Interface, Inc. (NASDAQ:TILE) is a global leader in design, production and sales of modular carpet, and a manufacturer, marketer and servicer of select other floor covering products for the commercial, institutional and residential markets. Interface markets modular carpet in over 110 countries under established brand names such as InterfaceFLOR, Heuga, Bentley Prince Street and FLOR. In broadloom carpet, its Bentley Prince Streetbrand is also a leader in the high-end, designer-oriented sector of the market. The company has a presence on four continents, with over 50% of the business coming from outside the U.S.
TILE is the largest global manufacturer of modular carpet, riding on the secular trend of modular carpet moving from a niche to a category. In recent years, modular carpet sales growth in the floor covering industry has significantly outpaced the growth of the industry as a whole, as designers and end users became more familiar with the unique attributes of modular carpet, including its dynamic design capabilities, cost advantages as a result of reduced waste in both installation and replacement, and the ease and speed of installation. Carpet tile was ranked as the number one “hot product” for the tenth consecutive year, according to the 2011 Floor Focus interiors industry survey of the top 250 designers in the United States. Also, carpet tile accounted for less than 50% of the commercial carpet markets in United States, Europe, Asia ex-Japan and Australia, where Interface is among the top two players in each regional market.
Interface has successfully diversified its end use markets in non-corporate office market segments, such as government, education, healthcare, hospitality and retail space, and reduced its dependence on the mature office market. This is evident in its mix of corporate office versus non-corporate office modular carpet sales, where non-corporate office modular carpet sales represented 53% and 40% of its 2011 America and company-wide sales respectively. This opens up new growth opportunities for the company, as non-corporate office market segments as a whole are almost twice the size of the $1 billion U.S. corporate office segment; and Interface is also targeting the $11 billion U.S. residential market segment for carpet as part of its diversification efforts.
TILE’s made-to-order and global manufacturing capabilities allow it to provide custom samples quickly to potential customers and on-time delivery of customized final products. The company has approximately 75% to 80% of its modular carpet products in the United States and Asia-Pacific markets made-to-order, with the United States, Europe and Asia Pacific accounting for 52%, 30% and 18% of its production, respectively. Its made-to-order capabilities increase speed to market, support a constant flow of new products and decrease lead time to customers; while its global manufacturing capabilities in modular carpet production give it an edge in serving the needs of multinational corporate customers that require products and services at various locations globally.
Valuation and Financial Analysis
Interface currently trades at a trailing twelve months EV/EBITDA of 14.8 and trailing twelve months EV/EBIT of 17.5. In terms of asset based valuations, its current 5.2x P/NTA and 3.8x P/B represent premiums of 18% and 35% over its respective historical five year averages. The company achieved a trailing twelve months ROE of 7.0% and a five year average ROE of 6.5%.
The company has a patchy earnings track record with five years of losses in the last decade, although it has achieved three consecutive years of profitability from 2009 to 2011. Its cash flow track record is more comforting, with positive operating cash flow in each of the last eight years starting from 2004. Free cash flow was positive in four out of the past five years, despite modernization and restructuring efforts over the past several years. TILE’s historical investments in global manufacturing capabilities and mass customization techniques and facilities, coupled with rationalization and repositioning initiatives in the last decade have paid off and enabled it to increase production levels at its existing capacity without significant capital expenditures. Its existing capacity allows it to increase production levels without significant capital expenditures, further enhancing its free cash flow generation capability as demand for its products rises
Interface is highly geared with a gross debt-to-equity ratio of 100% and a net gearing of 67%. Prior to 2006, The company’s gross debt-to-equity ratio was consistently above 200%. They re-initiated dividends in 2007 after a four year break and currently sport a dividend yield of 0.54%.
Investment Risks
Sales of the company’s principal products have been and may continue to be affected by weal economic conditions and the renovation and construction of commercial and institutional buildings. It has historically generated most of its sales in the corporate office segment, although it is making efforts to diversify its end markets and reduce its dependence on the corporate office market segment. TILE targets to eventually reduce the proportion of company sales attributed to the corporate office market segment to 30%.
Interface relies significantly on its principal design consultant, David Oakey Designs. David Oakey Designs provides carpet design and consulting services to TILE’s floorcovering businesses under an exclusive consulting contract that contains non-competition covenants. Its current agreement with David Oakey Designs extends to April 2013 and David Oakey Designs cannot provide similar services to any other carpet company while the agreement is still in effect. The company introduced more than 25 new carpet designs in 2011, and David Oakey Designs had a pivotal role in developing its i2product line, which features mergeable dye lots and carpet tile products designed to be installed randomly without reference to the orientation of neighboring tiles.
Conclusion
Interface is moving into growth stock territory with its current valuations. Despite its market leading position and strong growth opportunities, its low dividend yield and high gearing are stumbling blocks for value investors.
The article Interface Should Be Swept Under The Carpet for Now on Valuation Grounds originally appeared on Fool.com and is written by Mark Lin.
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