, we expect steel prices to
level off at their current price for the next 3 years due to
China’s weaker than normal GDP growth of 7.5%. China is a
major user of steel, and a decrease in their usage provides
relief to other users of steel.
(+) Emerging market growth opportunities: Opportunities
for industry growth exists in emerging markets. Currently,
emerging markets is estimated to constitute only 10% of the 4
public companies’ revenue sources, although they all have
strategies to pursue this region. Growth of 5 - 8% is expected
in key emerging market regions, such as China and India,
over the next 5 years.
INVESTMENT NEGATIVES
(-) Overvalued relative to S&P 500: The officefurniture
manufacturing industry is OVERVALUED relative to the S&P
500. This is based on the industry’s lower growth rate, higher
beta, and higher price to earnings (P/E) ratio as compared to
the S&P 500. The current industry P/E is 18.3 versus the S&P
500’s P/E ratio of 14.0.
(-) Strong competitive forces: The officefurniture
manufacturing industry is mature, with low company
concentration, which puts pressure on pricing and profitability.
Over 3000 manufacturers exist in this industry, 70% of which
have less than 20 employees and serve local communities.
The top 4 public companies represent only 25% of the total
revenue. We do not expect significant change to this
landscape over the next 5 years.
US Manufacturing Capacity Utilization (%)
We expect businesses to
add to infrastructure
(including office furniture),
as they reach pre-
recession
utilization rates.
Pre-recession
utilization
resistance level.
US Steel & Iron Prices (base 1982)
US Office Construction (10 Year Chart)
Expected to
gradually trend up
starting in 2013.
Henry Fund Research
THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
7
(-) Negative historical revenue growth: Industry revenues
declined by 4.5% per year over the last 9 years. US plants
have been shut down or consolidated at a rate of 1.1% per
year over the last 5 years.
(-) Pressure from low-cost imports: Less expensive imports
from China have taken 0.8% market share per year from US
office furniture consumption over the last 15 years. This trend
is expected to gradually weaken until 2018, when import’s
market share stabilizes due to higher Chinese wages.
Market/Overweight Discipline:
Our recommendation is to UNDERWEIGHT the officefurniture
manufacturing industry. If any of the following events occur we would
reevaluate this recommendation:
The 4 public competitors make stronger advances in
emerging markets, constituting a portion of sales over 30%
(currently estimated at 10%).
The industry average P/E ratio drops to 20% below the
S&P 500 average. (Currently it is 30% above the S&P 500).
A significant technological breakthrough in officefurniture
products, which enables businesses to substantially increase
productivity.
The 4 public industry players take major acquisition steps
to consolidate the industry and achieve increased efficiencies
and reduced competition.
REFERENCES
1
About.com, History of the Office”, Mary Bellis,
www.inventors.about.com/od/ofamousinventions/a/office.htm
2
IBIS World, "33721 - OfficeFurniture Manufacturing in the US",
March 2012, www.ibisworld.com.
3
FactSet, www.factset.com.
4
BIMFA, www.bifma.org/statistics/index.html.
5
Yahoo Finance, www.finance.yahoo.com.
6
S&P NetAdvantage, Sub-industry Review, “Office Services and
Products.” www.netadvantage.standardandpoors.com
7
Herman Miller, 2011 Financial Report
8
HNI, 2011 Financial Report
Additional sources of data are cited under the applicable charts
throughout this report.
IMPORTANT DISCLAIMER
This report was created by a student(s) enrolled in the Applied
Securities Management (Henry Fund) program at the University of
Iowa’s Tippie School of Management. The intent of these reports is
to provide potential employers and other interested parties an
example of the analytical skills, investment knowledge, and
communication abilities of Henry Fund students. Henry Fund
analysts are not registered investment advisors, brokers or officially
licensed financial professionals. The investment opinion contained in
this report does not represent an offer or solicitation to buy or sell any
of the aforementioned securities. Unless otherwise noted, facts and
figures included in this report are from publicly available sources. This
report is not a complete compilation of data, and its accuracy is not
guaranteed. From time to time, the University of Iowa, its faculty,
staff, students, or the Henry Fund may hold a financial interest in the
companies mentioned in this report.
. Investment Recommendation: UNDERWEIGHT
Henry Fund Research
OFFICE FURNITURE MFG. (US Based)
Ryan Jennings
ryan-d-jennings@uiowa.edu
Source:. propose to UNDERWEIGHT the US office furniture industry
based upon its current overvaluation relative to the S&P 500.
The office furniture manufacturing