Analyst Insight: Lovely Lovesac

Analyst Insight: Lovely Lovesac

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Here at MyWallSt, we’re looking for innovative companies. Ones that are changing the world and will hopefully grow exponentially along the way. This tends to be SaaS businesses or backend players who’ve automated some part of development you’ve never heard of. They have fat margins, a sticky product that keeps revenue consistent, and a P/S ratio that makes your eyes water.

That being said, sometimes we find a funky business, a rogue, an outcast. A company that defies reason and finds success in the most unexpected of ways. They’re high-risk, high-reward, and border on the ridiculous. But at the same time, you can’t help but love them.

That, my good friends, is Lovesac.

As a reminder, Lovesac is a couch company dedicated to sustainability. Its founder and CEO Shawn Nelson wants you to buy one couch and never get another. He hopes the company will eventually become an entirely circular business, simply remanufacturing couches and selling them again. This is a noble endeavor as furniture makes up one-third of the waste in landfills.

However, it also seems like a terrible business model.

Couches get old, the cushions go flat, and upholstery goes out of style. What happens if you move and the couch won’t fit in your new living room? Or you have kids and now need extra seats? Why would you discourage consumers from buying a whole new couch and deny yourself the revenue?

Well, Nelson believes that products should be “Designed for Life”. And to this end, every couch that comes off the assembly line can be customized, not just when it’s manufactured, but by you in the future.

These couches are called ‘Sactionals’ and they’re a type of modular furniture. Need an extra seat? You can buy one and extend the length of your couch. Want new upholstery? That’s easy, Sactional covers zip right off and can be replaced by one of the hundreds of other colors or styles. You can add footrests, under-couch storage, firmer pillows, or even a surround sound speaker system. And it’s not just when you make your initial purchase, but any time in the future.

With all this customization, Lovesac has essentially eliminated other couch companies’ moats. And even though it’s discouraging consumers from making repeat couch purchases, it’s locking them in for a lifetime of upgrades.

Maybe you can make money and have a positive environmental impact.

We’ve seen this type of product and value proposition work in the past. Yeti coolers are a great example. When they launched, they were ridiculed for their prices. “$300 for a cooler? You must be insane.” But Yeti justified its prices by promising consumers the highest standards of quality and durability. Yetis keep things cooler much longer than competitors, they’ve proven it time and time again, and this has allowed it to build a cult following and generate $1.5 billion in annual revenue.

Lovesac would appear to be on the same road.

In its most recent quarter, fiscal Q4 2022, Lovesac had sales growth of 51.3% year-over-year, while sales for the year were up 58%. That’s pretty astounding when you remember Lovesac had an excellent 2021 thanks to the pandemic and its convenient e-commerce channel. When Millennials were buying homes at the peak of quarantine, they just ordered their couches online, prompting annual revenue to jump 35% in 2021. I thought Lovesac was a pandemic play, experiencing a pull forward, but it would appear to be the opposite. It seems to have significant pent-up demand.

When we look at where these sales are taking place, that view is supported. In 2021, 37% of sales happened in a Lovesac showroom while 53% happened online. In 2022, 60% of sales happened in-store while 30% happened online. Clearly, consumers want to see their cushion and upholstery options in person before they buy.

Lovesac has also built out a strategic partnership with Costco, bringing mini Lovesac showrooms into regions where they don’t have any real estate. This seems to be paying off as revenue from this segment more than doubled this year.

When we take a look at margins and profitability, there is plenty to love. Despite supply chain issues and increased freight expenses, Lovesac was able to achieve a gross margin of 55.9%, a contraction of a mere 200 basis points. Operating expenses climbed slightly faster than sales grew but the company was still able to turn in a respectable 12.3% operating margin. For a manufacturer, especially in the present climate, that’s pretty good.

Altogether, this meant Lovesac beat analysts' expectations by a lot. Earnings per share were expected to be $0.54, Lovesac turned in $2.03 a share for the quarter. This sent the stock flying on Tuesday, rising by more than 20%. However, because of the current distaste for growth companies and small-cap stocks, Lovesac is still down 20% year-over-year.

Looking toward the long-term and short-term future, there is still plenty of potential and a few concerns. Supply chain issues will continue to place pressure upon margins, but management seems up for the challenge. CEO Shawn Nelson stated that the company has worked diligently with its manufacturing partners “to mostly stem inflation at the raw goods and labor input levels”. He hopes that this should mitigate pressures until at least 2023.

However, with inflation impacting consumers, I worry we will see a decrease in discretionary spending. In most cases, a new couch is a luxury, unless you’re moving into an unfurnished home. For this reason, I would assume Lovesac’s current growth rate is unsustainable. Management declined to give full-year 2023 guidance but did state for Q1 of 2023 that it expects sales growth of 39% year-over-year, which would make it the slowest quarter in more than a year and a half. Despite this, profitability is expected to improve and with its discounted share price, it may still be worth a look.

Turning towards the long-term horizon, Lovesac remains somewhat of a risky proposition. Much of its success rests upon its sustainability and customization and how these messages are conveyed to consumers. We know Millennials and members of Gen Z are more considerate with their spending, they’re looking for businesses to support so Lovesac is well-positioned. But, that places a lot of pressure on Lovesac’s branding.

Brand is always a precarious and fickle moat. Things tend to go out of style and that can leave companies vulnerable, especially when you only make one type of couch and one type of bean bag chair.

That being said, sustainability is so built into the fiber of Lovesac, that I think it would be difficult to quickly replicate. From the fabrics used, to the bean bag filler, to the packaging process, everything that can be made green has been. And the company is only getting better and more circular. This may grant Lovesac’s brand longevity and make it successful for decades to come.

Anne MarieAnne Marie

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