LL - LL Flooring: Challenges Continue In 2023

2023-04-25 16:00:13 ET

Summary

• LL Flooring did not provide financial guidance for 2023.
• However, it indicated that SG&A spend would be up from 2022, while adjusted gross margins should improve.
• Floor & Decor expects flat growth to a -3% comparable store sales decline in 2023.
• LL Flooring has consistently underperformed Floor & Decor, so that could mean high-single digits comparable store sales declines in 2023 or worse.
• I now expect LL Flooring to potentially have $40 million in cash burn in 2023, before income tax refunds.

LL Flooring ( LL ) did not provide financial guidance for 2023, but its general commentary plus guidance from other flooring companies suggests that this year may be quite challenging for it.

LL Flooring may see high-single digits (or worse) comparable store sales growth if it continues to underperform Floor & Decor ( FND ). This may lead to around $40 million in cash burn during 2023, excluding potential recoveries of income tax.

I had previously thought that LL Flooring might be able to keep its adjusted operating margin to around -1%, which would enable it to stay near breakeven cash flow with a limited capex budget. LL Flooring's 2023 results may be substantially worse than that though, leading to declining book value.

If it can stabilize its cash burn by early 2024, it may still be worth $5 to $6 per share. However, there is substantial risk that LL Flooring continues to have substantial cash burn, which would reduce its value over time.

Uncertain Near-Term Sales Outlook

LL Flooring declined to provide financial guidance for 2023 due to the uncertain macroeconomic environment. It cited inflation, declines in existing home sales and the volatile mortgage rate environment as factors that were creating uncertainty.

LL Flooring did provide some commentary about its expectations for 2023 though. The commentary about its sales outlook was the most nebulous, probably because there is a good chance that its comparable store sales will be down significantly compared to 2022.

Floor & Decor has been consistently outperforming LL Flooring, but even Floor & Decor expects relatively weak sales in 2023, with guidance for -3% to flat comparable store sales. Floor & Decor's Q4 2022 comparable store sales ended up at +2.5%, around 1200 basis points better than LL Flooring's -9.5%. Thus it seems reasonable to expect a high-single digits to low-double digits comparable store sales decline for LL Flooring in 2023.

Commentary On Costs And Margins

LL Flooring's commentary around costs and margins was more positive sounding than its commentary around sales, although the outlook around costs and margins is still mixed.

LL Flooring expects its adjusted gross margins to improve year-over-year, with more strength in 2H 2023. This is expected to be driven by lower sourcing costs and international shipping rates, along with a shift in the mix towards higher margin products. LL Flooring's adjusted gross margin was 36.2% in 2022, down from 37.6% in 2021. LL Flooring's adjusted gross margin was also 35.6% in 2H 2022, making for an easier second-half comparison in 2023.

It also mentioned that it expects both SG&A dollar spend and SG&A spend as a percentage of sales to increase year-over-year. This is attributed to inflationary pressures on wages and benefits, as well as productivity investments. However, if LL Flooring's comparable store sales end up declining, that will also be a significant contributor to SG&A spend increasing as a percentage of sales.

Potential 2023 Results

If LL Flooring's comparable store sales decrease by high-single digits in 2023, it may end up with around $1.03 billion in net sales. If adjusted gross margins end up at 37% (an improvement from 36.2% in 2022) and its SG&A dollar spend goes up 1% to $417 million in 2023, then LL Flooring would be projected to end up with a $36 million operating loss in 2023. This would be an adjusted operating margin of approximately -3.5%.

After factoring in interest costs, LL Flooring's book value may be reduced to around $216 million at the end of 2023, a $40 million reduction from the end of 2022. It may receive some income tax refunds though due to ongoing losses.

Notes On Valuation

LL Flooring is now trading at approximately 0.45x its projected year-end 2023 book value. This is a relatively low multiple, but it no longer appears capable of operating near breakeven cash flow. It expects to spend $15 million to $20 million in capex in 2023, which means that if it does end up with a high-single digits comparable store sales decline in 2023, it will have around $40 million in cash burn (less whatever income tax refunds it receives).

LL Flooring had $135.6 million in liquidity at the end of 2022, so it should be able to withstand near-term cash burn. However if it continues burning cash into 2024 and 2025, it may have some problems. LL Flooring's credit facility matures in April 2026.

If LL Flooring can recover to around breakeven cash flow by early 2024, I'd now value it at $5 to $6 per share. However, continued cash burn along projected 2023 levels would result in it losing $1 to $2 per share in value per year.

Conclusion

LL Flooring has not provided guidance for 2023, but Floor & Decor's comparable store sales guidance (flat to slight declines) suggests the potential for significant comparable store sales declines for LL Flooring.

LL Flooring's commentary around margins and costs suggests that it may end up with around $40 million in 2023 cash burn (before income tax refunds) if it ends up with high-single digits comparable store sales declines during the year.

This cash burn is eating into LL Flooring's value. LL Flooring is valued at well under book value currently, so if it can staunch its cash burn, it should have a fair bit of upside. However, it is quite uncertain if/when LL Flooring can end its cash burn.

I am currently neutral on LL Flooring due to the uncertainly around the duration of its cash burn. It appears to be currently fairly priced for continued cash burn (at around $30 to $40 million per year) until early 2025.

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