FLWS - 1-800-Flowers: Pressure On Revenue Growth Continues

2023-09-12 04:59:24 ET

Summary

• The company's revenue decreased by 17.9% YoY, while the operating loss (% of revenue) reached 6.1% YoY.
• Consumer pressure from macro headwinds and declining economies of scale continue to weigh on revenue growth and profitability.
• My recommendation is hold because I believe pressure on revenue growth will continue, while improvements in gross margin may take longer than it seems.

Introduction

Shares of 1-800-Flowers ( FLWS ) have fallen 34% YTD. Despite the fact that the company continues to pass on increased inflation rates to the end consumer, lower transaction volumes and lower economies of scale continue to have a negative impact on the business's financial performance.

Investment thesis

Although the company's management sounds quite confident when talking about future financial results due to inventory reduction, lower freight costs and optimization of marketing expenses, in my personal opinion, the company may continue to experience both lower revenue growth rates and pressure on the level of operating profitability, despite the fact that the company's management expects some improvements at the gross margin level.

Company overview

The 1-800-Flowers company sells gifts (fresh cut flowers, gourmet foods, cookies, chocolates, candies etc) for various occasions. The main business segments are Consumer Floral & Gifts (62% of revenue), BloomNet (8% of revenue) and Gourmet Foods & Gift Baskets (30% of revenue). The main brands are Cheryl's Cookies, Harry & David, Shari's Berries etc. The company was founded in 1976 and operates in the US market.

4Q 2023 (fiscal) Earnings Review

During 2023 (fiscal), the company's revenue growth rate was in the negative zone due to a decrease in consumer spending due to macroeconomic uncertainty. Although volume in monetary terms continues to decline, the company has taken a number of initiatives (increasing the share of premium price points, increasing product prices and optimizing operating expenses) to maintain business profitability.

In 4Q 2024 (fiscal), the company's revenue decreased by 17.9% YoY . The largest contribution to the decline in revenue was made by the “Consumer Floral & Gifts” and “Consumer Foods & Gifts Baskets” segments, where sales decreased by 17% YoY and 18.7% YoY, respectively.

Gross profit margin increased from 33.7% in 4Q 2022 (fiscal) to 37.1% in 4Q 2023 (fiscal) due to higher prices for the company's products and lower freight costs. You can see the details of the gross margin changes for each segment in the graph below.

Operating expenses (% of revenue) increased from 39.3% in 4Q 2022 (fiscal) to 43.1% in 4Q 2023 (fiscal) due to lower economies of scale. The largest contribution to the growth of operating expenses was made by expenses for G&A (% of revenue) and technology and development (% of revenue), which increased from 4.9% to 7.9% and from 3.1% to 4.1%, respectively.

Thus, the operating loss (% of revenue) increased from 5.6% in the 4th quarter of 2022 (fiscal) to 6.1% in the 4th quarter of 2023 (fiscal).

In addition, the company's management published guidance for 2024 (fiscal). So, management expects the company's revenue to decline in the mid-single digits, so I assume that we could see a 4%-6% decline in sales compared to last year. You can see the details in the graph below.

My expectations

On the one hand, I expect pressure on revenue growth to continue in the coming quarters. First, inflation is still at a relatively high level, which may contribute to lower consumer spending in the discretionary segment because consumers continue to face higher costs for food, rent and interest payments. Secondly, if we look at the dynamics of marketing expenses (% of revenue), we will see that marketing expenses have decreased to 27.8%. On the one hand, optimizing marketing costs helps increase profitability, but on the other hand, in my personal opinion, this can have an additional impact on the rate of revenue growth in the future. In addition, in accordance with the company's guidance, management expects revenue to decline in the mid-single digits.

In addition, the company's management expects that thanks to higher prices, a favorable product mix and lower freight costs, we may see a recovery in the gross profit margin in the coming years. In accordance with management comments during the Earnings Call following the release of financial results, management forecasts that gross margin levels could reach historical levels of around 42%. However, I would like to highlight the fact that: 1) I do not expect the company to be able to reach this level within the next year, as sharp price increases could lead to additional pressure on the number of transactions. According to management comments, recovery may take several years 2) despite improvements at the gross profit margin level, the operating profitability of the business may continue to be in the negative zone due to the deleverage effect due to a decrease in the scale of the business.

As we look a little further down the road, say, the next year, two or three, we expect our gross margin to continue to benefit from these factors and return to its historical 10-year average of approximately 42%

Drivers

Revenue: an increase in the average check, an increase in the number of orders, the development of a loyalty program and cross-selling may contribute to an increase in revenue growth in the next quarters.

Margin: lower freight costs, higher prices for the company's products and lower operating expenses (marketing) could support profitability in the future.

Risks

Margin: decreasing economies of scale and increasing raw material costs may have a negative impact on operating profitability.

Competition: increased competition can lead to both a slowdown in business revenue growth and a company's market share, and pressure on profitability due to the need for additional investment in marketing.

Macro (general risk): a decline in real consumer incomes due to increased inflation may lead to pressure on consumer spending in the discretionary segment, which may have a negative impact on revenue growth rates in the future.

Valuation

Valuation Grade is A. In accordance with the P/E ((FWD)) and EV/EBITDA ((FWD)) multiples, the company is trading at 20.5x and 6.4x, respectively, which implies a premium to the sector median of about 42% and a discount to the sector median about 34%, respectively. Despite the fact that the company's shares are relatively inexpensive, I believe that this is still not the best time to take a long position because I do not see additional catalysts for the stock price to rise in the coming quarters.

Conclusion

Thus, my current recommendation is Hold because I expect pressure on revenue growth and margins to continue in the coming quarters. I believe investors need to wait for the next quarters' results before deciding to buy the stock. I would like to say that I will happily change my recommendation to buy when I see signals of a recovery in consumer demand in the discretionary segment.

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