Category: Equities – long

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Should SodaStream go Single?

Recently, we wrote about the key positive characteristics of SodaStream’s business and financials versus Green Mountain Coffee Roasters’ (“GMCR”)link.

So where does GMCR’s business concept excel over SodaStream? 
Investors are going gaga over the thought of a SodaStream single-serve soda maker similar to GMCR’s Keurig brand that would be marketed to consumers.  However, we believe the economics aren’t viable for the home market.  While SodaStream competes with store bought soda, GMCR  competes with retail store-brewed coffee such as Dunkin Doughnuts, McDonald’s and Starbuck’s.  Given the labor-intensity/rents of in-store coffee,etc., GMCR’s at-home cost remains significantly cheaper compared to store-bought coffee.  For comparison, a *typical k-cup is about $0.60 compared to $1-$2 for retail store coffee.  This represents a discount between 40-75% (see Table 1 below). Furthermore, customer ratings are high (according to Amazon.com reviews).
 *We acknowledge that k-cup price ranges can be huge, from $0.44/unit to over $1/unit.  Prices are even cheaper from indirect sellers such as Ebay.

                            Table 1 <click to enlarge>

While single-serve soda data is not available for SodaStream, its cost-benefit to the consumer will likely be far worse compared to single-serve coffee.  In order to determine whether single-serve soda will be cost-effective, one must first determine if the cost/liter of SodaStream’s soda is significantly cheaper than store-bought soda.  As consumers realize all too well, serving costs increase sharply as serving sizes decrease.

In Table 2 below, we analyzed the cost differences for the consumer between SodaStream’s system versus purchasing soda from the store.  We showed both SodaStream’s advertised cost/liter as well as a more realistic, or actual number.  This number is based on amounts actually reported by consumers on Amazon.com, etc.  Note that Table 1 is an analysis of single-serve coffee while  Table 2 compares cost/liter.  According to the table, at best, the consumer realizes a 23.5% discount to store-bought soda.  At worst, SodaStream consumers actually pay more for soda (and this doesn’t include the labor involved, aka the “fun-factor”).  Note that the prices surveyed for store-bought soda were both for Coke and Pepsi as well as white-label brands.   Presently, nearly all of SodaStreams flavors are white-label/private brands.

                         Table 2 (click to enlarge)

In conclusion, if SodaStream cannot produce a cost-effective product on a per-liter basis, it stands to reason that a cutting-edge single-serve soda machine would not be able to achieve such a goal.

Further, both GMCR’s and SodaStream’s  cost estimates exclude the price of the machines, which sell for  $100-$150 on average.  So then… how would Socially Responsible Investing solve this problem?

 List of Operational Tactics recommended to SodaStream:
 

1.  The Single-Serve maker and other innovations should be targeted to the “SOHO” market.  This is because the machine would likely be significantly higher priced than SodaStream’s $100 machines, and the soda volumes would be far higher, legitimizing the machine-cost.  Further, the higher volumes would increase corporate profitability as the margins are significantly higher for consumables (CO2, flavors) compared to the traditional home-consumer market.  There is also a fixed-cost component to SODA’s operations further boosting margins. Of course, this would be a direct challenge to Coke/Pepsi, which have soda dispensers in most offices.  The key would be to “fly below the radar” by marketing to “mom/pop” businesses.

2.  Lower the sales price of the beverage machines: The company already makes a decent margin on them and could afford to do this. Reducing the machine price would also strengthen the company’s business model, and increase longer term profits (as the blades bring in higher gross margins compared to the razor-blades).

3.  Outsource beverage machine production:  This could lower machine prices, better match logistically with end market demand and importantly, significantly reduce geopolitical risk (e.g, West Bank, see point 7).

4.  Utilize and leverage core competencies (i.e., technology).  When this writer heard that SodaStream was Israeli, the first thought was Jewish “Silicon Valley” where several innovative companies are based.  SodaStream should license its technology to white-lable brands and boost R&D. This would be a better use of R&D dollars compared to consumer single-serve.  It is requested that management disclose R&D numbers in its financial statements.

5.  Make alliances with soda beverage companies for brand-name & proprietary flavors. The most frequent complaint among users is that several of the flavors are “just aweful.” Many noted that SODA mixes sugar substitutes into their flavors, leaving a horrible after-taste.  We note that consumers’ ratings on SodaStream are worse than they are for Green Mountain Coffee Roasters.  This problem must be immediately addressed to lower long-term customer loss-rates.

6.  Market to consumers an easy way to return the empty CO2 refills.  Netflix can perhaps “lend a hand” on this!  This is the second largest complaint by users.  I would suggest the company negotiate with UPS and offer its customers prepaid envelopes to return the empty C02 refills.  SodaStream should also increase control of its complicated distribution network in the U.S.

7.  Become a truly Socially Responsible Company by investing in local communities, investing in its employee community and by creating a set of metrics to measure the company’s production of greenhouse gases, etc.  The company should acknowledge that transportation costs for refills does create significant greenhouse gases.

Lastly, it should also address the controversies over its West Bank plant location.  SODA’s principal manufacturing plant is located in Mishor Adumim, an area in the West Bank that is the subject of dispute between Israel and the Palestinian Authority.  There has recently been negative publicity against companies with facilities in the West Bank.  And a number of activist groups have called for consumer boycotts of products produced in the West Bank.


Disclosure:  the author is long GMCR, SODA.

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    Interface churns out another good quarter (1Q’11)

    On April 27, Interface (IFSIA) reported First Quarter 2011 earnings.  Highlights…

    • Revenues rose 13% to $245.4MM
    • Operating Income was 7.8% of sales (up 27.4%)
    • Net income was $9.8MM vs. $4.9MM.
    • The above translates to EPS of $0.15 vs. $0.08
    • EPS met analysts’ consensus estimates.
    • Note: all of the above exclude charges.  1Q is the company’s slowest quarter.
    • link to 1Q’11 Press Release 

    Overall:  Interface continues to perform as expected, and the company has experienced few downside surprises.
    Click the image above for clearer wording.  Source: Interface.

    What’s Changed vs. our Initial View:  Based on what I’m hearing from the street and economics departments, the carpet industry will continue to be weak at best.  New Construction will remain lackluster, so the company’s growth will depend on increasing market share in the office market and getting the word out to consumers (as it tries to compete in the retail market).  Based on earnings data and conference call comments, we believe both Operating and Free Cash Flow will be somewhat lower than initially forecast (see below for additional information.)

    What we liked in the 1Q’11 report:
    Interface has been able to increase profitability despite rising raw material costs and the weak construction market.  Plants are running smoothly.

    IFSIA remains committed to sustainability with recycled fiber reaching a high of 40%.  Though, Interface will not stop there, as its long-term goal is 80%.  An interesting remark on the call was that few consumers were interested in buying green carpets, and that Interface’s ESG won’t be in the headline marketing for the retail business. This demonstrates management’s authenticity in my view.

    Interface: Historical data on Recycled Materials

    What we didn’t like:
    As mentioned earlier, company is spending heavily on promoting its carpets (new direct retail channel), and increasing manufacturing production.  This is pressuring Free Cash Flow, indirectly via higher SG&A, higher Capex, and working capital.


    What’s Interface worth?
    Interface’s shares appear fully-valued using Price-to-Earnings data, and earnings estimates.  I believe a corporation’s P/E ratio primarily reflects earnings growth, of which is then adjusted for industry structure and the firm’s leadership position.  As such, the current P/E of 21x appears to fully reflect earnings growth for 2012.   This number is lower than the 27x when we first wrote about IFSIA; however growth is expected to slow in 2013 (unless economic growth picks-up).

    Earnings & Cash Flow Quality:
    Perhaps it’s appropriate to add a few comments given that this website’s “raised Hell” about the earnings quality of Green Mountain Coffee Roasters–>STORY.

    Compared to the same quarter last year, both earnings and quality of cash flow was High.  Interface continued to incur start-up costs at its plant in China.  It could have separated these in its earnings presentation to make earnings appear better.  Though, management chose not to.  Last year the company had bond retirement and restructuring charges that were presented separately from GAAP earnings.  This quarter’s earnings release was “cleaner” as it only presented GAAP earnings.  Operating Cash Flow was depressed from higher inventories (see comments below) and a speedier payoff of short-term bills/payables.  Hence, we also rate Cash Flow quality as HIGH.

    Click the image for clearer wording.  Source: Interface.



    1Q’11 Earnings Highlights:

    • Revenues rose 13% and business is tracking well.  Though the first month of the quarter started weak because of bad weather both in US and Europe.  2Q’11 is off to a good start.
    • Geographically:  Growth witnessed in all regions.  Though some parts of Asia growing slowly, however, Australia is doing well.  Europe is doing ok, with strength in Italy (small market) and Germany.  Biggest opportunity is Germany which has the lowest modular carpet penetration and the biggest volumes.  However, overall European business is too low, keeping capacity use at just 60%.  This hinders profitability. Management specifically stated that it needed the UK to kick in.
    • Orders grew 10% Y/Y.  This is okay, but lower than previous quarters. Though, momentum rose as quarter progressed. (In fact, an analyst from Raymond James Financial was concerned over the Book/Bill ratio on the conference call.)
    • Profitability: Interface is able to maintain and increase profit margins.  So, far it’s been able to pass along price increases. There will be another increase in May.  SG&A expenses, which increased as we expected, are now forecast to decline in the coming quarters both on a % of sales basis, and in dollar terms. (Though, we acknowledge this seems inconsistent with the company’s plan to increase market share.)
    • Direct-Channel:  Retail stores are doing better than expected.  Chicago’s same-store-sales rose 50%, and the new store in SOHO, New York City had a successful March opening.  Note that this is a new business area, and S/S sales data may not represent true secular growth.
    • Operating Cash Flow for the quarter was weak (an $18MM deficit) due to high working capital usage. Interface spent 38% more on inventories Y/Y as it was worried that it would repeat the under-investment of 2010.  It also over-ordered some raw materials before expected price increases.
    • China plant (and costs thereof) continue as planned.  No surprises.  I’ve seen photos of the plant; it appears modern and well designed, and will include both a showroom, and open views of the factory floor (which is also great for transparency). See image below, courtesy of Interface Inc.
    • Will add 50 salespeople to boost share in non-traditional end markets.

       Disclosures:  The author is long IFSIA.  Information for the above report based on industry data, the company’s press release, Investor Presentation 2010, conference calls, and data provided by sell-side equity analysts.

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        Interface (IFSIA): 4Q’10 Update

        On 2/23/11, Interface Inc. (IFSIA) reported a decent 4Q’10, meeting analysts’ consensus expectations of $0.21 (actually beating them ever slightly).   Press Release

        Overall, we have few issues with the company, so will report only key points…

        • Backlog was good (+15% Y/Y) but less than the previous quarter (+20% y/y).  This was due to inclement weather, as we’re all too familiar w/ this winter.

        • The company’s customer diversification strategy is tracking well.  For example, sales outside of traditional offices (such as retailers, education) picked up during the quarter.

        • Raw material costs rose about 5%, and the company is likely to raise prices.  However, given the still-weak US Consumer Economy, we don’t expect the company will be able to continue such a strategy in 2011/12 unless economic growth accelerates.  Also, raw prices are likely to remain high, given Mideast Turmoil and high demand for most commodities in Emerging Markets.

        • The Chinese plant opened, but is still not profitable (as expected).  We still think this is the key plant and market to watch.  So far, both are tracking well.  While small, Emerging Markets are continuing to grow quickly and show that Interface made a wise decision to invest in a new Chinese plant.

        • However, these new investments are keeping Free Cash Flow at bay.    FCF was just $10MM for full year 2010.  As a result, FCF for 2011 may be a bit lower than I had predicted in my original Analysis (the above is due to simultaneous increase in Capex and lower operating cash flow than expected).

        Note that the company reported Non-GAAP numbers, but we are of the belief that such numbers are valid given that the company had a one-time Bond Refinancing that is truly a non-recurring event.

        Conclusion:  A good quarter for IFSIA, would have been even better, if well, Mother Nature was in a better mood.  Looking forward to continued momentum on existing trends.

        Posted on

        SRI Analysis: Interface, Inc. (IFSIA)

        Introduction:  Interface Inc. (NASDAQ: IFSIA) is an environmentally responsible manufacturer and marketer of interior floorings.  This Atlanta, GA based company specializes in modular carpets.  Modular carpets are essentially the square carpet tiles one often observes on the floors of open offices.  The photo below highlights the company’s fancier squares marketed to the more fickle consumer market.
        Interface Inc. is what this website labels a Socially Responsible Investment.  The various sections below examine different parts of the company and factors affecting its valuation (stock price).  This research report examines the company from all perspectives, not just whether it fits our ESG criteria.  We have gone to great lengths to examine the company as objectively as possible.

        Stock Chart courtesy of Google Finance.
        Disclosure:  the author is long shares of IFSIA.
        Executive Summary
        What we really like…
        And not so much..
        ·     Attentive, focused management
        ·     Shares near 52week high
        ·     Brand leader, high market share
        ·     Moderate financial leverage
        ·     Strong orders/business trends
        ·     High volatility of stock (Beta)
        ·     High peak-earnings power
        ·     High earnings volatility
        ·     Leadership in Sustainability
        ·     Low business diversity
        ·     Conservative accounting
        ·     Sensitive to the business cycle
        ·     Successful restructuring
        ·     Moderate Insider Selling

        We believe Interface, Inc. is a good SRI investment candidate.  Our rating is “7” (out of a possible 10).  This rating incorporates quantitative and qualitative factors, including the corporate, social and responsibility efforts of the firm.  The Executive Summary above summarizes key investment factors/risks.  With the goal of maintaining objectivity, every investment is required to have a full list of Negatives, or if you will, “things we don’t like very much.”

        Firstly, this is a company with a soul, best exemplified by its chairman and founder, Ray Anderson.  In 1994, he set his company the aim of having zero impact (“Mission Zero”) on the environment by 2020.  As Ray describes, it was a dramatic wake up call, analogous to “a spear in his chest.”  He challenged his employees “to head the first company that, by its deeds, shows the entire industrialized world what sustainability is in all dimensions: people, process, product, place and profits – and in doing so, become restorative through the power of influence.” And the company hasn’t looked back since!
        After a long day trail-running in Bend, Oregon, it was a pleasure to run into Ray Anderson’s book at the local library.  Readers are encouraged to literally check it out!

                                            
        This “Mission Zero” has enabled the company to be ever focused on its customers, end markets and products.  In fact, the company now specializes only in modular carpet.  This enabled Interface to become a leading niche player in flooring, though to the risks of low business diversity and high sensitivity to the Business Cycle.

        One big byproduct of Mission Zero has been a transformed culture, one that has inspired creative solutions, making carpeting as exciting as iPads.  Key share data and our rating are below:

        Share Data:
        Interface, Inc.
        IFSIA-Nasdaq
        Price (1/03/11)
        $16.20
        Our Rating:
        52-Wk Range:
        $17.15 – $7.05
        7
        Out of 10.  Higher is better.
        YTD % Change
        88%
        Market Cap (mm)
        $1,020mm
        Shares Outstanding
        63mm
        Beta:
        1.6x  (Bloomberg)
        Dividend (Yield %) qtr.
        $0.02 (0.5%)
        Price/Book value:
        3.8x
        Earnings estimate:
        $0.60 (12/2010)
        This report is provided for information purposes only and is not a recommendation.
        P/E ratio (on above est)
        27x

        Share Data on Interface Inc. (see table) reveals a company with moderately-priced shares as measured by their Price/Book value (3.8x), Price to Earnings (P/E) ratio, and the fact that its share price is closer to its $17.15/share 52-week high, than to its low.  Dividend Yield (of <1%) and high Beta imply volatility of the shares.   Market Capitalization of $1Bn categorize this as a Small-Cap investment, further increasing return, as well as risk.  Our overall investment rating is 7, reflecting strong business order trends, but higher-than-average balance-sheet and share price volatility.

        Given the company’s higher overall volatility, we expect its share price to be highly sensitive to the business cycle.  The best time to purchase shares of such industrials are during the bottom of business cycles (e.g., 2009) when companies are reporting net losses.  Based on economic forecasts, it appears economies (especially the U.S. are in the beginning to mid-stage of recovery).  Hence, upside “remains in the cards.”
         Income Statement (’09)
              Balance Sheet
         Cash Flow statement
        Revenues:    $858.9mm
        Current Assets: $388.0
        Cash Operating: $55.5
        Oper Inc.:         64.7
        Total Assets:        727.2
        Cash Investing:   (-7.4)
        EBITDA:         89.9
        Total Liabilities:  481.1
        Cash Financing:  (-3.5)
        Net income:     10.9
        Total Sh.Equity:  246.2
        Free Cash Flow:  43.6
        Revenues for FY Dec’09 were $858.9mm, down from the $1.1Bn peak reached in both FY’08 and FY’07.  Given strong order growth, analysts say revenues could reach their previous peak by FY’11.  We believe Interface can easily meet this estimate given its excellent execution.  As such, the most vital factor will be whether or not a secular transition to modular carpets continues overseas, particularly Germany (a large market), where carpet tile penetration remains under 10%.  (Refer to the Industry Discussion for additional information.)
        Interface has large operating leverage as well as moderate to high financial leverage.  This combination can yield exciting earnings gains when business trends improve.  Thus, a 1% Revenue gain will likely lead to far higher changes in net income.
        Shareholders’ Equity of $246.2mm is somewhat low, given the company’s moderate (mostly long-term) debt profile needed to support fixed assets/machinery.  Shareholders’ Equity has declined over the last 1½ years given net losses and a restructuring.
        Surprisingly, Interface managed to remain Free Cash Flow positive over the last 3years, though this was attributed to the inclusion of non-cash items.
        In the charts below (sourced by Bloomberg LLC), rather than focusing on the absolute dollar level over the years, note the volatility of them.  This volatility can be seen in nearly all aspects of the company ranging from earnings, cash flows, assets and share price.  Such volatility visually demonstrates that this company is riskier than average.  From left to right number 1) is Revenue, 2) Operating Income, 3) Pretax income, 4) Income bef XO items, 5) Net income, 6) Basic EPS before abnormal items. 

        Profitability
        E: estimate
        Gross Margin (%)
        35.1% (2010E)
        EBITDA Margin
        12.5% (2010E)
        Operating Margin
        9.8% (2010E)
        Return on Assets
        5.3% (2010E)
        Return on Capital
        6.0% (2009)
        Net Profit Margin
        2.6% (2009)
        Gross margins have been fairly good, rising from 33% in FY’09 to 35% by 2010E.  We expect this to continue into 2011, as the company moves up-market into the consumer market.  However, it is not certain how net income will be affected, as the consumer market requires more advertising spending.  Overall, net profit margins are likely to surge given the company’s high operating leverage.  Interface’s Return on Capital is also expected to rise given the above comment, as well as lower interest costs related to its recent bond refinancing.
        Recent Financial Performance:
        3Q’10 highlights, and trends
        Revenues
        $253MM (+16% Y/Y) ­
        SG&A
        61.4MM (24% of sales) 
        Operating Income
        $28MM (11% of sales)­
        Net Income
        $12MM (5% of sales)­
        Recent Financial Performance:  In the table above, we summarized Interface’s 3Q’10 financial performance.  Please see link for Press Release.  Rather than reiterate the company’s statements, we highlight key data points, comments and provide our opinions below.
        • Overall performance was quite good (rising GPM, OpM and NPM compared to previous quarter and year-ago).
        •  Profitability and margins accelerated.  However, we expect limited SG&A improvements.  In fact, management stated SG&A might not go lower than 23% going forward.
        • Revenue growth rate accelerated (+16% Y/Y) 
        •  Order growth was very good (+20% Y/Y)
        • Company is gaining market share
        • Geographic strength in Emerging Markets (China, India, Brazil)
        • The upscale consumer business; Bentley Prince Street, is slowly returning to profitability (but not yet…)
        • Management indicated that 4Q’10 is tracking well.
        The most important factor in the 3Q’10 report, in our opinion, was the strength in Emerging Markets.  This strength is vital as the company is about to open a new plant in China, and needs the demand.  This plant likely won’t be profitable until sometime later in FY’11, given start-up costs and low initial capacity utilization (15%-20%).  We also note that the Chinese authorities have made significant efforts over recent months to cool their economy and associated inflation.
        Liquidity / Credit Stats:
        E: estimate
        Credit Ratings (Moody’s / S&P)
        B1/B+ (senior secured ratings)
        Bank lines:
        New $300MM Revolver on 11/9/10
        Cash & Near Cash items:
        $115.4MM (FY’09) $81MM (Sept’10)
        Capex
        $28MM E (FY’10)
        *Significant Debt maturities:
        $100MM (FY’12) $150MM(FY’13)
        Free Cash Flow:
        $50MM E (FY’10)
          *company is refinancing its public bonds
        Overall liquidity is quite good, supported by a new revolving credit facility, positive Free Cash Flow and longer debt maturities.  During Nov’10, Interface announced it would refinance its two bonds with a new $275MM senior notes due 2018.  At a 520bp spread (estimated) the notes would yield approximately 7.6%.  This compares with a weighted average coupon of 10.6% on the retiring bonds (aggregating to $260MM).  Both Moody’s and S&P affirmed Interface’s credit ratings in their review of the company’s new notes.
        Leverage
        FY’09 ended 12/09
        Operating Leverage
        3 (very high)
        TD/ Common Equity
        124% (moderate)
        TD / Total Capital
        54.5% (moderate)
        TD /EBITDA trailing 12 mos.
        3.3x (moderate)
        Net Debt / EBITDA
        2.0x (low to moderate)
        Total Debt / Market Capital
        56% (moderate)
        Cash flow Operations / TD
        18% (low to moderate)
        As implied from the table above, Total Leverage (operating leverage + financial leverage) is high.  Using 3Q’10 data to calculate Operating Leverage, for every 10% increase in revenues, Interface’s EBIT rises 30%.  Total Debt is somewhat high too, especially relative to Common (Shareholders’) Equity, which in itself has been volatile over the last 10-year period.  (Refer to the chart below.)  However, other measurements such as Net Debt/EBITDA indicate a company with lower financial leverage.
        Source: Bloomberg LLC

        Valuation:
        Forward data based on estimates
        P/E ratio:
        33x  (TTM FY’10)  27x forward P/E
        Price /Book
        3.8x (as of 3Q’10 ended Sept.)
        Price / Sales
        1.1x  (TTM FY’10)
        EV / TTM EBITDA
        10.5x (TTM FY’10)
        Dividend Discount Model (DDM) calculated price:
        $4.20 (Source:  Bloomberg LLP)
        Actual Share Price
        $16.20 (as of 1/03/11)
        DDM price vs. actual share price
        (-74%) thus shares are Overvalued
           Notes: EV: Enterprise Value,  TTM: trailing 12 months.
        Interface is moderately priced using most measures.  In one extreme, Price-to-Sales is low, indicating undervalued shares.  On the other extreme, the Dividend Discount Model (DDM) is indicating very overvalued shares.  The model utilized is a 3-stage DDM consisting of a growth, transition, and mature stage.  The Beta applied was 1.56x (source: Bloomberg) which we confirm given Interface’s high share and balance sheet volatility.  (In fact, the Beta provided by Google Finance is even higher, at 2.5x.)  The long-term growth rate used was 14.7%, which declines to 8.7% at the Maturity stage.  Both growth rates are higher than we are comfortable utilizing.
        As a check on the DDM, we calculated an intrinsic share price value based on the Free Cash Flow (FCF) model.  Under the above FCF model, the equity valuation of the firm was $10/share, using a 1.56x Beta, but more conservative growth rates, including 3% terminal growth rate.
        ESG Profile
        CsrHub ratings:
        Rating
        AGR Rating
        Overall rating
        47
        CONSERVATIVE
        Community rating:
        46
        AGR Score
        Employees rating:
        50
             93rd Percentile
        Environment rating
        44
        Governance rating
        45
        Equity Risk Factor:  5 (best)
        Source: CSRhub.com
        Highest rating is 100
        Source: Audit Integrity
        As mentioned in our introduction to Interface Inc., the company is a global leader in sustainability.  This would be the “E” in ESG.  While not a recognized leader in overall ESG, I believe the company may be better than what’s implied by its CsrHub rating (left column).  CsrHub rates Interface an overall 47 rating.  This is slightly below the average rating for a US company as well as its industry peers.  They do, however, give Interface a 50 rating for its relationship with employees, which is higher than the overall company average of 48.
        This website will use CsrHub and Audit Integrity ratings given that they are a good standardizing and benchmarking tool.  However, we also recognize the high weighting of qualitative criteria in Socially Responsible Investing.
        CSR Hub is a website used to aid people such as SRI investors and socially conscious consumers make decisions on whom to do business with.  CsrHub’s overall ratings are based on four categories that are in the table above.  Their major data sources are ASSEAT4 (from Thomson Reuters) Governance Metrics International, IW Financial, Trucost, Vigeo, and several others.
        Interface has received numerous awards over the years, including advancing to 16th place in CRO Magazine’s 100 Best Corporate Citizens.  This is a prestigious ranking often cited by the media.  Though, we note the company hasn’t placed in CRO Mag’s more recent lists.  Interface was also recognized by Time Inc. 2007 edition of Heroes of the Environment magazine special.  More recently, Interface was honored by the Centers for Companies That Care.

        Another aspect of SRI due diligence is analyzing the company’s quality of financial reports and accounting.  This website will rely on Audit Integrity to benchmark companies in this area.  Interface, Inc. earns high ratings in this category, rated in the 93rd percentile of all companies examined by Audit Integrity.  This means the company’s financial statements and governance have not been flagged by Audit Integrity.  Flagged companies tend to have a higher probability of earnings restatements, and litigation.  AGR, did note though, that executive/board Insider Selling was a concern.

        Further, Interface’s AGR score has remained high (usually above-average) over the last 3 years (See chart below).  The company also earns an Equity Risk Factor of “5”, its best rating.  Companies with such a rating have outperformed the market.

        Industry & Macroeconomic Data:

        Industry / factors:
        Broad End-market
        End Markets
        Carpet/Flooring
        Commercial
        Corporate Office
        Growth: 3% CAGR
        Consumer
        Consumer/Home
        Size: $2.3Bn U.S. (2009)
        Institutional
        Government
        Secular Trend towards Modular carpeting
        Healthcare
        Mature industry
        Hospitality
        Retail
        Interface participates in the carpeting segment of the Flooring industry.  The Flooring industry is in the Maturity stage of its life cycle.  This stage is marked by low growth, high penetration, high competition and revenue cyclicality.   Despite competition with fairly large companies (e.g., Mohawk Industries: $5.4Bn in revenues FY’09) Interface continues to compete successfully using a niche strategy focusing on innovating the modular carpet market.  During the last 10 years, it has shifted its business from 40% modular to 92%. 
        Most readers are probably familiar with modular carpet.  It’s basically the square carpet tiles seen in offices.  In modern day offices, they offer some key advantages, allowing technology workers to simply add/remove floor cables without having to cut into the whole floor.  Modular tiles also have no need for padding, offer quick installation, and produce less waste.  And what waste there is left over, can easily be recycled thanks to Interface’s lead in sustainability.
        The total U.S. Commercial Carpet market was $2.3Bn in 2009 and is forecast to grow 3% annually to $3.3Bn by 2020 (Sources: Interface, Invista, Floor Focus, Carpet & Rug Institute, Catalina Research).  Penetration of modular carpet was 38%, up from 26% in 2004, and the company hopes this could reach as high as 65% by 2020.
        In the United Kingdom (not part of the above research data) the penetration rate is as high as 44%, hence this implies some room for US penetration increases.  The largest opportunity lies in Germany where the market size is large and the penetration rate is just 8%.
        Of course, carpet growth is influenced by construction activity, and anyone following the Financial Crises is well aware that construction is at recessionary levels.  The table below forecast that both non-residential (e.g., offices) and residential construction won’t take off until 2012.  However, we note new construction is only one part of the equation, as office remodelings are another demand factor.  Interface estimates that remodeling is as high as 90% in the U.S., but far lower 10% in Emerging Markets.  Of course, most of the buildings in Emerging Markets are relatively new, so there’s a lower need for remodeling.
        Forecast for end markets
        2010e
        2011e
        2012e
        2013e
        Real GDP (United States)
        2.6%
        2.4%
        3.3%
        3.2%
        Real Nonresidential Construction
        (14.8%)
        (4.9%)
        4.4%
        14.7%
        Residential Construction
        (3.7%)
        8.4%
        32.4%
        15.8
        Source:  S&P Economic Research,  Baseline forecast.

        While the majority of revenues have historically been to the Office Market, Interface is expanding its customer base into the Retail, Government, Healthcare and Education Segments.  It’s also moving into the Consumer market via its upscale FLOR brand.  Interface opened its first retail store in Chicago in 2009.  This is a big risk and return opportunity for the company.

        Peer Analysis:
        As stated earlier, the module carpet industry is a segment of the larger Carpet industry, which includes conventional broadloom carpet.  However, several carpet companies are part of larger, home furnishing companies.
        Interface’s largest direct competitors are highlighted in yellow shading below.  Interface also competes directly with Shaw Industries (not in table below) especially for modular carpeting.  Shaw, which is also Georgia based, was acquired by Warren Buffet’s Berkshire Hathaway in 2000.  Shaw is the world’s largest carpet company with estimated revenues of $5Bn and over 30,000 employees.

        As the reader can see from the above tables, Interface, is smaller than the largest publicly-traded home furnishings/carpeting companies.  Interface’s revenues approximate nearly $1Bn; however this compares with the industry median of $2.8Bn.  Though, revenues and EBITDA are expected to grow much faster relative to the industry, which has been suffering a slow turn-around.  (All numbers, including estimates were provided by Bloomberg LLC.)  This faster growth results in a higher than peer group P/E ratio of 25x. (Note: P/E based on stock price data as of 11/2010).

        The P/E column is repeated in the second table for Valuation comps with its peers.  Interface’s shares are clearly trading at above its peer group.  We have also provided the WACC, showing just how high weighted average cost of capital is not only for Interface, but the industry as a whole.  Privately-held Shaw Industries, in comparison has the luxury of being under the Berkshire Hathaway umbrella; and the firm likely has a far lower cost of funding compared to most of its peers.
        In conclusion, we truly believe Interface will continue to do well in business and Mission Zero, as the company continues to grow more innovative, smarter, and maybe even a bit kinder!
        DISCLOSURE:  The author is long IFSIA, Interface, Inc.   The above research is not a recommendation to purchase the securities of Interface, Inc.
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