TTSH - Tile Shop: Focus On Outlook And Buybacks

Summary

• Tile Shop's 2023 outlook is negative, even though its 2022 earnings exceeded expectations.
• TTSH stock's below-historical average valuations and potential share repurchases should limit the downside for its shares.
• My rating for Tile Shop remains a Hold, considering both the company's unfavorable financial outlook and the possibility of share buybacks.

Elevator Pitch

I rate Tile Shop Holdings, Inc.'s ( TTSH ) stock as a Hold.

My earlier write-up for TTSH published on November 8, 2022 touched on the company's store expansion plans, new product, profitability expectations, and shareholder capital return.

With this current update, I come to the conclusion that Tile Shop still deserves a Hold rating after taking into account both TTSH's lackluster 2023 prospects and a potential share buyback catalyst.

TTSH's 2022 Results Review

Tile Shop reported the company's earnings for FY 2022 on March 2, 2023 before the market opened.

Revenue for TTSH increased by +6.5% from $370.7 million in fiscal 2021 to $394.7 million for FY 2022, which turned out to be -1.4% below the Wall Street analysts' consensus top line forecast of $400.4 million as per S&P Capital IQ data. Also, the company's sales expanded at a much faster growth rate of +14.0% in FY 2021. Tile Shop mentioned at its FY 2022 earnings briefing that it was negatively affected by "macro headwinds that contributed to lower levels of traffic in our stores", and this explains why TTSH's top line came in below the market's expectations.

But Tile Shop still delivered a decent increase in its bottom line which was higher than what the sell-side had anticipated. The earnings per share or EPS for TTSH rose by +10.3% from $0.29 for FY 2021 to $0.32 in FY 2022. Tile Shop's actual 2022 bottom line beat the analysts' consensus estimate of $0.30 (source: S&P Capital IQ ) by +6.7%.

Operating profit margin for TTSH improved by +0.1 percentage points from 5.6% in 2021 to 5.7% for 2022. Tile Shop's actual operating profitability was better than the analysts' prior expectations of a -20 basis points contraction in operating margin to 5.4% for last year as per S&P Capital IQ data.

There were two factors which led to Tile Shop reporting above expectations earnings and profit margins. One key factor is that a meaningful proportion of TTSH's compensation expenses are tied to sales performance, so the company's bottom line benefited from a decrease in variable compensation costs last year. The other key factor is that Tile Shop incurred lower than expected freight charges in the prior year, as supply chain-related headwinds eased.

Tile Shop's Shares Didn't Perform Well Despite Earnings Beat

Tile Shop's post-earnings announcement stock price performance was poor notwithstanding its above expectations EPS. TTSH's share price fell by -5% from $5.28 as of March 1, 2023 to $5.01 at the end of the March 2, 2023 trading day.

My view is that the market is looking beyond TTSH's 2022 EPS beat, and focusing on Tile Shop's 2023 financial outlook instead. There are two key points to note regarding TTSH' prospects in the current year.

Firstly, Tile Shop is most likely going to struggle to achieve top line expansion for 2023.

TTSH's comparable store sales growth turned negative declining by -2.8% in Q4 2022, which doesn't bode well for the company's 2023 comparable store sales growth outlook.

In my previous article for Tile Shop written in early November 2022, I highlighted that TTSH is "looking at opening new stores in a very cautious manner" in view of challenging macroeconomic conditions. This implies that new store openings are also unlikely to be a major driver of revenue growth for TTSH in the current year.

The current sell-side analysts' consensus FY 2023 top line projection for Tile Shop is $395.5 million, which translates into a marginal expected revenue growth rate of just +0.2% for this year. This consensus revenue forecast appears to be realistic.

Secondly, it will be tough for TTSH to record a substantial improvement in its profitability (i.e. gross margin) this year, taking into account the company's pricing strategy.

Tile Shop noted at its most recent full year results call that the company will be "very strategic" about pricing in 2023. Tile Shop want to ensure that its pricing moves for the current year does not "impact traffic", and that it doesn't "price ourselves out of the market." As such, the current analysts' consensus bottom line estimate points to flattish EPS growth for Tile Shop for the current year which seems reasonable.

In conclusion, TTSH's shares performed poorly post-results release, because of the company's unfavorable 2023 outlook.

Valuations And Share Repurchases

Tile Shop's 2023 outlook isn't good as discussed in the preceding section, but this has been largely priced into TTSH's current valuations. The market values TTSH at 8.5 times consensus forward next twelve months' EV/EBITDA now. Tile Shop's current EV/EBITDA multiple is much lower than the stock's 15-year mean EV/EBITDA metric of 10.8 times as per S&P Capital IQ data.

Separately, there is a good chance of Tile Shop initiating a new share buyback program to support its stock price. When asked by an analyst at the 2022 earnings call whether TTSH is in a position to "take on more debt and potentially expand the buyback", Tile Shop responded by emphasizing that "we believe we can." Previously, Tile Shop had kept high levels of inventories on its books to act as a buffer against supply chain disruptions. With supply chain woes becoming less of a problem, TTSH has the intention to lower inventory levels for 2023 which will potentially boost its free cash flow and capacity for further share repurchases.

Concluding Thoughts

Tile Shop's shares are worthy of a Hold rating. On one hand, I am positive that TTSH is likely to engage in share repurchases which will limit the downside for its shares. On the other hand, there is a high probability that the company will experience modest top line and bottom line growth for 2023.

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