Flooring & Decor: Turning into The Subsequent House Enchancment Retail Large (NYSE:FND)

Funding Thesis

Flooring & Decor (NYSE:FND) is a tough floor flooring retailer and industrial flooring distributor with 191 warehouse-format shops and 6 small design studios throughout 33 states. With an skilled administration group, the corporate lays out an growth plan to drive future retailer base development at 20% yearly. It provides FND a runway to develop to grow to be the subsequent dwelling enchancment retail big.

FND additionally has carried out effectively financially over the previous few years. Income per share rose 64%, and EPS surged 83% from 2019 to 2021. Nonetheless, FND declined over 50% from its all-time excessive in December 2021 and had a disappointing efficiency in 2022 as a result of miserable housing market. This permits traders to purchase this unimaginable development firm at a considerably discounted value for my part. Thus, I charge FND as a “Sturdy Purchase”.

Victorious Enterprise Mannequin

A group of skilled executives, together with Chief Govt Officer Tom Taylor, manages FND. He had 23 years of expertise at The House Depot (HD) and assisted in increasing the shop base from 15 shops to over 2,000 shops. FND is within the early rising phases. His priceless expertise offers glorious steering for FND to scale.

FND’s warehouse-format shops present one-stop companies for his or her prospects to buy laborious floor flooring supplies and related instruments and supplies. The corporate gives merchandise from over 60 proprietary manufacturers and roughly 4200 inventory conserving items (“SKU”) in every retailer, far higher than different flooring retailers. As a buyer, an built-in retailer like FND is one thing I’ve longed for. It saves appreciable time from touring between shops to seek for flooring supplies of various kinds and types.

Apart from, the concentrate on Professional prospects offers a aggressive edge for the corporate. Though the Execs are solely accountable for 40.7% of complete gross sales, they’re more likely to make extra frequent retailer visits, and their skilled opinions usually have an effect on owners’ decisions. Thus, FND gives a devoted Professional gross sales power at every retailer to assist the Execs store extra effectively. Additionally, to enhance their loyalty to FND and have interaction new Execs prospects, the corporate launched a Professional loyalty rewards program. Within the newest earnings name, the administration supplied some encouraging numbers associated to Execs:

Professional transactions have been up 7% through the quarter, and the highest 10% of our PPR members spent 24% greater than they did a yr in the past. If you consider that is 185 shops in a extremely tough macro to have the ability to join one other 29,000 Execs through the quarter, that is all good for the long run.

E-commerce is comparatively much less necessary to a tough floor flooring materials retailer as prospects might want to have first-hand experiences to really feel the textures and supplies of the flooring supplies. Solely 16% of the whole gross sales are from e-commerce channels. However FND continues to be desirous to develop its on-line platform because it assists prospects in exploring design choices and enriches the entire procuring expertise.

With an important number of merchandise, knowledgeable gross sales group and an skilled administration group, the corporate achieved a exceptional 14.2% comparable retailer gross sales development per yr over a thirteen-year interval (2009 – 2021) and a 12.6% development from 2017 – 2021.

The Subsequent House Depot?

FND operates in a big however fragmented U.S. flooring coverings market, estimated to have an addressable market measurement of $30 billion. Arduous floor flooring materials has just lately gained reputation, partly due to higher hygiene and better sturdiness. The market measurement is roughly $41 billion if related instruments and supplies are included.

Presently, FND solely has 197 shops and studios, which is barely lower than one-tenth of House Depot’s retailer rely. As the ground masking market within the U.S. is extremely fragmented, FND nonetheless has a large and lengthy runway to develop as one of many largest dwelling enchancment retailers within the U.S. The administration estimated that FND represented solely 8% of the whole addressable market.

To achieve market share, the laborious flooring masking retailer has an growth plan to develop its retailer base by 20% yearly for the subsequent a number of years in new and underserved markets. Growth to a minimum of 500 shops nationwide over the subsequent 8 to 10 years is anticipated. The corporate demonstrated that the aggressive plan is achievable this yr. They opened 32 new warehouse shops throughout the U.S., a 20% improve from final yr’s retailer rely.

Performances of the newly opened shops have been promising already. All new shops are worthwhile of their first yr and obtain higher comparable retailer gross sales development than current shops.

Apart from FND’s growth plan to accumulate market share from this fragmented sector, a pending 2023 recession can also be a wonderful alternative to develop market share. Small and closely indebted flooring masking corporations could also be compelled to close down below a difficult financial backdrop. The stability sheet of FND must be wholesome sufficient to outlive the recessionary surroundings. And it’ll possible be capable of gulp the launched market share from these unable to get by means of powerful occasions.

The corporate is on a runway to develop its enterprise to 500 shops this decade. The laborious floor flooring masking business is rising at 4% yearly. With its fragmented nature, it won’t be shocking if this well-managed firm continues to realize market share and turns into the subsequent dwelling enchancment retail big like House Depot.

Strong Steadiness Sheet

Acquisition actions and the aggressive retailer growth plan might stress the corporate’s stability sheet because the latter incurs important pre-opening bills (e.g., development value, coaching value, commercial value). Particularly the capital expenditure of the corporate has been on an growing development over current years.

Nonetheless, I discovered the stability sheet of FND pretty stable, and its growth plan would unlikely impression its monetary efficiency adversely. FND now owns $374 million in debt in Q3 2022, the place nearly all of debt might be matured post-2026. The quantity of debt is simply barely greater than its fairness worth. A abstract of monetary energy ratios is tabled beneath for simple reference.

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(Supply: Creator, information from Gurufocus)

Potential Dangers

Types of tiles and laborious flooring supplies are like garments in your closet. They may change seasonally. Thus, the growing stock degree is my concern, as old style flooring masking supplies might grow to be outdated. There’s a danger that the corporate will mark down the costs to clear the extreme and out-of-style inventories. The stock degree doubled from $654 million in 2020 to $1,320 million in TTM. The excessive degree of stock additionally introduced the working money circulation down sharply within the first three quarters of 2022. On the identical time, free money circulation dropped to a unfavorable degree in the identical interval.

Nonetheless, the sharp development in stock degree to some extent mirrored the frequent opening of latest shops and new in-store merchandise. As defined within the newest earnings name:

The stock development was in keeping with our expectations and mirrored our new retailer development. We have now been making to enhance our in-stock stock, inflation and the addition of latest modern SKUs.

The second concern would be the declining current dwelling gross sales and residential enchancment incentives. Present dwelling gross sales information fell for eleven consecutive months (since February 2022). And The Main Indicator of Reworking Exercise anticipated dwelling enchancment and upkeep expenditures would peak within the second quarter of 2023, and its development charge would additionally gradual sharply in 2023. We might conclude that the disappointing housing information will possible decrease laborious floor flooring materials demand in 2023.

Some might argue the weakening housing market will severely have an effect on dwelling enchancment retailers like FND. Nonetheless, even throughout powerful occasions, FND nonetheless delivered sturdy monetary outcomes. Complete gross sales and EPS grew 25.2% and 16.7% YoY in Q3 2022, respectively. The administration group can be assured in attaining 14 consecutive years of comparable retailer gross sales development.

Valuation and Conclusion

FND has an important enterprise mannequin and administration group to scale itself within the extremely fragmented laborious floor flooring masking business to grow to be the upcoming dwelling enchancment retail big. In earlier years, the inventory has demonstrated sturdy monetary efficiency.

The inventory is now considerably discounted. FND has a P/E ratio of 27.09 at the moment, which is 43% decrease than its 5-year common P/E ratio. The corporate’s 5-year common P/E ratio is affordable because it matches its 5-year common EPS development (42.5% CAGR).

Nonetheless, the common P/E ratio will possible decline because the Avenue anticipates a slower development charge within the subsequent few years. Beneath are my bullish and bearish instances of valuation, assuming the inventory returns to a P/E ratio of 33.6 (70% of the present 5-year common P/E ratio).

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One further motive to personal FND is that Berkshire Hathaway (BRK.A) (BRK.B) established their place of FND in Q3 2021 and elevated their place at ranges between $81 to $130. Entry at present costs will present traders with a reduction over Mr. Warren Buffett.

Please kindly word that every one information on this article is abstracted from FND’s convention name transcript in 2022 Q3 and 2021 annual report, except in any other case specified.