Analyst(s): Budd Bugatch

• Wednesday, the Business and Institutional Furniture Manufacturers Association (BIFMA) released its market statistics for January 2011. The month's order and shipment statistics were derived from a sampling of 30 companies in the contract office furniture industry whose combined shipments make up about 74% of total industry volume.
• BIFMA estimates January orders increased 23% year-over-year compared with a 24% increase last month. The prior year comparison for January was ~400 basis points easier. January 2010 orders declined 15% versus (11)% in December 2009. January marked the industry's eleventh consecutive month of year-over-year incoming order growth. January orders declined 23% sequentially, worse than the 20-year median December-January drop of 13%. In last month's update we suggested a larger than normal seasonal decline seemed likely given comments from industry participants regarding a year-end rush of projects.
• January shipments increased 22% year-over-year, accelerating modestly versus a 19% increase last month despite a much tougher prior year comparison [January 2010 shipments declined 12% versus (20)% in December 2009]. December marked the ninth consecutive month of year-over-year growth for the industry. Unfilled order backlog increased 32% year-over-year to $1.205 billion, though declined 2% sequentially.
• Looking ahead, it seems likely that February 2011 order growth should decelerate as comparisons get tougher. The 20-year median sequential change in February has been up 9%, which would imply February 2011 orders of $642 million. This is 10% higher than the previous year. Beginning in March 2011, industry orders will be comparing against positive growth in the previous year. Shipment growth; however, is likely to remain strong given robust recent order trends and improved backlog.
• On balance, the January 2011 BIFMA statistics were consistent with our favorable industry thesis. Over the next few years, we expect the industry to rebound from just more than $8 billion to nearly $10 billion driven by a recovery in corporate profits, improving business confidence, growth in white collar payrolls, and positive net absorption of office space. We anticipate significant margin improvement for our companies under coverage given their attractive operating leverage to incremental sales (~30% to 35% contribution margins) and attractive shareholder returns given the high correlation between industry volumes and share performance.
• On Feb. 22, BIFMA, (in conjunction with Global Insight) updated its periodic forecast for the industry. BIFMA now expects 2011 orders and shipments to increase 9.1% and 14.0%, respectively. This is up from 5.6% and 8.3% previously. While we have respect for the methodology Global Insight uses to develop its forecasts, we are less impressed by its point estimate forecasts for shipment and order growth. When issued, the updated forecasts reflect the recent changes in the underlying variables. Those variables, for the most part have been increasingly positive causing the "official" forecast to ratchet higher. Given the sizable reversal in year-over-year order and shipment changes that began in March/May 2010, we believe momentum will necessarily slow as the year unfolds and comparisons toughen. Below, we discuss our view about the sustainable growth rate for industry and the supporting rationale, concepts we postulate are more important for a reasoned investment thesis in the industry.
• As the cycle matures, we believe the "right" long-term growth rate for the industry should be Real GDP (historically ~3%) plus the inflation rate for the industry (historically ~2%). Throughout most of the 1980s and 1990s, the industry grew above this normative rate, driven by benefits from major product cycles (cubicles in the 1980s; PCs in the 1990s). Over the past decade, in the absence of a non-economic growth driver, the industry has become much more cyclical: experiencing two 30% or more declines (2001-2002 and 2008-2009).
• U.S. office space construction activity remains depressed; per the Conference Board, spending on new office construction declined 23% year-over-year in January. The Architect's Billing Index (which tends to lead non-residential construction by 9 to 12 months) fell to 50.0 in January from 53.9 last month, though increased relative to 43.6 last year. The index has been at or more than 50 (the line of demarcation between expansion and contraction) in each of the past three months.
• According to Reis, the national vacancy rate in 4Q10 was 17.6%, essentially unchanged versus 3Q10, but up from 17.0% last year. As we have also stated in past updates, we believe the high national vacancy rate suggests early improvements in project business may be driven more by absorption of existing space and be less dependent on new office construction. In fact, Reis also reported that occupied office space increased by 2.5 million square feet in 4Q10. This was admittedly modest, but still the first increase in three years.
• On balance, office furniture is a late cycle industry, typically lagging the broader economy by two or three quarters. While the industry's economic drivers remain mixed, accommodative fiscal and monetary policies appear to have taken the risk of a double-dip recession off the table for now, barring an unanticipated external shock. Nonetheless, we continue to expect a subdued and uneven recovery due to the lingering effects of high unemployment, depressed housing activity, and the high level of national debt. After moving aggressively to cut costs and preserve cash during the downturn, corporations have substantially improved profitability and built cash on their balance sheets. Business confidence continues to stair-step higher. While companies have again begun to invest in projects and equipment, the pace of new hiring remains unspectacular. Ultimately, it will take a more robust pace of hiring that will be needed to sustain the recovery beyond the furniture events of office space churn.
• According to BIFMA, January orders were $590 million, up 23% versus $480 million last year. Estimated trailing 12-month orders were $8.78 billion, up 15.5% year-over-year, and marking the highest level since July 2009.
• BIFMA estimates that January shipments increased 22% year-over-year to $675 million. Trailing-12-month shipments increased 8.4% year-over-year to an estimated $8.4 billion, the best since September 2009.
• January unfilled order backlog improved 32.4% year-over-year to $1.205 billion, though declined 2% relative to December. This represents the ninth consecutive month of year-over-year backlog growth.