2023-05-22 09:42:28 ET
Summary
- Floor & Decor reported the first quarter of falling comparable sales.
- It also opened only three warehouse stores in Q1'23.
- However, the hard-flooring retailer outperformed Home Depot and Lowe's in organic sales.
- Management reiterated store opening targets and FY23 guidance.
- I continue to find FND attractive.
Floor & Decor’s primer
Floor & Decor ( FND ) is a hard-flooring warehouse retailer with a 9% market share operating 194 stores across the US. It has a clear capital allocation plan to widen moats and win market share. At maturity (450 stores in 10 years - my base case), I estimate that FND could command 25-30% of the market at the expense of the industry leaders, Home Depot ( HD ), Lowe’s ( LOW ), and even more so, the independent and ‘mom-and-pop’ shops.
Q1’23 FND Results Review
Financial performance:
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Net sales of $1,122.1M increased 9.1% YoY.
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Comparable store sales decreased by 3.3%, the first drop for years stretching to 2013 and slowing pace QoQ compared to Q4’22.
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Diluted earnings per share of $0.66, flat YoY.
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Opened three new warehouse stores, a total of 194, and 5 design studios.
Commentary:
My focus is on management's 500 warehouse stores target by 2032. To get there, Floor & Decor must open roughly 25 stores yearly or at a 7% CAGR. Why does store expansion lead to success? As a reminder of FND’s bull case:
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FND has a differentiated product line. It has 3x SKUs (1700+) vs Home Depot.
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Lower prices due to direct and in-bulk sourcing supply chain.
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Better shopping experience . FND has 10-15x the floor space (78K sq feet) vs Home Depot’s 5K sq feet, 55 flooring customer service employees per store vs 2 in HD’s store.
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Hyperfocus on Pro customers , who drives frequent and large ticket sales; to date, Pro customers account for 42% of total sales.
But success and store expansion won’t be a straight line. The past few quarters outlined a challenging FY2023 as home improvement projects declined from Covid peak and slightly below pre-covid levels. Recent Home Depot Q1’23 earnings also reported slower home improvement activities for DIY and Pro customers’ projects, and they see backlogs:
are changing from large scale models to smaller projects.
It’s not a surprise to see FND slowing the pace of store opening, with three store openings in the first three months of the year.
Nothing to worry about here. I believe the multi-year thesis is intact. Q1’23 also added more data points to show that Floor & Decor continued to gain market share by:
+ increasing sales faster than peers (more on this later) by opening new stores and increasing organic sales / comparable sales.
+ increasing customer value by passing along its cost advantage to maintain as the lowest cost and most differentiated hard-flooring retailer.
+ continue to prioritize added services to loyal pro-customers and homeowners.
I have selected a few quotes from the CEO, Tom Taylor, and President, Trevor Lang, in the Q1’23 conference call :
On passing on benefits of economy of scales
we are building on our value proposition in 2023 by passing along some favorable supply chain costs to our customers by selectively lowering prices on specific SKUs . We intend to maintain or widen our product price gaps with our competition and are monitoring unit price elasticity to enable us to drive incremental growth. We have introduced new lower price signage in our stores and website further reinforcing our strong value message.
On focus on homeowners and pro-customers
we are intently focused on driving further engagement with our homeowner and pro customers in 2023.
On market share
Yes. If you look at our market share versus the growth in the industry, when you look at market insights and some of the other people that provide that, that they’re not showing the market growing at the same rate we are. And we had one of the largest credit card issuers at least for their business, which they own a substantial portion of the U.S. credit card business show that, that since 2020, we’d had over 500 basis points of market share gain relative to what they saw from their other people buying from specialty flooring as well. So the three – the ways we triangulate it shows in all cases, we’re gaining market share in this environment.
Peers - beating HD, LOW in organic growth
Above is the proof that FND is outperforming peers in this challenging period, growing organically faster. The blue line - FND shows superior comparable sales than Home Depot and Lowe's between Q1'22 and Q4'22.
For Q1'23, FND has done better than HD, and we will know soon if it continues to outperform Lowe's. I’m using Lowe’s optimistic Q1’23 comparable sales estimates of -2.2% in the chart, as their Q1’23 results are not out until the end of May.
In the Q1’23 conference call , Home Depot explained the 4.6% decline in comparable sales was due to bad weather and falling lumber prices.
“After a three-year period of unprecedented growth for our sector, during which we grew sales by over $47 billion, we expected that fiscal 2023 would be a year of moderation for the home improvement market . Our sales for the quarter were below our expectations, primarily driven by lumber deflation and unfavorable weather , particularly in our Western division, as extreme weather in California disproportionately impacted our results,” said Ted Decker, chair, president, and CEO.
HD sees 2023 as challenging and provides weakening guidance for fiscal 2023:
• Sales and comparable sales to decline between 2% and 5% compared to fiscal 2022, vs. flat in Q4’22 guidance
• Operating margin rate to be between 14.3% and 14.0% vs. 14.5% in Q4’22 guidance
This means FND is likely to outperform HD again for fiscal 2023 as per guidance:
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Net sales of approximately $4,610 million to $4,750 million
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Comparable store sales of approximately (3.0)% to flat
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Diluted EPS to be in the range of $2.55 to $2.85
I’ll update the stats when LOW’s Q1’23 results come, but we can now conclude FND’s outperformance.
Other notable mentions
Pro customer counts
What I like even more is the continued growth in comparable sales within the Pros segment. They are the industry's most knowledgeable, frequent, and high-ticket buyers segment. Thus, their affinity for FND’s products speaks volumes.
The pro segment grew +19.1%, 2x total sales growth (+9.1%), making up 42% of total sales. By comparison, Pros accounted for 35% of FY21 sales. The positive trend shows FND’s success in catering to Pro customers.
Spartan and RAM commercial business
Moving to commercial, Spartan's (commercial arm acquired in 2021 for $77M)and RAMs (protective floor board) outperformed in the quarter. Spartan revenue increased 32% YoY with ~2x faster EBIT growth of +74%. The management noted they now have 65 reps, an increase from 40 in the prior year. Meanwhile, the RAM business performed even better with an impressive sales growth of 70% YoY, keeping up with Q4’22 growth of 72% YoY.
While sales are small and still very early, the commercial segment has added $5B to FND’s total addressable market and is worth tracking.
FY2023 guidance
The outlook for FY2023 remains the same as set in Q4’22
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Net sales of approximately $4,610 million to $4,750 million
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Comparable store sales of approximately (3.0)% to flat
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Diluted EPS to be in the range of $2.55 to $2.85
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Adjusted EBITDA* in the range of $605 million to $650 million
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Depreciation and amortization expenses of approximately $190 million
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Interest expense, net of approximately $17 million to $18 million
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Tax rate of approximately 23%
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Diluted weighted average shares outstanding of approximately 108 million shares
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Open 32 to 35 new warehouse-format stores.
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Capital expenditures in the range of approximately $620 million to $675 million
we expect existing home sales to remain challenging in 2023 and customers to increasingly prioritize value and savings seeking out those retailers that best meet these needs. We believe we are well-positioned to navigate these headwinds and grow our market share even as the flooring industry contracts in 2023.
Tom Taylor, Q1'23
Valuation
Tom Taylor, the CEO, ten-year target is to build 500 stores. As a reminder, he revised the target two times in the past, from 400 store target at IPO and 315 back in 2012.
So my original valuation (below) was that FND would build new stores aggressively at a 20% CAGR for the next two years (39 stores in FY2023 and 45 stores in FY2024) and then slows down to a 7% CAGR until FY2032 to reach 450 stores (base case). Considering the worst-case scenario, I also projected a significant sales decline of 20% and 5% in FY2023-2024.
With FY2023 guidance, I revised the store expansion plan for 450 stores in 10 years (base case).
And I am using the new store unit economics management guide,
We get to a revenue projection of $16B in year 10, FY2032, assuming an 8% SSS and 3% & 2% sales reduction in 2023 and 2024 to consider the (milder than I previously thought) impact of the housing market downturn.
With a 9% WACC and 3% terminal growth, that brings us to $1.4B in FCF by FY2032 and roughly $12B in Market Cap, or $110/share, implying a 25% upside from today’s price.
This is $6/share lower than my original valuation, driven by fewer store openings in the next five years, pushing the impact of a higher return on invested capital ((ROIC)) and free cash flow generation further to the later stage.
Nevertheless, my updated DCF valuation still shows an attractive investment today.
In terms of multiples, we can work out the intrinsic value by applying 5x, 10x, and 15x to the terminal FCF, $1.4B, in the base case. You get a ~$7B, ~$14B, and ~$21B business in ten years, respectively.
Below are the various multiples from 2017 to 2032 at the base case.
Floor & Decor’s EV/E has ranged from 21x to 52x since IPO. Thus, the stock appears cheap at the FY2023 27x. By 2032, FND could be valued at 5x Earnings and 7x FCF.
Together both valuation methods point to an attractive price. But as my base case valuation of $110/share doesn’t provide a 30% margin of safety from today’s price at $90/share (it’s at 25%), I am happy to wait for the price to go down to around $85/share to accumulate my Floor & Decor position to 3%.
Closing thoughts
FND continues to beat peers. It may get worse in 2023, but I believe FND is resilient and prudent in balancing between expansions and managing profitability. I reiterate a BUY rating for FND's stock.
For further details see:
Floor & Decor: Q1 2023 Results Review - Outperformance Continues