TTSH - Risk-Reward For Tile Shop Is Balanced

2023-07-13 06:19:18 ET

Summary

• Tile Shop doesn't have plans to open a meaningful number of new stores, and the company is also holding back on returning capital to shareholders.
• The Company's cost pressures are easing, and its new products are gaining traction with customers.
• I make no changes to my existing Hold rating for Tile Shop, taking into account the balanced risk reward for TTSH.

Elevator Pitch

Tile Shop Holdings, Inc. ( TTSH ) shares continue to warrant a Hold rating in my opinion. I previously wrote about TTSH's 2023 financial prospects and the potential for share repurchases for the company in my March 3, 2023 article .

My latest analysis leads me to the conclusion that investing in Tile Shop has its fair share of risks and rewards. The key risks for TTSH are that the company continues to hold back on buybacks and dividends, and that its store network expands slowly. On the flip side, Tile Shop does offer potential rewards in the form of margin recovery in the medium term and revenue expansion for the long run. The factors mentioned above suggest that a Hold rating for Tile Shop is fair.

Key Negatives For Tile Shop

Tile Shop is an unappealing investment candidate, when one considers the company's new store opening plans and its shareholder capital return strategy.

TTSH had 142 stores in operation as of the end of the first quarter of 2023, as disclosed in its Q1 2023 results press release. Investors are going to be disappointed, if they expect the company to have aggressive plans for new stores. At the company's Q1 2023 earnings briefing , Tile Shop highlighted that it had only two new stores in the pipeline for now, and also noted that it wished to relocate one of its existing stores.

The company registered top line expansion rates of +14.0% and +6.5% for FY 2021 and FY 2022, respectively. In contrast, the Wall Street analysts expect Tile Shop's revenue growth to slow to +0.7% and +2.8% for FY 2023 and FY 2024, respectively. It is no surprise that TTSH's top line outlook is lackluster, given that the company doesn't have plans to expand its store network in a big way for the foreseeable future.

Another key negative for TTSH is that the company won't be executing on any shareholder capital return initiatives in the very near term. TTSH had revealed at its most recent quarterly results call that it is "not planning on any share buybacks or dividends at this point."

Tile Shop stressed at the company's Q1 2023 results briefing that its target is to "get debt-free and then figure out how we're going to return shareholder value." As per S&P Capital IQ data, TTSH's net debt-to-EBITDA or net leverage ratio was a comfortable 1.63 times as of March 31, 2023. As such, there doesn't seem to be a compelling need for TTSH to deleverage at a rapid pace right now.

Instead, I think that TTSH can create shareholder value by re-allocating capital from debt repayment to share repurchases. Tile Shop is currently trading at undemanding consensus forward FY 2024 Enterprise Value-to-Revenue and EV/EBITDA multiples of 0.63 times and 5.7 times, respectively. In my opinion, TTSH's top capital allocation priority should be share buybacks rather than deleveraging.

In summary, Tile Shop's unexciting new store opening plans and the absence of shareholder capital return make the stock unattractive.

TTSH's Key Positives

There are negatives associated with Tile Shop as outlined in the preceding section, but TTSH also has some investment merits relating to its intermediate-term profitability outlook and its long-term revenue growth potential.

2023 is likely to be the bottom for Tile Shop when it comes to the company's profitability. TTSH's EBITDA margin is projected to decrease from 12.6% for FY 2022 to 10.3% in FY 2023, before rebounding to 11.1% for FY 2024.

The expectations of a recovery in TTSH's operating profit margins starting next year are validated by the company's management commentary. Tile Shop noted at its first quarter earnings call that there has been a "reduction in freight costs" for "the past few months" and mentioned that its "product cost has come down." TTSH also stressed at the recent quarterly results briefing that the company's "focus is on the profitability of our business."

In that respect, Tile Shop has a good chance of having its profitability improve in the mid-term, as supply chain constraints and inflationary cost pressures ease.

For the long run, TTSH still has a decent growth runway, even though it has become very conservative with regards to new store openings. This is because Tile Shop has been expanding its product portfolio in a bid to generate more sales from its existing clients.

At its Q1 2023 investor earnings call, Tile Shop emphasized that it has "identified a number of high-quality products that we can source for lower price points from suppliers", which included "LVT (Luxury Vinyl Tiles) products" which "are gaining momentum."

I think that these new products that are of better quality should put Tile Shop in a good position to penetrate the premium consumer segment, and this will expand the company's Total Addressable Market or TAM. That said, TTSH has yet to disclose the revenue contribution from LVT products or other new products separately, so it is reasonable to assume that Tile Shop isn't generating significant sales from these new offerings at this point in time. But I will expect these new products to be a long-term revenue growth driver for TTSH.

In a nutshell, there is a high probability of Tile Shop achieving an improvement in profit margins for the medium term and a faster pace of top line growth driven by new products in the long run.

Closing Thoughts

The risk-reward for Tile Shop is fairly balanced now with a mix of both positives and negatives. Therefore, I don't see any good reasons to change my current Hold rating for TTSH.

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