2023-08-13 08:34:26 ET
Summary
- My recommendation is a buy rating for LESL, with an expectation of demand normalizing in FY24.
- LESL should revert to its long-term growth algo by FY25.
- Even if valuation stays at the current multiple, upside remains attractive.
Investment action
Based on my outlook and analysis of Leslie’s Inc.'s ( LESL ) 3Q23 earnings results, I recommend a buy rating. I expect FY24 to be a year of turnaround for LESL as the inventory situation normalizes and LESL returns to its long-term growth algorithm by FY25, where margins will follow through as well. This should also help push valuation higher, but being conservative, I am attaching a 20% margin of safety discount to the S&P500 to benchmark my expectations. Even so, the upside is attractive.
Basic info
LESL retails outdoor supplies and sporting goods. The Company offers solar covers, pool filters, pumps, filter cartridges, salt systems, cleaning attachments, spa chemicals, ladders, and accessories. For those just tuning in, here's a quick refresher: the company is sustained by the long-term care of a sizable installed base of pools. Over the COVID period, however, the industry as a whole has experienced significant inflation, which has contributed to an inventory surplus.
Review
LESL 3Q23 revenue was $610.9 million, and its adjusted EBITDA was $129.0 million. Compared to the reported preliminary range of $124 million to $128 million, adj EBITDA was slightly ahead. My analysis of the results for 3Q23 focuses on two main areas: store traffic and the overall landscape of the industry.
LESL has seen another drop in traffic (LDD% in 3Q23) compared to the same period last year, and they don't anticipate any improvement in 4Q23. Unsurprisingly, this was the main driver of 3Q pressure on LESL's top line. For starters, I believe the weather headwind (500bps headwind) felt during the quarter was outside of management’s control, so if we adjust for it, traffic decline is probably in the HSD%. The problem is the remaining HSD% headwind, which I also don't think will be fixed in the next quarter alone. The industry continues to face the problem of oversupply, as of customers entered the pool season with an oversupply of chemicals from the previous year (which is also a major factor in the reduced traffic volume).
“So we believe this is a one-season occurrence based on three years of highly unstable supply and price inflation, leading people to stockpile.” 3Q23 earnings
In my unbiased opinion, this situation is a short-term drag, but it bodes well for FY24 as consumers use up their stockpile. Since large-scale purchases of chemicals are unlikely to occur again (barring another COVID-like scenario), I do not anticipate a repeat of the current oversupply situation. As consumers finish their stockpile, they will reach a situation where they need to restock their inventories. As this restocking dynamic happens across a bunch of consumers, LESL should see periods of accelerated growth. Given LESL's weak FY23, a resurgence of growth in FY24 will see easy comp as well, driving better headline growth.
“given the rather extraordinary inventory levels we took to ensure supply, and were unwinding knows now, it will start in the fourth quarter and should be completed by the end of the year.” 3Q23 earnings
Based on LESL's credit card data, the company's performance appears to be in line with or slightly better than the industry average. This implies that the industry-wide underperformance is not exclusive to LESL alone. In my view, the data provided by management is highly encouraging and should reassure shareholders that LESL is maintaining its market share. Nevertheless, it's worth noting that certain factors impacting demand might have been specific to LESL. For instance, during the initial phase of the season, customers seemed more price-conscious regarding LESL's pricing above specialty retail, prompting a swift correction by LESL on June 1st. This pricing headwind should not happen again in the coming quarters, since it has been fixed.
“That relative price position was out of balance for some weeks in the third quarter, which we addressed with our June 1st price actions. Those actions resulted in essentially flat year-over-year chemical pricing, despite higher costs.” 3Q23 earnings
I expect LESL's to return to see normalized demand environment (mid- to high-single-digit revenue expansion, as indicated during the 2Q22 earnings call) in FY24 and a return to its long-term growth algo in FY25. Management aligns with my perspective, anticipating that, unless unexpected adverse weather effects intervene, LESL will witness a demand landscape that regains normalcy in terms of seasonal patterns and overall levels.
Valuation
Author's work
I believe LESL revenue growth will revert to its long-term algorithm of mid- to high-single digits over the next 2 years as the inventory oversupply situation eases. As the situation normalizes, I expect margins to grow as well, as LESL sees operating leverage from its business model. Looking at LESL’s historical forward PE valuation, it has derated significantly from the height of 50+ to the current 14x, and as such, its historical average is not useful here. To benchmark its valuation, I compared it against the broad market (lack of publicly listed peers). Given the cyclicality and discretionary nature of the business, I expect it to trade at a discount to the general market. Attaching a modest 20% discount to S&P (my margin of safety), the LESL stock is worth $9.93 in FY24.
Risk and final thoughts
LESL's main risks would be competition from large peers like Walmart and Amazon, which have significantly better negotiating power to get supplies at a lower price. They also have a broader reach than LESL. As such, LESL is always under the threat that these big boys will come at it aggressively, subsidizing products to limit LESL's profit margin potential.
In conclusion, I recommend a buy rating for LESL, with a focus on FY24 as a potential turnaround year. I expect the oversupply situation to normalize, contributing to accelerated growth in FY24 and an easy comp for better headline growth. Despite short-term challenges, LESL's credit card data aligns with industry trends, indicating it's not uniquely impacted. While 3Q23 saw traffic decline and pricing adjustments, these issues are being addressed.
For further details see:
Leslie's Inc: FY24 Should Be A Year Of Turnaround