Retail The global economy overall is mending from the 2008 crisis. Many key metrics over the past 5 years have improved materially relative to the crisis years. The S&P 500, for instance, after reaching its low in 2009 has recovered more than 150%. The financial markets are now more stable through the enactment of various legislation including Dodd-Frank and Basel III. Even unemployment has rebounded steadily as consumers are more confident of their future prospects. These trends bode very well for the furniture retailing industry which was devastated by the financial crisis. As such, I believe many companies within this sector are poised for a strong and sustained recovery. Of the many companies and competitors within the sector, Ethan Allen Interiors, Inc. is best positioned for sustainable long-term growth (Gray, 1977).

To begin, the company is fortunate enough to have a strong economic tailwind behind it. The housing sector, which is indirectly responsible for a majority of the company's revenue, was devastated in 2008. As such the company suffered dramatic loses in regards to many of the more common financial metrics. Below is a chart indicated revenue and earnings per share for the company over the past 10 years. Notice in both fiscal year 2009 and 2010 were met with negative operating margin and earnings per share. In short, the company lost money in both years due to macroeconomic conditions prevailing at the time. The business is heavily cyclical, and dependent on both consumer sentiments and disposable income to capture large profits (Robert, 1988).

Chart 1

2004-06

2005-06

2006-06

2007-06

2008-06

2009-06

2010-06

2011-06

2012-06

2013-06

Revenue USD Mil

1,066

1,005

Gross Margin %

48.3

48.6

50.7

52.4

53.7

51.5

47.5

51.5

53.5

54.6

Operating Income USD Mil

96

-73

-12

32

50

60

Operating Margin %

13.4

13.6

13.4

11.1

9.8

-10.8

-2

4.7

6.8

8.3

Net Income USD Mil

80

79

86

69

58

-53

-44

29

50

32

Earnings Per Share USD

2.1

2.19

2.51

2.15

1.97

-1.83

-1.53

1.01

1.71

1.11

As the recovery continues to take shape, I believe Ethan Allen can regain much of the momentum of the 2004- 2007 period. During this period, the company had strong earnings per share growth, coupled with strong returns on both assets and equity. In fact, prior to the crisis, the company was an industry leader in both categories. Chart 2 indicates the firms ROA, ROE and Return on invested capital during the past 10 years. In addition the chart displays critical information regarding margins and asset turnover, both of which are critical to proper functioning of the furniture industry. Notice once again, the substantial decline in the years of 2009 and 2010. The company now has rebounded very promisingly from those devastating years. I believe the company is poised for still further growth.

Chart 2

Profitability

2004-06

2005-06

2006-06

2007-06

2008-06

2009-06

2010-06

2011-06

2012-06

2013-06

Net Margin %

8.41

8.36

8.03

6.89

5.93

-7.81

-7.51

4.31

6.81

4.45

Asset Turnover (Average)

1.38

1.48

1.48

1.25

1.25

0.96

0.92

1.08

1.15

1.16

Return on Assets %

11.59

12.37

11.9

8.57

7.42

-7.48

-6.93

4.64

7.81

5.15

Financial Leverage (Average)

1.42

1.45

1.95

1.96

2.03

2.11

2.44

2.23

2

1.85

Return on Equity %

16.09

17.73

20.12

16.74

14.79

-15.46

-15.7

10.83

16.47

9.9

Return on Invested Capital %

15.71

17.21

14.96

10.03

8.51

-11.09

-10.73

4.26

9.22

5.49

The reason for the bullish sentiments regarding Ethan Allen is rooted primarily on the company's strategy and how it intends to leverage strong future trends. First, the housing recovery is still moving forward at a steady, albeit tepid pace. The macro environment is well poised for an economic recovery in regards to housing. Housing is unique as it is the foundation for the entire economy in many respects. Not only do individuals need to purchase a house, but they also need to purchase furniture, bedroom sets, dining sets, appliances and so forth. As such, as consumers continue to purchase available inventory, Ethan Allen will indirectly benefit. This is particularly true as the company now has a profound focus on millennial that are increasing their purchasing power at a rate that directly corresponds to the low interest rate environment. As such, many young adults are entering the workforce at precisely the right time in regards to affordability. As such, home purchases are very attractive to millennial workers looking to purchase their first home. This will likely bode well for Ethan Allen who is heavily dependent on housing to foster growth. Another look at Chart 2 indicates this. The company had its strongest ROE figures during the best years of the housing cycle. The company had ROE's from the mid...

As housing continues to recover, I suspect Ethan Allen to repeat these numbers.
In addition, consumers are deleveraging. They are saving more, paying down debt, and postponing large amounts of consumption. Housing inventory is declining while household formation is increasing. In many of the more prominent housing areas (Nevada, Miami, Phoenix) housing prices have now recovered. In many areas, it is now cheaper to purchase a home than it is to rent an apartment. Homes are now at more affordable with the 30-year rate at roughly 4.34%. This again bodes well for the company has it now cheaper to simply purchase a home than it is to rent an apartment. This is a very compelling value proposition for the consumer. Consumer confidence is rising while jobs are becoming more bountiful. All of these factors bode well for a housing recovery in 2013 or 2014. With a large market share and locations in strong rural areas, Ethan Allen is poised for a recovery (Evens, 1997).

In addition, to the tailwinds of economic growth, a steady housing recovery, and rising consumer confidence, Ethan Allen has altered its product lineup. 60% of its line has been replaces or refreshed. As compared to competitors this makes it the newest lineup in years. The company is also offering free interior design classes to better engage potential consumers. In addition, the company has expanded heavily into emerging markets such as China and India. This expansion diversifies the company's revenue stream and doesn't make it entirely dependent on one particular region. This has directly impacted both the balance sheet and income statement of the company. Chart 3 below indicates many key financial measures adjusted at a percentage of revenue.

Chart 3

Margins % of Sales

2004-06

2005-06

2006-06

2007-06

2008-06

2009-06

2010-06

2011-06

2012-06

2013-06

Revenue

COGS

51.72

51.42

49.27

47.62

46.32

48.49

52.5

48.53

46.49

45.36

Gross Margin

48.28

48.58

50.73

52.38

53.68

51.51

47.5

51.47

53.51

54.64

SG&A

33.58

35.01

36.95

39.99

43.18

52.37

49.08

46.6

46.71

46.35

R&D

Other

1.31

-0.02

0.4

1.34

0.7

9.94

0.41

0.17

-0.01

Operating Margin

13.38

13.59

13.38

11.05

9.8

-10.79

-1.99

4.7

6.81

8.29

Net Int Inc. & Other

0.28

0.05

-0.43

-0.14

-0.39

-1.25

-1.2

-0.82

-1.16

-1.41

EBT Margin

13.66

13.64

12.95

10.91

9.41

-12.04

-3.18

3.88

5.65

6.88

Notice that COGS as a percentage of revenue continues to decline. Ethan Allen's strategy to diversify operations in low labor countries has enabled the firm to lower costs associated with manufacturing merchandise. The new refresh of its products correlated directly with the relocation efforts of facilities, mentioned above. As such, COGS as a percentage of revenue have declined from 51.72% down to 45% as of 2013. Conversely, gross margins have now become industry leading due primarily to cheaper labor and material cost. As of 2013, cross margins are now 54% with its two nearest competitors at 51% and 49% respectively. COGS, Gross Margin and EBT margin have increased for 3 consecutive years, indicating improve market and industry dynamics.

Why choose Ethan Allen over its two other competitors? The reason to choose Ethan Allen over the other two furniture retailers is simple and is rooted in both quantitative and qualitative terms. Below is chart 4 indicating financial results of Ethan Allen and its closest competitors.

Chart 4

Market Cap

Net Income

P/S

P/B

PP/E

Div. Yield

5-Yr Rev

Op. Rev

Interest Coverage

D/E

Ethan Allen Interiors, Inc.

32

1.1

2.3

24.2

1.3

-5.7

5.8

5.9

0.4

Mohawk Industries, Inc.

9,477

1.4

2.3

33.9

-5.3

5.6

5.1

0.6

Fortune Brands Home & Security Inc.

7,060

1.9

2.8

44.8

0.5

3.1

18.7

0.1

From a valuation perspective Ethan Allen is cheaper using the Price to Sale, Price to Book Value, and Price to Earnings ratio. In addition, the company has the highest dividend yield out of its two main competitors. In addition, using the income statement analysis above, Ethan Allen has the highest year over year revenue growth out of its competitors. Finally, investment is about risk vs. reward. The furniture business is highly cyclical and is fixed cost based. As such, the company may be heavily reliant on debt financing to provide manufacturing equipment, property, and building. The ability to repay interest in a timely fashion is paramount to the future success of any furniture company. When looking at both the balance sheet and income statement, Ethan Allen has the best ability to repay its interest and debt burdens. Its interest coverage ratio is 5.9, meaning it has $5.90 in revenue for each dollar of interest that it will need to service in the future. In addition, the company has the best free cash flow numbers out of all its competitors, meaning, after accounting for capital expenditures, the company has more than enough money to…