Summary
- Although margin performance was lower than expected, I believe FY23 guidance is conservative.
- I have some concerns on consumers buying smaller buckets of chemicals and growing preference to repair vs replace.
- I believe LESL efforts in expanding pool base, driving sales in Pro, conducting value-accretive deals, driving migration tendencies, and gaining market share will support revenue growth and sustain higher margins.
Recommendation
In spite of the highly competitive business environment, I continue to have faith in Leslie’s ( LESL ) because of the potentials for share growth in the near and longer-term. In addition, I believe that LESL has a number of strategic levers to pull, such as increasing wallet share from the Pro, increasing unit growth, making strategic acquisitions, and promoting AccuBlue Home. Nonetheless, I think it's important to point out that there appears to be full inventory levels, which poses a promotional risk for LESL going forward, especially in Trichlor, but this risk appears to be baked into Leslie's 2023 guidance.
Despite a -5% weather-related headwind in the quarter, LESL reported 1Q23 SSS of -4%, which was better than expected compared to the consensus of -8.7%. Margin performance was less than expected, with an adjusted EBIT margin of -12.3% compared to the consensus estimate of -9.6%. Management maintained FY23 guidance despite the mixed results, which I find to be conservative especially since a bunch of the cost headwinds are already felt in 1Q. The fact that Trichlor's management has already begun preparing for deflation despite no evidence of price declines lends credence to my view.
Earnings results
While a 4% decline in LESL SSS in 1Q23 may seem bad at first glance, when viewed in the context of a 2 years stack basis, it is an increase of 16.5%. Overall pool sales are down 3% at LESL, but hot tub sales are up 35%, and sales of Pro pools are up 11%. In terms of unit economics, ARPC increased by 6%, the number of customer files remained unchanged, and AOV grew by 7%. Overall business activity decreased by 1%.
When compared to the same period a year ago, LESL's total inventory increased by 76% in 1Q23, down from the 82% growth seen in the previous quarter. Looking over a longer period (a 3 year basis), 1Q saw a 110% increase in LESL stock. Management has acknowledged a current surplus of inventory; however, this is largely attributable to a deliberate effort to bring forward stock, which they see as prudent in light of future supply uncertainty. Considering LESL's need to make sure they can keep up with demand during pool season 2023, I the strategy to pull forward supply a smart strategy. This is in-line with LESL strategy in that – stocking more inventory across their system is a key tenet of its supply chain resiliency strategy.
Concerning factors
Customers appear to be buying smaller buckets of chemicals, continuing the trend from FY22. My speculation is that some people may be using sub-optimal amounts of chemicals in an effort to lower their annual expenditures. The logic behind this is that mediocre performance is acceptable in place of perfect performance. It's also possible that some shoppers are waiting for prices to drop before making any purchases. Naturally, I'm hoping for the latter rather than the former. In the event that the former becomes more likely, chemical sales may fall short of expectations. Some consumers are also showing a greater willingness to repair broken gadgets rather than buy brand new ones.
Guidance
LESL has reiterated its guidance for FY23. Management maintains its midpoint forecast of 2.5% decline in non-discretionary sales, 12.5% decline in Trichlor sales, and 17.5% decline in discretionary sales. Management also anticipates a 2.5% drop in SSS and a 5.0% increase in non-comp sales, at the midpoints. Importantly, management has stated that they are factoring in a recession scenario and the possibility of deflation, especially in Trichlor, into this set of projections. From what I can tell, management is taking a cautious and careful approach to providing guidance.
Valuation & model
I expect LESL revenue growth to be supported by its efforts in expanding pool base, successful execution in driving sales in Pro, conducting value-accretive deals, driving migration tendencies, and gaining in market share. Since the pool industry typically maintains price increases even after cost inflation subsides, I expect sustained higher margins as LESL grows.
With the revised model, I believe LESL still has 22% upside from here. The change is mostly from the increased exit multiple that I think LESL deserves given the high possibility of sustained margins.
Summary
I remain optimistic about LESL due to its potential for share growth in the near and long term. The company has several strategic options for growth, including increasing wallet share from the Pro segment, increasing unit growth, making strategic acquisitions, and promoting AccuBlue Home. Despite full inventory levels, which could pose a promotional risk, this has already been considered in Leslie's 2023 guidance. Although margin performance was lower than expected, management still maintained their FY23 guidance, which I believe is conservative given the sales beat and cost leveraging in the second half of the year.
For further details see:
Leslie's: Still Confident On The Company's Ability To Grow And Scale