2023-08-15 12:49:02 ET
Summary
- LL Flooring Holdings, Inc. reported -22.2% comparable store sales in Q2 2023, along with a -7.5% adjusted operating margin.
- These results were even worse than I was expecting and points to LL Flooring's value eroding rapidly.
- Cash burn (before working capital changes) may be around $75 million per year in its current state.
- LL Flooring rejected Sullivan's non-binding offer of $5.76 per share for the company.
- It is exploring strategic alternatives, but may not be able to get a similar or better offer than $5.76 per share now.
LL Flooring Holdings, Inc.'s ( LL ) Board of Directors rejected Tom Sullivan's non-binding offer of $5.76 per share for the company. LL Flooring then made a number of new leadership team hires in an apparent attempt to find help turning around the company.
I had previously believed that LL Flooring should carefully consider Sullivan's offer since it was on track to have the intrinsic value of the company fall below $5 per share by early 2024 due to weak business results.
LL Flooring's Q2 2023 results were even worse than I expected, though, and show that it has a very big hole to dig itself out of though. This results in its intrinsic value being projected at around $4 per share in early 2024 based on its updated sales trends.
LL Flooring has now announced that it will explore strategic alternatives , including a potential sale of the company or a merger. However, it is uncertain whether it can get an offer that matches the $5.76 per share offer that it rejected.
Worsening Sales Results
LL Flooring reported Q2 2023 results that were quite disappointing. Its comparable store sales showed further sequential declines in the quarter, going from -9.5% in Q4 2022 to -15.4% in Q1 2023 and now -22.2% in Q2 2023.
I have been using Floor & Decor's results as a benchmark. The performance gap between the two companies has increased too, going from a 12.1% difference in Q1 2023 to a 16.2% difference in Q2 2023 (with Floor & Decor reporting -6.0% comparable store sales in Q2 2023).
LL Flooring has blamed the challenging macroeconomic environment for much of its weak sales performance, but its problems appear to go beyond that. If LL Flooring was doing -10% comps, I would feel more comfortable that it could do okay if/when the macroeconomic environment improved. A quarter with -22.2% comps is quite weak though, and is around 7% worse than I was expected after its Q1 results, and around 12% worse than I thought it would do at the start of 2023.
LL Flooring also appears to be dealing with some self-inflicted wounds as it has mentioned low brand awareness resulting from its name transition away from Lumber Liquidators as a contributing factor to its challenging results.
Declining Operating Margins
LL Flooring's gross margins have been decent, with its 36.7% adjusted gross margins and its 35.8% gross margins both up slightly compared to Q2 2022. However, its SG&A costs as a percentage of sales continued to increase due to its low sales volumes combined with operating cost inflation.
Due to rising SG&A percentages, LL Flooring's adjusted operating margins declined to -7.5% in Q2 2023 compared to -4.5% in Q1 2023.
Notes On Cash Flow
Despite its poor results, LL Flooring still managed to generate $8 million in free cash flow in Q2 2023 after reporting $21 million in free cash flow in Q1 2023. This was driven by changes in working capital though, as LL Flooring has been drawing down its merchandise inventory and ending up with increased accounts payable.
Excluding changes in working capital, LL Flooring would have had negative $13 million in free cash flow in Q1 2023 and negative $19 million in free cash flow in Q2 2023.
LL Flooring will not be able to indefinitely continue to draw down its inventory and allow its accounts payable to increase. If it does not improve its business results from current Q2 2023 levels, it is looking at around $75 million in cash burn per year. For reference, at the end of Q2 2023, LL Flooring had $145.5 million in liquidity.
As LL Flooring's debt increases, its interest costs will also go up. The interest rate on its credit facility isn't that bad at around 7% currently, but the additional borrowings will still add incrementally to its rate of cash burn.
Notes On Valuation
LL Flooring had a book value of $7.23 per share at the end of Q2 2023. Its projected cash burn will reduce this quickly (by around 65 cents per quarter) unless its business results improve.
A valuation of 0.75x book value would make it worth approximately $4 per share at the end of Q1 2024 if it doesn't reduce its cash burn and sales decline.
Conclusion
I had previously modeled LL Flooring's 2023 results assuming a mid-teens comparable store sales decline, but it then reported -22.2% comps in Q2 2023. The decline in sales levels have also contributed to its adjusted operating margin falling to -7.5%, with the potential for $75 million in cash burn per year before working capital changes.
These dismal results are eroding what is left of LL Flooring's value, and it may be challenging for it to get an offer that is similar or better than the $5.76 per share non-binding offer that it rejected.
For further details see:
LL Flooring: Weak Q2 2023 Results Leave It In A Challenging Position