Whitney Tilson Thinks Lumber Liquidators Should Have Known Better - Home Depot (NYSE:HD), Loews (NYSE:L)

Lumber Liquidators Holdings Inc LL fell more than 20 percent Monday following a "60 Minutes" report that the company's China-sourced lumber contained dangerous levels of formaldehyde.

The company claimed, however, that the test was inaccurate and that its flooring was safe.

Hedge fund manager Whitney Tilson, who was featured in the report, issued a letter to investors addressing the company's claims.

When it came to Lumber Liquidators challenging the test results, Tilson commented, "I can't figure out if they are evil liars, trying to cover up the fact that they're knowingly poisoning their own customers to save a few bucks on sourcing costs, or whether they're just incompetent – but it's one or the other."

Tilson claimed that the testing used by Lumber Liquidators "is largely a sham" and does not conform the the same rigor as that of regulator or other companies. Tilson even commissioned his own test, which indicated the laminated wood being sold by the company was "highly toxic."

Tilson also argued that it would be "complete nonsense" if the company later claimed it was "defrauded unscrupulous Chinese mills." The price Lumber Liquidators paid for wood in China had too large of a profit margin for a "low-end, global commodity." In Tilson's view, the company was savvy enough to know there was something wrong with the wood or its source.

The investor's letter illustrated the idea that Lumber Liquidators should have known better and used the example of a tourist in Shanghai buying a $2 DVD of a newly released Hollywood film that is still in theaters. As a buyer, according to Tilson, the tourist knows enough to assume that the merchandise is illegal or forged and cannot legitimately claim they did not know.

Tilson continued along the argument and stated, "Even if the Chinese mills said they were CARB 2 compliant and even if they were supposedly inspected, this cannot be relied on. Heck, this is a country that sold us defective wallboard that soon [became] filled with toxic mold, and which pumped pigs full of clenbuterol."

From Tilson's perspective, many Chinese companies in highly competitive industries "scoff at most regulations" and have no hesitation at shipping defective products to the United States.

The other problem with the company's claims, according to Tilson, is due to the fact that Home Depot Inc HD and Lowe's Companies L also buy laminated wood from China and "don't have a formaldehyde problem" because "they have serious, rigorous compliance programs and understand that you can't hit the low bid in China and expect to get high-quality, compliant product."

Tilson concluded that Lumber Liquidator's reason for buying the high-profit margin but potentially defective lumber was to drive a "higher stock price so insiders could cash out.

Shares of Lumber Liquidators recently traded at $41.25, down 20.4 percent.

Image credit: Eden, Janine and Jim, Flickr

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