Merion Road Capital Management, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. A quarterly return of 11.2% was reported by the fund’s Long Only Large Cap Fund, while its Long Short Small Cap Fund delivered a 14.0% gain in the second quarter of 2021, outperforming its Russell 2000, Barclay Hedge Fund, and S&P 500 benchmarks that delivered a 4.0%, 4.0%, and 8.4% returns respectively for the same period. You can take a look at the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of Merion Road Capital Management, the fund mentioned Flexsteel Industries, Inc. (NASDAQ: FLXS) and discussed its stance on the firm. Flexsteel Industries, Inc. is a Dubuque, Iowa-based furniture company with a $259.2 million market capitalization. FLXS delivered an 8.15% return since the beginning of the year, extending its 12-month returns to 140.13%. The stock closed at $37.82 per share on August 24, 2021.
Here is what Merion Road Capital Management has to say about Flexsteel Industries, Inc. in its Q2 2021 investor letter:
“We own shares in Flexsteel (“FLXS”) a residential furniture manufacturer. After making a series of questionable decisions, the prior CEO and CFO were replaced in 2018 and 2019. New management took swift actions to stabilize the business by disposing of excess capacity, exiting non-core product lines and rationalizing SKUs, and scrapping a poorly executed ERP upgrade. While most of the heavy lifting has been completed, the stock remains quite attractive at 7x FCF excluding excess cash on the balance sheet. Comparable companies trade around 9x (again adjusted for cash on the balance sheet).
There are a couple of reasons for this disconnect. FLXS is a relatively underfollowed company with a market cap of $250mm that has zero analyst coverage / earnings estimates. The company likely screens poorly too, as historic revenue growth has been understated due to shuttered business lines. For instance, revenue growth for the remaining business grew 33% YoY last quarter, versus the 20% that was reported. Optics will improve in their next quarterly report as numbers will be on an apples for apples basis.
The fundamentals seem like they are poised to outperform as well. FLXS lost share leading up to the management transition as the ERP debacle disrupted customer orders. Employee turnover subsequently increased given the uncertainty from the restructuring actions. Today the ERP system has been stabilized and employee retention has gotten better. FLXS upgraded its talent in marketing/sales and operations and is regaining share. Furthermore, the company will benefit from broader industry tailwinds with the increased focus on home upgrades; this is evident in their backlog that is up to $140mm vs $34mm at this time last year. While demand has been great, the industry has suffered from cost inflation and supply chain bottlenecks coming out of covid. The company’s ability to convert backlog into sales will be dependent upon their ability to source material in a timely manner. Similarly, they must be able to pass through pricing increases in order to maintain margins. I have been encouraged by their performance so far.
Over the past year management has used excess capital to repurchase 15% of their shares outstanding at an average price of $24.33. While they will continue to remain opportunistic on repurchases, they will likely use remaining capital to support growth. Front and center is expanding their e-comm presence. FLXS recognizes that they need to go deeper with Amazon and Wayfair by increasing their 3P business so they can control brand experience, pricing, and customer relationship. Additionally, they recently launched their own DTC brand and are in the process of overhauling the Flexsteel website.
They have a goal of doubling revenue from this distribution line. At just 7x FCF it does not seem like we are paying much for this option.”
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Based on our calculations, Flexsteel Industries, Inc. (NASDAQ: FLXS) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. FLXS was in 9 hedge fund portfolios at the end of the first half of 2021, compared to 10 funds in the previous quarter. Flexsteel Industries, Inc. (NASDAQ: FLXS) delivered a -20.50% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
