LL - LL Flooring: Weak Business Performance But Trading At 0.6x Book Value

Summary

• LL Flooring's three-year stacked comps and adjusted operating margins both turned negative in Q3 2022.
• It also is reducing its new store opening plans for 2023.
• The weak macroeconomic environment is giving it problems, although it is also significantly underperforming competitors such as Floor & Decor.
• LL Flooring is trading at 0.6x book value currently.

LL Flooring ( LL ) is underperforming business-wise as its three-year stacked comps turned negative in Q3 2022 and its adjusted operating margins also turned negative. These challenges resulted in its scaling back its new store opening plans for 2023 to reduce capex.

As long as LL Flooring's results don't deteriorate further though, it should be able to operate at roughly breakeven cashflow. It is also trading at approximately 0.6x book value, so despite its problems I think it has upside if it can tread water until the macroeconomic climate improves. LL Flooring has not met previously reduced expectations , so its estimated value has been reduced to $7 to $8 per share though.

Store Openings And Stock Repurchases

LL Flooring is slowing its pace of new store openings, while planning on putting money towards share repurchases again. It opened 18 new stores in 2022, but now expects to open only three to four new stores in 2023 due to the uncertain macroeconomic environment.

On the other hand LL Flooring plans to repurchase shares again, with $43 million available under its existing share repurchase program. It will probably need to improve its business performance at least a bit to be able to repurchase shares without incurring more debt though. While LL Flooring could repurchase shares by borrowing more money under its revolving line of credit, that would be a risky strategy. It does note that it may suspend or discontinue its share repurchase program at any time.

Struggling Business

LL Flooring has been struggling with declining sales recently. It reported net sales growth of -4.8% in Q3 2022, along with comparable store sales that were down -7.3%. While LL Flooring has reported a string of negative quarterly comparable store sales results since Q3 2021, it previously could point to tough comparisons to past quarters as a reason for the negative comparable store sales. This is no longer the case as LL Flooring's three-year stacked comps went negative (to -0.9%) in Q3 2022. LL Flooring attributes its challenges to continued lower consumer spending, while its sales to Pro customers grew nearly double-digits in Q3 2022.

The weak sales combined with continued cost inflation pressure to push LL Flooring's adjusted operating margin negative in Q3 2022. It reported gross margins of 35.6% in Q3 2022 (down from 37.3% in Q3 2021), as it could not fully mitigate the large impact of higher material and transportation costs. Meanwhile adjusted SG&A went from 33.1% of net sales in Q3 2021 to 37.1% of net sales in Q3 2022, as it invested money to support its business plans and had lower sales levels to support the SG&A.

This resulted in LL Flooring's adjusted operating margin going down to -1.6% in Q3 2022, compared to 4.1% in Q3 2021 and 2.0% in Q2 2022.

In contrast, Floor & Decor reported +11.6% comparable store sales in Q3 2022 while maintaining a 9.3% operating margin (down only 0.2% from Q3 2021). It appears to be navigating the macroeconomic challenges much better than LL Flooring.

Notes On Cash Flow

Although LL Flooring's adjusted operating margin was negative -1.6% in Q3 2022, with a slight improvement to its operating margins it could avoid burning cash in 2023. Since it plans to cut back capex and open only three to four new stores in 2023, its capex might end up in the $5 million to $10 million range. LL Flooring's depreciation and amortization is around $18 million per year, and that affects operating margins. A -1.0% adjusted operating margin should result in roughly breakeven cash flow based on its reduced 2023 capex budget.

Valuation

As noted above, despite its challenges LL Flooring may be able to operate at around breakeven cash flow if it spends a limited amount on capex in 2023. It also noted that it had approximately $134 million in liquidity ($6 million in cash and $128 million available for borrowing on its revolving line of credit) at the end of Q3 2022.

LL Flooring had a book value of approximately $270 million ($9.40 per share) at the end of Q3 2022, and it is currently trading at around 0.6x book value. Due to its general business underperformance, I am reducing its expected value to approximately $7 to $8 per share. LL Flooring is essentially treading water at the moment and hoping for an improved macroeconomic environment as a rising tide lifts all boats. While it will also attempt to improve its results independent of the macroeconomic environment, its success in that area is uncertain given its past issues.

Conclusion

LL Flooring's business results have been disappointing with both three-year stack comps and adjusted operating margins turning negative in Q3 2022. The macroeconomic environment is challenging, but competitors such as Floor & Decor are performing much better.

That being said, LL Flooring is now valued at only 0.6x book value, and if the environment does not get significantly worse, it should be able to keep its book value relatively constant, while waiting for an improvement in the macroeconomic environment to improve its fortunes.

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