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The market momentum behind Floor & Decor Holdings (FND) is strong. The company’s stock has completely shrugged off the March market sell-off and has been trading at its all-time highs of approximately $70 per share.
The market strength has been shared with other home improvement retailers, with Home Depot (HD), Lowe’s (LW), and Lumber Liquidators (LL) all showing the same pattern and momentum.
We believe the strength in FND can be attributed to a strong rebound in sales and management’s commitment to growing its new store footprint by 20% in 2021 and beyond. The company is already planning the opening of 27 new stores in 21 on top of the 13 stores opened year-to-date.
The added scale is a plus to margins moving forward, as it would give them the ability to take costs out from their suppliers with the increase in volume. Also, there is leeway for margin improvement once the company stops with its store expansion plans, allowing for a higher percentage of the incremental revenues to fall to the bottom line. Management believes FND can achieve long-term EBITDA margins of 15% or higher, compared to EBITDA margins of 11.7% in 2019.
From a valuation perspective, the company is trading at a forward earnings multiple of 47x, almost double the forward P/E of HD at 25x. LL and LOW trade at 18x and 19x respectively.
While the forward PE of 47x sounds exuberant, we need to acknowledge the impressive growth rates of FND. For example, the company has managed to grow revenues and EPS at a 3-year CAGR of 19.8% and 26.6%, respectively, compared to 7% and 6.4% for HD. That said, maintaining such high growth rates would depend on the achievement of reaching 400 stores, the target set by management. Any slow down in new store growth could cause multiples to contract, as expectations deflate.
At this point, paying 47x for FND’s forward earnings doesn’t look like a good risk/reward opportunity. Besides the high expectations embedded in its share price, the company is not immune to the effects of COVID-19. Q2 results showed declining sales as the company was affected by the pandemic.
We believe the stock is too hot right now and we would rather wait on the sidelines.
Sequential improvement; quarter-to-date sales up 16%
FND reported second-quarter sales of $462M, down 11% on a year-over-year basis but beating sales expectations by $40M. The company also reported a non-GAAP EPS of $0.13 beating the consensus by $0.06.
Second-quarter sales were impacted by a decline of 20.8% in comparable-store sales due to COVID-19 and related store closures. Management transitioned to a curbside pickup model after closing their stores to help offset the decline in sales. Total comparable store transactions declined by 22.3% during the quarter compared to its prior-year period, while the average ticket increased by 2%, highlighting trip consolidation by their customers.
On a monthly basis, store sales have been improving sequentially, with comparable-store sales down 51% in April, improving to a 26% decline in May and followed by a positive increase of 7.7% in June. Management noted an increase in comparable-store sales from reopened stores of 8.6% (from the day each store went back online to the end of Q2) compared against the same time period in 2019. The momentum has continued on a quarter-to-date basis, with comparable-store sales up 16%.
Reaffirming store expansion plans
Management is not taking its foot off the gas pedal. During its conference call, they kept its guidance for 20% new store growth and remained optimistic about the future pipeline.
The market has reasons to be cheerful from such news. Management noted that a 3-year old store generates on average around $21M in sales and approximately $5M in 4-wall EBITDA. A new store, based on management’s expectations, can generate approximately $13 to $15M in sales. With 125 stores at quarter-end and 40 new stores planned for ’20 and ’21, sales from new stores can generate incremental revenues of $560M at the mid-point following the company’s estimates.
Adding to the optimism, management made comments about how the current environment is causing some weaker competitors to exit the market, especially in the northeast, creating the opportunity for FND to get more stores in better-positioned areas. The current weak environment is also causing rents to come down:
So we were — the last few years, we’ve probably been paying rents closer to somewhere in the $12 to $15 range. And it looks like the class of ’21 is going to be sub-$10 per square foot in rent. And so we are seeing lower rents. – Goldman Sachs 27 thAnnual Global Retailing Conference Sept. 10 th
Long-term tailwinds? Or just demand moving forward?
It is difficult to determine whether the strong rebound in sales could be sustainable moving forward. The pandemic caused more people to spent time at home, shifting demand from travel and entertainment towards home renovations and other projects, benefiting companies such as FND. Stimulus checks might have also played a role in the incentive for people to work on home renovation projects.
Although we do not expect comps growing at double-digit rates, there is a strong case for continued revenue strength due to the low-interest-rate environment and the commitment from the federal reserve to keep them that way.
A strong housing market coupled with low-interest rates could be a growth driver for FND as people refinance their homes and reinvest it back in renovations. From a macro perspective, these are tailwinds that FND can capitalize on, especially since they are trying to capture market share by opening new stores and targeting the “professional” market.
The Bottom Line
While FND has clear growth revenue opportunities, we believe the market might be a bit too optimistic about the stock.
The company benefited from pent-up demand, and with discretionary spending shifting from travel and entertainment towards home projects, FND was a clear winner.
However, we see two near-term risks that could deflate expectations. First, we saw that FND is not invulnerable to the effects of COVID-19, resulting in negative sales growth for Q2. With no end in sight to the COVID-19 problem, it is a risk that it might not be reflected in the stock price. Secondly, if the environment does “normalize”, how long would it take before demand shifts back again towards categories like travel and entertainment? Any shift in demand could change the way consumers spend their discretionary income, translating into a softer home renovation market impacting sales at FND.
At a forward PE multiple of 47x, we believe the market is pricing FND for perfection. However, any slight disappointment in results could bring those high multiples back to earth. For these reasons, we rather stay on the sidelines.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.