Three-minute pitch # 7
Deep, deep value with inflecting earnings
You have to be crazy to like a name like this.
This is a deeply neglected, orphaned asset - a European company that trades solely in the US and has been public since the 1990s. This is a stock that has gone nowhere and has been in perpetual turnaround mode for over a decade. It’s also illiquid and small, trading at a market cap of under $100m.
However, I believe this left-for-dead stock is now incredibly compelling, offering a multi-bagger potential once its cyclical end industry recovers and providing meaningful downside protection given the company’s substantial assets.
Let’s take a look.
Natuzzi (US: NTZ ADR) is an Italian manufacturer and marketer of leather and fabric upholstered furniture (sofas, loveseats, sectionals, etc) worldwide through its own and franchised stores. The company operates distinct brands, including Natuzzi Italia, Natuzzi Editions, and unbranded furniture. Despite an under-the-radar listing, the Natuzzi brand is well-known and well-regarded due to its 60-year heritage. In the last few years, sales have approximated €400m.
NTZ has a market cap of €62M (11m shares O/S), has €37m in cash, and ~€52m in debt, which puts the enterprise value at €76m. The company’s debt comes in the form of an A/R securitization facility (~€30m, <1 year) and a mix of mortgages and longer-term debt. The company has significant real estate assets (€160m at cost, or €60m of net book value), net operating loss carryforwards of ~€370m (€360m never expire), and a joint venture in China that should be worth at least ~€30m. Tangible book (ex. leases) is about €100m, or €9 per share ($10 USD/share).
Importantly, NTZ is in the process of selling two buildings - its US HQ and showroom in High Point, NC, and a tannery in Italy. I estimate that the proceeds from these sales should be at least €15m. On a pro-forma basis, if you net out the proceeds and the value of the Chinese JV, you are looking at an EV of ~€30m. This means NTZ is trading at less than 0.1x EV/sales on a TTM basis.
However, this is a story of inflecting earnings. There has been a fundamental shift in the underlying earnings power of the business, which has been obscured by the post-COVID whipsaw and consequent housing slowdown.
Before 2020, the company struggled due to a structurally unprofitable cost structure; due to tough labor laws, Italian operations had too many “redundant workers, " resulting in a high fixed cost base. Exacerbating the issue, the patriarch of the business, Pasquale Natuzzi, who built the business from the ground up, prioritized lower-margin wholesale and private-label furniture.
However, the outlook for the company changed in mid-2021. Pasquale decided to step back from the business and brought on Antonio Achille as the new CEO. Prior to joining Natuzzi, Antonio was a former Partner at McKinsey and Head of the Global Luxury practice in Europe. Since then, Antonio has focused on righting the ship through multiple initiatives that have started to drive margins materially higher: de-emphasizing private label, de-emphasizing wholesale, building and franchising Natuzzi stores (which capture incremental margin), and right-sizing operations - moving/restructuring out of Italy to new geographies as well as improving utilization in manufacturing.
While this is a gross oversimplification of the company’s efforts, the net effect of these positive changes has been steadily improving margins over the last few years, with EBIT margins going from negative MSD to positive LSD in 2022. Unfortunately, the tougher environment for furniture demand has masked incremental progress since. On a TTM basis, gross margins have improved by roughly 600bps to ~37% within the last 3 years.
While sales are running materially lower this year (down ~30% YoY), I believe that if NTZ is able to get back to its 2019 level of revenue (€385m), it should now be earning roughly a 5% EBIT margin, or about €20m. Obviously, this is a fairly significant earnings power on a PF EV of ~€30m. There is no guarantee that the company will get there anytime soon. The good news is that NTZ has done a good job of keeping losses small, with flat EBIT margins in Q1/Q2 and a small loss in Q3 despite the steep drop in revenue.
However, I think there are green shoots emerging. During the Q3 earnings (November 27) call, Antonio mentioned that they had seen order growth for the past 19 weeks, marking a possible turn to a 15-month period where they had consistently seen decreasing orders year-on-year.
At €20m in operating profit, I think NTZ could trade for ~8x pre-tax earnings, which would yield a €15.5 stock ($17 in USD vs $6 today). A good comp to look at is the French company Roche Bobois, which has a very similar business and size (revenue of ~€ 400m) and sports EBIT margins near 10%. Roche trades at ~13x forward pre-tax earnings or about ~1.4x sales.
In the long term, I believe that if NTZ is able to grow sales beyond 2019 levels, then the company could get to a high-single-digit EBIT margin. This would square with previous management commentary (given in May 2022). Some growth is not out of the question, as the company has been more focused on rolling out owned & operated Natuzzi stores, particularly in the US.
If the company does not turn around, I believe that you should be well protected given the significant asset value and upcoming asset sales (HQ + tannery). In a tough environment, the company should also be able to keep losses small. Moreover, small-cap activist David Kanen owns about 11% of the company through his fund, Kanen Wealth Management. If this were to go off the rails, having a well-aligned activist could lead to a better outcome overall (although, keep in mind that this is 61% owned by Natuzzi and family).
Given the potential upside from an improved market for furniture and the downside protection, I am LONG shares of Natuzzi.
Appendix
One quick note - what’s crazy about NTZ is how deep the bench is in terms of talent, particularly for a company under $100m in market cap. These are some of the key hires they’ve made over the past couple of years:
Antonio Achille (CEO) - Former Partner at McKinsey + Head of Luxury
Carlo Silvestri (CFO) - Former CFO of Ferragamo
Jason Camp (Head of US) - Former Sr. Exec at Restoration Hardware
Gilles Bonan (Board member) - Former CEO of Roche Bobois
Catalysts
Revenue growth given the improvement in orders. Keep in mind that comps get significantly easier in Q4 2023 and from there on.
Completion of a sale of non-core assets for EUR 15m or so.
Continued recovery in the furniture market. Lower interest rates in the past couple of weeks should start to help.
IPO of Chinese JV - this is more of a wildcard. Management has mentioned this as a possibility, but it seems unlikely in the short term.
Risks
Furniture demand remains weak.
I could be wrong about the company’s turnaround/improvement in the cost structure, and the company could remain loss-making.
This is very small and illiquid, so there’s a risk the market won’t care or won’t give it an adequate multiple.
Thanks so much for reading! Let me know if you have any thoughts, questions, or pushback in the comments below.
Do you have further intel on the stock option plan and the CEO’s incentives to increase stock price? I couldn’t find any specifics for individuals in any of the filings.