2023-05-31 22:17:44 ET
Summary
- 2Q23 results show a mix of positives and negatives, with management optimistic about order book strength and market outperformance, but concerns remain over inflation and high interest rates impacting consumer demand.
- The anticipated recovery in 2H23 is uncertain due to the current economic climate, making it difficult to rely on historical seasonality trends.
- My recommendation for Leslie's has been adjusted to a hold rating until concrete evidence of a recovery in the second half of the year is observed.
Recommendation
While I remain long-term positive on Leslie’s ( LESL ) based on the likelihood of market share gains in the short and longer term given their highly fragmented industry, I am getting incrementally cautious on the short-term outlook after the 2Q results. I view the 2Q23 results as pretty mix of both positives and negatives. On the positive end is the positive commentary from management that they are seeing signs of strength in terms of orderbook and outperformance of markets that are not impacted by the weather. In addition, management also maintained FY23 guidance as demand is expected to be pushed into 2H23 with the return of more normal seasonal purchasing patterns. On the negative end, the inflationary environment and high rates make it hard for investors to underwrite the recovery in 2H23. It might be true that historical seasonality suggests 2H23 to be a recovery period, but there was no hot inflation or high rates for the past decade. As such, I am a not super confident if this time will be the same. Net-net, I am adjusting my recommendation to a hold rating until we see evidence that 2H23 is really going to experience a recovery.
Positives
Despite a 13.5% year-over-year decline in LESL's comparable sales for the quarter, mainly influenced by the normalization of seasonal purchasing patterns and adverse weather conditions, management highlighted several positive aspects that suggest LESL is experiencing signs of resilience. Firstly, the 1Q23 results have demonstrated unequivocally that underlying performance was very strong in markets (excluding markets that faced bad weather) like Texas, Florida, and California. Second, despite fewer pools opening in 1H23, management anticipates a higher demand for 2H23 openings based on their order book. The visibility into 2H23 based on the order book certainly lends credibility to management 2H23 guidance. If I had to be completely objective, I'd say that LESL business is going through a slump, just like every other industry. Long-term secular tailwinds are still present, and that is what really matters. More than 14 million pools and spas are in use in the United States, and this number has grown dramatically over the past few decades, providing strong evidence for the industry's resilience. There will always be a need to perform routine maintenance in a pool or spa, regardless of when it was installed. It is estimated that the annual cost of upkeep for an in-ground pool is at least $24,000. The figures cited in LESL's S-1 suggest that the average lifespan of today's in-ground residential products has increased from 19 to 22 years. As the base of customers increases and the lifetime of products extends, I believe the aftermarket for both components and maintenance services is only going to grow.
Negatives
The obvious downside is the effect of inflationary conditions, which have significantly reduced consumers' discretionary income. According to the results, weak sales in 2Q23 can be attributed primarily to lower discretionary demand (-$18 million), which was primarily driven by lower sales of hot tubs and above ground pools. Weather, smaller tax refunds, and higher interest rates were cited by management as factors dampening demand for these more expensive items. In light of the current economic climate, I fear that the higher interest rates will continue to act as a drag on demand for these more expensive items. If this affects 2H23 as well, it will be a major headwind worth -$36 million.
This brings me to my next point – underwriting 2H23 recovery. I do acknowledge that 1H23 performance weak (in my view) as consumers returned to pre-pandemic seasonality spending (and vs tough comps in 2Q22), where sales should be more heavily concentrated in 2H. Due to the supply chain situation, I suspect consumers stocked up earlier in the season, which shifted sales dollars from 2H to 1H during peak COVID and made the 1H23 comparison more difficult. Assuming supply chains have returned to normal, I expect sales to once again peak in the second half of the year when people are using their pools. These factors, along with the order book, provide strong support for the expectation of a robust recovery in 2H23. Until the results are in, however, there is very little that can be done to verify and prove this theory. The fact of the matter now is that inflation rates are high, which has an effect on disposable income. The worst thing that could happen is 3Q23 performance comes in weaker than expected. At that point, I think the sentiment would be even worse as the burden now falls on 4Q to significantly outperform. Investors that are very confident today might see their confidence level get shaken up as well, which could lead to some of them dumping the stock to cap their losses.
Summary
The 2Q23 results for LESL presented a mix of positives and negatives. While management expressed optimism regarding signs of strength in the order book and outperformance in certain markets unaffected by adverse weather conditions, I have concerns regarding the inflationary environment and high interest rates impacting consumer demand. The ability to underwrite the anticipated recovery in 2H23 is uncertain, as historical seasonality might not hold true in the current economic climate. Hence, I am adjusting the recommendation to a hold rating seems prudent until there is concrete evidence of a recovery in the second half of the year.
For further details see:
Leslie's: Hard To Underwrite H2 2023 Recovery