Lumber Liquidators Holdings Inc (LL): This 500% Gainer Could be About to Take a Double-Digit Dive

As the housing market showed tentative signs of a recovery in the summer of 2011, many investors assumed that buying shares of homebuilders would lead to considerable profits. These stocks have indeed rallied nicely in the past two years, but have been outpaced by a more stealthy housing play, Lumber Liquidators Holdings Inc (NYSE:LL).

In the past 24 months, this stock has risen more than 500%. Trouble is, the stock is now disconnected from the fundamentals, and a sharp reversal may soon be at hand.

Lumber Liquidators Holdings Inc (NYSE:LL) sells a wide range of flooring materials through a network of more than 300 stores. Through much of the past decade, when the housing market was still going strong, the company posted solid growth.

Sales grew at least 20% a year from 2004 through 2007. Even the housing bust couldn’t slow this company down, as sales have continued to grow at a 10% to 20% annual pace since 2008. Analysts look for continued gains both this year and next. In fact, recently released Q2 sales grew a solid 22%, highlighting this company’s ongoing momentum.

Many other companies are in the midst of similar solid growth trajectories, but few can boast such an amazing stock price move. So what explains the appeal behind Lumber Liquidators?

The bottom line: metrics. The company’s gross margins typically hovered in the mid-30s, though thanks to economies of scale of a larger retail store base, coupled with benign lumber prices, that metric now exceeds 40%. Operating margins have typically hovered in the 6% to 8% range, but that metric should push above 10% this year.

And a company that never earned even a $1 a share in its history, earned $1.68 a share in 2012, and is on track for more than $3 in per-share profits by next year, according to consensus forecasts. In sum, a steadily expanding store base, coupled with solid same-store sales gains, has led to even more robust profit growth.

Yet, as is the case with many other great retail growth stories, Lumber Liquidators Holdings Inc (NYSE:LL) is about to hit stiffer headwinds. For starters, the company is on the cusp of adding roughly 10% more stores to its existing store base count this year.

Management has presumably already picked the “low-hanging fruit” in terms of ideal locations, and it’s unclear if the next wave of stores will start to cannibalize existing locations or will generate as much foot traffic as previously opened stores. Such a trend has tripped up The Gap Inc. (NYSE:GPS), Abercrombie & Fitch Co. (NYSE:ANF) and many others in the past, and Lumber Liquidators Holdings Inc (NYSE:LL) may be closer to market saturation than many suspect.