Wednesday, July 27, 2022

Maybe not a Nova

Nulla Spe means no hope in Latin. 

I like to invest in stocks lacking expectations. If enough investors dislike and sold the stock, it would have little room to decline further. My downside risk is limited.

The upside is potentially significant. It doesn't take much to move a hopeless stock. A government contract, one significant customer, or a slightly less negative guidance would suffice. Its underlying business just has to become functional from being outright dreadful.

Heads I win, tails I don't lose much. 

I like those odds. 

This effective yet simple philosophy once didn't resonate with me. It started my investing journey, and had excellent results, but was seemingly too simple for outsized returns. 

What I have learned, after reflecting on a painful stint in growth investing, is that I was the simpleton who was unable to uncover its full potential

Let's move on to the first stock I found upon returning to the nulla-spe philosophy: Nova Lifestyle (NASDAQ: NVFY), a debt-free nano-cap ($5m market cap) wholesale supplier of furniture.

True to its name, NVFY behaved like a nova, shining brilliantly during its initial public years before fading. At .24x tangible book now, it is priced to perish, but would it? Look at the list of disasters it survived:

2018: A short attack by Andri Capital, which rated NVFY a Strong Buy in November 2018 before reversing into a Strong Sell a month later

2019: Higher trade tariffs imposed by the Trump administration devastated NVFY's margins made on importing Chinese furniture, forcing it to stop imports and reducing sales by 73%

2020: Covid lockdowns in China reduced the Company's imports further. Sales fell 48%.

NVFY is showing encouraging signs of a turnaround. In 2021, sales increased yoy for the first time in 4 years. The shift towards higher-margin products has worked. Higher ASP, lower volumes, and revenue growth were observed in 2021 and q122. 

q122 also didn't have any write-downs of slow-moving inventory, the first since 2019. NVFY may finally have the right inventory now.

Its working capital cycle appears to be normalizing as well. Inventory turnover is getting faster, and receivables are turning over much faster than in previous years (perhaps due to factoring, which wasn't mentioned in the 2021 10k). Given its recent history of inventory write-downs, I'm glad that someone is willing to buy its receivables

NVFY still has a long way to go to return to its former glory. It used to trade at 1-4x tangible book pre-tariff. If it could adapt to a post-tariff environment with higher-margin products, it may return to a 1x TB multiple (a 4x return!).

Warrants would trigger a 17% dilution at $3.50/sh, which is distant for investors targeting a 4-5x return from current levels.  

I don't know whether NVFY would maintain sales and margin momentum for the rest of 2022. Management is certainly incentivized to right the ship. Liu, a vice-president, has owned 30% since 2018, and CEO Lam about 1%. The ownership structure makes me think that Liu is the real leader.  

Perhaps the sales growth so far was more a result of a Covid-led stay-home boom than improving product-market fit? Who knows. 

All I know is the stock looks like an asymmetric bet at all-time lows.