6.3.13 | St. Petersburg, FL | Raymond James & Associates analyst Budd Bugatch, commenting on BIFMA’s market statistics for April 2013, noted that while the acceleration in order growth was encouraging, “we would caution readers to not to get too excited on the basis of one month. The contract office furniture industry is inherently lumpy, and the timing of large projects entering the order book can sway the monthly figures.”

>Friday after the stock market close, the Business and Institutional Furniture Manufacturers Association (BIFMA) released its market statistics for April 2013. The month's order and shipment statistics were derived from a sampling of 27 companies in the contract office furniture industry, the combined shipments of which make up about 73% of total industry volume.

>BIFMA estimates April orders increased 13% year-over-year, a marked acceleration compared with March's 1% increase. The prior-year hurdle for April was unchanged relative to March (both April 2012 and March 2012 orders declined 3%). Thus, on a two-year stacked basis, April order growth was ~800 basis points (bp) better relative to March. April orders decreased 5% sequentially, better than normal seasonal trends (the 20-year median March to April percentage change has been -9%). Trailing 12-month orders totaled $9.39 billion, essentially flat versus the prior year but 24% above the February 2010 trough.

>According to BIFMA, April shipments increased 6% year-over-year, also nicely improved compared with flat shipments last month. The prior-year comparison for April was about 300 bp easier (April 2012 shipments were down 4% compared with -1% in March 2012). Consequently, the two-year stacked shipment growth rate for April was ~400 bp better than February. Trailing 12-month shipments were $9.275 billion, down 0.9% year-over-year but 22% above the April 2010 trough.

>April Order Growth Encouraging, But Let's Not Get Carried Away Just Yet. The April BIFMA statistics were nicely better than our pre-report expectations with order growth accelerating on a one- and two-year basis versus last month and demonstrating a smaller than seasonal sequential decrease. Notably, April's 13% order growth rate marked the highest percentage increase since June 2011. Given our positive fundamental view of the industry, a strong double-digit order growth number is certainly preferable to a weaker one. Nonetheless, we would caution readers to not to get too excited on the basis of one month. The contract office furniture industry is inherently lumpy, and the timing of large projects entering the order book can sway the monthly figures. Historically, April is seasonally the third smallest month of the year for industry orders and in 2012; April was actually the second lowest month. Thus, the strong growth came from a small base. In a nutshell, we don't think much has changed. The industry continues to slowly improve as better demand from corporate customers is being partially offset by continued weakness in federal government.

>Looking ahead, the 20-year median change in orders from April to May has been +10%, which would imply May orders of ~$870 million (up ~4% year-over-year). Notably, prior year order comparisons will be relatively easy for the next five months. The year-over-year percentage change in orders ranged from -2% to -8% from May through September 2012.

>We characterize the industry's key drivers as positive or improving. That said, the pace of change has been frustratingly slow due in part to the continuing drag of weaker federal government shipments (impacted by the sequestration). Job growth has been positive since October 2010 - nonetheless, the trend has been choppy and the gains very modest. Positively, corporations are experiencing record or near-record levels of profitability and balance sheet cash. However, fiscal uncertainty has driven some hesitancy among decision makers. While the absolute level of office construction remains depressed, trends have stabilized (following a roughly 50% peak to trough decline based on Census Bureau data) and are beginning to modestly improve. The Architects' Billing Index - which leads non-residential construction by 8-13 months - had been above 50 (the line of demarcation between expansion and contraction) for eight consecutive months (August 2012 to March 2013), but decreased to 48.6 in April compared with 51.9 in March.

>According to Reis, net office space absorption was positive by ~17 million square feet in both 2011 and 2012 and is forecast to continue to slowly improve going forward. Vacancy rates peaked in 1Q11 and have begun to tick lower but remain elevated relative to history. This should support continued office churn, as corporations move and/or consolidate space, taking advantage of favorable lease rates and motivated landlords.

>This month, BIFMA updated its periodic industry forecast. BIFMA increased its 2013 order outlook from +3.4% to +4.8%, though held its shipment growth estimate steady at +2.1%. BIFMA expects 2014 orders and shipments to increase 5.8% and 7.2%, respectively (down from its previous estimate of 9.2% order and 9.0% shipment growth. We believe BIFMA's outlook for modest growth in 2013 followed by acceleration in 2014 seems reasonable given continued improvement in the broad economy and the later cycle nature of the office furniture industry.

>We view price-to-earnings multiples for Steelcase, Herman Miller, and Knoll as attractive given our positive longer-term view on the cycle and prospects for higher sales and margins in coming years. Generally speaking, industry margins should benefit from favorable mix (normalizing levels of commercial versus government business), better net pricing/input costs, and improved efficiencies due to more consistent production - partially offset by increasing levels of investment in product development, marketing, and other growth initiatives. Strong balance sheets and positive cash generation also seem likely to benefit shareholders through further deleveraging, dividends/stock buybacks, and tuck-in acquisitions.

>Office furniture is a structurally attractive industry for investors. Collectively, the four publicly traded manufacturers (Herman Miller, HNI Corporation, Knoll, and Steelcase) hold roughly a 60% North American market share. While the industry is highly competitive, it is largely rational. Furthermore, the industry has historically been successful at passing through pricing to recover input cost inflation. In contrast with residential furniture, office furniture has also been resistant to significant import penetration given the high degree of customization and exacting requirements of architects and building managers.

>Each of the companies we cover is well managed and of high quality, in our opinion, boasting solid balance sheets, positive cash flow, attractive operating leverage, individual competitive strengths, and somewhat differentiated strategies. Despite choppy macro conditions, we continue to believe we are in multiyear revenue and margin recovery, which bodes well for shareholder returns given the high historical correlation between industry volumes and equity performance.