Wednesday, April 20, 2005

Furniture Business--North Carolinas Bread and Butter

North Carolina has long been the furniture manufacturing capital of the world. Recent years have been tough for most labor intensive manufacturing businesses in the states. Yesterday, I received my semi-annual report from the High Point Home Furnishings Market. (This long standing market place is being threatened by a new market in Las Vegas. The apparent theory is that buyers would rather party in the after hours in Vegas. The High Point Market is a serious market but certainly a part of the sales promotion is to wine and dine the big buyers. In my opinion, the major market will remain in High Point.)

It is interesting that some of the top selling pieces this year are very expensive "home made" products. Ironically, some of the very best "home made" products were only designed here. Those furnishing their dream home are apt to spend more on furnishings. In case you missed it, the home business has been in a super strong cycle for ten years or more. Millions of Americans having built a large equity in their first home have now "moved-up" to their dream home. Millions of others have purchased second homes and most of these are not the rustic cabins or beach cottages of days gone by. Buyers who feel threaten by the ups and downs of stocks are comforted by seeing the gradual climb in market values of homes. The last few years the gradual climb has steepened.

The above is not written to suggest that the furniture business has not been "leaning" itself down--lowering production cost, reducing over-time pay, substituting capital for labor and over-turning every stone to increase productivity. In today's Winston-Salem Journal it was reported that Canac Kitchens, a wholly owned subsidiary of Kohler Co, is building a new factory in Statesville NC. The company plans to hire 400 employees over 3 years. The Governor of NC has released a $250,000 grant to attract the business to NC. The company is based in Wisconsin and it is the largest supplier of frame-less cabinets in North America.

The $250,000 invested by the state is a drop in the bucket compared with the money spent to woo Dell Computer to the middle of furniture country. The investment by Kohler of $20,000,000 is about one tenth of the investment by Dell but still an important deal for NC.

Cabinetry is a fragmented business. Cabinets are typically lower cost products than stand alone furniture with more hidden components made of cheaper materials. The margins are tighter and the cabinets are often made in the same region of the country where they are used. In other words, shipping cost must be significant enough relative to production costs to encourage regional manufacturing. However, it is also true that like stand alone furniture, more and more of the mill work is being done in developing countries or by computer programed machines that allow more flexibility of manufacturing, higher productivity and longer distribution lines. Some American manufacturers are converting at least part of their business to becoming assembly plants with parts being shipped in from far and wide.

As an investor, I have mixed feelings about investing in furniture stocks at the current time. The manufacturing economy is recovering, consumers are buying homes and consumers are flush with liquidity. Taxpayers have just been hit with the most alternative minimum taxes ever but capital gains tax rates are already set to go down again in the next couple of years. The demand side should remain fairly strong for the next several years. The problem I have is in capacity. Whenever an industry starts adding capacity, the beginning of the end is at hand. One could say that the housing industry added capacity 10 years ago and continues to add capacity but the demand is absorbing the new capacity. This would be true, but the demand for real estate is basically an investment demand whereas the demand for furniture is more of a discretionary item.

Obviously, the cabinet business mentioned is tied strongly to the construction of homes. But extra capacity could reduce margins even in a period of strong demand. Regardless of what happened in the past ten years, the housing business is a cyclical business. America has enjoyed the benefits of immigration and our baby boomers and echo boomers have taken advantage of liberalization of financing laws. There are still millions of Americans who can afford a second home who have chosen not to buy one.

My wife and I are planning to work hard this winter via the internet. We have our first home for sale and we plan to do our work this winter from a rental unit in the deep south. We see no point in buying a winter home when there are so many available for rent at reasonable rates. A recent study showed that in some markets the rental costs are now only 47% of the costs of ownership. The owners renting at such spreads must be banking on future capital gains. If the capital gains of these markets slow, the housing boom will stop dead in its tracks.

I believe in buying the "big" US companies in the current market. Furniture is fragmented and subject to foreign competition more than the "big" companies. I am a Bull on the market. I simply have not gotten excited about any particular furniture company. If you have one to suggest, I would be happy to hear from you.