Flooring & Decor Stock: Expensive Despite Recent 30% YTD Drop (NYSE: FND)

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Investment thesis

In a September 2021 article, I explained how overvalued Floor & Decor Holdings was (NYSE: FND) has been. Since then, the stock has lost more than 25% and has clearly underperformed the market. From an operational perspective, I think the company is executing its long-term strategy well. However, I believe the recent underperformance is due to a large discrepancy between what the market expects from FND and its actual growth prospects. In other words, FND’s valuation simply doesn’t justify the company’s outlook, making the bullish thesis risky.

Company details

Floor & Decor is a specialty retailer of hard surface flooring and related accessories that was founded in 2000 and is headquartered in Atlanta. The company offers an assortment of tile, wood, laminate, vinyl and natural stone flooring, as well as decorative and installation accessories, at competitive prices. FND estimates that it has a market share of around 9%. It is one of Fortune’s 100 fastest growing companies with approximately 160 warehouse format stores and 2 standalone small format design studios in 33 states. In addition to the above, the company topped Floor Covering Weekly’s “Top 50 Retailers” list for 2021 and has been in the top 10 for 5 consecutive years.

The market opportunity

According to Statista, the flooring industry in the United States is expected to generate $25.7 billion in revenue in 2021 while growing at an average CAGR of 2.03% from 2021 to 2025. So this is a slow growing market. In fact, if you take into account a long-term inflation rate, the market is stagnating. Despite the unattractive outlook for this market, I personally believe there is an opportunity for businesses to grow at a higher rate. This is a very fragmented sector where I see mergers and acquisitions as a clear catalyst for growth.

The commercial strategy

In my previous article on FND, I explained how the company uses a 5-pillar approach to drive growth. After the latest quarterly results, I can say that the company is on track to meet its targets.

Store openings in new and existing markets

The company plans to reach a target of 400 stores within 8 to 10 years. I personally believe that the company is well on its way to achieving this goal. In the fourth quarter of FY21, FND opened a total of 7 stores in line with management’s previous guidance. With a total of 27 new outlet stores opening during the year, this represents an increase of 20.3% compared to FY20. FND plans to open 6 new outlet stores in the first quarter of FY22, including a new outlet store in Garden City, New York, slated for March.

For fiscal 2021, we opened 27 new warehouse-format stores, which represents a growth of 20.3% compared to fiscal 2020. We ended 2021 by operating 160 warehouse-format stores and 2 design studios in 33 states, further expanding our in-store presence and brand awareness. We plan to open 32 new warehouse-format stores in fiscal 2022 and expect approximately 56% of store openings to be in existing markets and 44% in new markets. Of the 32 new warehouse store openings, we expect 7 to be owned.

Tom Taylor – Chairman and CEO – FY21 Fourth Quarter Earnings Call Transcript

Increase same store sales

Fiscal 21 fourth quarter comparable store sales increased 14% year-on-year. Additionally, compared to FY19 to exclude the impact of COVID-19, FND’s same-store sales quarter-to-date increased by 10% CAGR. More importantly, both measures of same-store sales growth are above FND’s long-term goal of mid-to-high single-digit growth, which I think is remarkable. According to management, customers are moving to the best and highest price points within FND’s merchandising assortments, which is a key explanation for the strong performance. The best part is that the strong performance doesn’t seem to slow down. February MDT comparable sales are up ~24%. Personally, I believe these levels are unsustainable in the long term, and it is best to focus on management’s expectations of mid to high single digit growth going forward.

We are pleased with our sales exit rate in the fourth quarter and the start of the first quarter of fiscal 2022, where our January same store sales increased 11.5% and reached 23.9% since the beginning of the month in February.

Tom Taylor – Chairman and CEO – FY21 Fourth Quarter Earnings Call Transcript

Extending the “Connected Client” experience

The company is moving from a traditional retailer to a modern business strategy based on omnichannel selling, where the different sales channels are interconnected. For example, 79% of FND customers who purchased in stores in the fourth quarter of FY21 said they went to the company’s website, and 71% of customers who purchased online said they had gone to the store. I believe FND’s investments in e-commerce over the past few years have improved conversion and led to higher online sales penetration. E-commerce sales penetration rate stands at 16.4%, compared to 9.4% in FY19, while e-commerce sales increased by 45% YoY in the last quarter .

Over a 13-week to 13-week period, our fourth quarter e-commerce sales increased 45.1% over last year and 61.7% when measured on a rate basis. of 2-year compound annual growth compared to fiscal 2019. As a result, our fourth quarter e-commerce sales penetration rate increased 190 basis points to 16.4%, from 14.5% l last year. For the year, our online sales increased 30.2% year-over-year and on a 52-52 week basis and accounted for 16.1% of our sales, compared to 17.4% in 2020 and 9.4% in 2019.

Tom Taylor – Chairman and CEO – FY21 Fourth Quarter Earnings Call Transcript

Invest to win and retain Pro customers

Q4 FY21 Pro sales penetration increased year-on-year and exceeded the previous 2 FY21 quarters. Pro sales exceeded $1 billion in FY21, which is a significant milestone. Some of the drivers behind the strong performance of the Pro segment include customers’ need for quality products at low cost as well as excellent relationships with FND’s Pro desk. The company will be rolling out new features for Pro customers such as PPR enhancements including loyalty tiers, SKU-based bonus point promotions and Pro credit card incentives which I believe will further boost engagement .

Invest in design

FND’s focus on design services resulted in a 78% increase in design appointments in FY21. In the third quarter of FY21, FND announced the introduction of a pilot home design service in Dallas and Houston, where homeowners and professionals can schedule appointments with FND’s home designers. This is an important growth area for FND as gross margin and average ticket are higher when a designer is involved.

Overall, the strong operational performance was reflected in the financial results. Total sales increased 26.4% year-over-year in the fourth quarter of FY21. Despite the positive revenue trend, the company generated negative free cash flow of approximately $106 million during the year. 21, as it increases its CapEx program. However, I personally like the fact that a large portion of operating cash flow is reinvested in the business rather than paid out to shareholders in the form of dividends and buybacks.

Business valuation

Based on 104.9 million shares outstanding and a price of $99 per share, the company has a market capitalization of approximately $10.4 billion. In this part, I used a discounted free cash flow model to value the business. The following assumptions were made in the model:

  • FY22 estimated free cash flow of $230 million, lowered from my previous article to reflect higher costs associated with FND’s CapEx program.
  • A growth rate of 20% over the next four years.
  • A terminal growth rate of 4.5%.
  • A discount rate of 10%.

Author

Author’s DCF model

Based on the model, the intrinsic value of FND is approximately $58 per share. The stock is currently priced at over 40x free money LTM, despite being down around 30% year-to-date. In my opinion, the current market price still does not justify the company’s growth prospects. For the above reasons, I think FND will continue to be volatile in the near future and I wouldn’t rule out another 10-20% drop from the current level.

Key points to remember

FND is always a growth story. Management continues to do a great job of growing the business and I see no reason for this trend to stop or slow down in the future. However, the market more than fully assesses the quality of the company. I continue to believe that the main risk factor here for an investor is not necessarily the company itself, but the valuation of FND.

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