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Stocks A to Z / Stocks E / Ethan Allen Interiors Inc. (ETH)

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Author: mjohn707

Number: 112 of 136

Subject: A Quick Look at Ethan Allen
Date: 10/4/2001 11:50 AM
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No. of Recommendations: 9

Introduction

Ethan Allen is a manufacturer, distributor, and retailer of home furnishings. It sells through a
network of independently and company owned stores that exclusively carry their branded
merchandise. Ethan Allen's vertically integrated structure is unique in the industry. I think this
structure combined with a great management team, a 68-year-old brand name, and a large
investment in operating assets give EA a significant (and sustainable) advantage over its
competition. EA's business performance demonstrates the effectiveness of its strategy: margins and
return on owner's equity for the last ten years are both far above average, even without the use of
long term debt.

Future Growth

Ethan Allen believes that it can double the number of US stores from the current 270 in the future.
They also believe that there is considerable room for growth in same-store sales. Ethan Allen's best
stores have a penetration rate of over $80 per household compared to their average store's
penetration of just over $38 per household. Sales per store can scale up with little extra cost to the
company, so it's definitely the healthiest kind of growth.

Management

Management is really good. The head guy, Farooq Kathwari, has been with the company since it's
merger with KEA International in 1973. He led the management buyout that took the company
private in 1989, and took the company public again in a 1993 IPO. Kathwari emphasizes long-term
thinking when making business decisions, and strives to achieve growth only as long as service and
product quality are maintained. Management is focused on operating their business, maintaining a
healthy corporate culture, and is shareholder friendly. Kathwari recently did an interview with
"LEADERS Magazine," and I recommend it to anyone interested in learning more about his
management style.

Competitive Advantages

1. Ethan Allen claims they are 'vertically integrated,' which means that they control the
manufacturing, distribution, and retailing of their product. This allows them to be flexible and
responsive to a customer's needs. A customer can order custom upholstery from an Ethan Allen
store, and the company can then manufacture the furniture in their own factories, and deliver the
finished goods through their own distribution channels. This gives the customer more options
without costing Ethan Allen more money, and lets the company process customized orders quickly.
Management claims that delivery times are only four to six weeks for nearly half of these types of
orders, and that they can bring a product from design to display in less than six months.

2. Ethan Allen has a brand recognition of nearly 100% in households making over $50,000 a year.
More money is spent advertising Ethan Allen furniture than any other brand in America. Customer
retention rate is probably high (I couldn't find a figure anywhere) since redecorating is an involved
and lengthy process, and once a customer finds good service he's unlikely to take a risk with his
living room the same way he might take a risk and try a different kind of ice cream.

3. Each store has several on-staff 'design professionals' trained by Ethan Allen to help with
decorating decisions at no charge. An Ethan Allen designer usually visits a customer's home after an
in store meeting. Though the customers making use of this service are only a small percentage of
the total (5% - 10%), they produce over 50% of the company's sales. The management calls these
sales 'house-calls,' and Ethan Allen's ability to encourage and retain these customers is the heart of
their competitive advantage.

As an Ethan Allen store's sales increase in an area, they build a local reputation for good service and
high quality furniture. New customers looking for furniture or a decorating service are likely to
choose Ethan Allen because of their strong brand recognition and local reputation, and existing
customers are likely to stay with them because of previous good experiences with the company.

4. Each store sells a full range of home furnishings ranging from furniture, to rugs, to wallpaper, to
clocks. A customer could decorate and furnish a room using only the materials available for sale at
an EA store.

5. Furniture retailers can't offer Ethan Allen's full range of services because they don't have access
to their own manufacturing plants, and probably don't have the resources to build them either. While
furniture manufacturers can (and plan to) replicate EA's store model, it'll be difficult for them to
attain the same brand strength, network of stores, and reputation for service that Ethan Allen already
has.

I don't believe that other manufactures should be in a big hurry to build stores competing with their
own retail customers anyway. The new stores will likely only cannibalize their current
manufacturing sales. A shift to an all company controlled store format (like EA has now) is
probably the best way to compete, but most manufacturers are unlikely to take that step and give
away all their manufacturing sales to competitors.

Risks

1. Someone might replicate Ethan Allen's store model, service culture, and brand image.

2. Cheaply produced foreign furniture could put pressure on margins. The Sequoia Fund, a major
shareholder of Ethan Allen, mentions this risk in their 2000 Annual Report.
 3. Fashion risk. Quickly changing fashions can be just as bad for a business as quickly changing
technologies. Ethan Allen has had problems with fashion before. As a result, they expanded product
offerings, and haven't had any major problems since. Furniture fashion won't ever be as fickle as
clothing and shoe fashion because most people can't afford to redecorate their living room every
fall. There's a link on the Ethan Allen web site to an interview where the CEO specifically mentions
managing fashion, and I'd recommend it to anyone interested in the company.

Competition

1. IKEA Furniture - IKEA is a major low cost retailer. Their strategy is to purchase or manufacture
goods at the cheapest locations around the world, design products for the best shipping rates, and
deliver their goods at low cost high volume retail locations. Each store has a restaurant and is set up
like a huge showroom. Customers buy items directly from the warehouse shelves and load up their
own cars. Some furniture even requires home assembly. All these steps help keep costs at a
minimum for the company and the customer. While IKEA is definitely an interesting business, it
will never be the way most people shop for furniture, and it is not a direct competitor of Ethan
Allen.

2. Bassett Furniture - Bassett is a traditional manufacturer of moderately priced furniture. They sell
mainly through department stores, large dealers, and a couple of their own stores. They've made
plans to restructure their operations to resemble Ethan Allen's operations, but their success has been
limited so far. Their largest customer's bankruptcy hurt their results in 2000, and at best, the
company's brand name and product quality are only average. Bassett is a direct competitor, but not a
very good one.

3. Thomasville Furniture (A division of Furniture Brands International) - A traditional manufacturer

in the process of a major expansion of their retail divisions. Thomasville's Home Furnishing Stores
are probably the biggest threat to Ethan Allen. Thomasville is one of the strongest brands in the
industry, and the company plans to open more than 25 stores a year. While Thomasville makes great
furniture, I think they'll have difficulty competing using the 'furnishing service' store concept against
Ethan Allen.

Valuation

At $28, Ethan Allen is priced at less than 15x normalized earnings. If it can manage to compound
owner earnings at 8% for the next ten years, it should prove to be a good value.

mjohn707

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