hikesterson/iStock via Getty Images
hikesterson/iStock via Getty Images
Early in 2023, I believed that there might be some cracks in the floor in the case of shares of Floor & Decor Holdings, Inc. (NYSE:FND) after the business has seen a tough 2022. This was driven by higher interest rates causing a shadow on the housing market, and also related things that were housing-related, including spending on flooring.
Being a big believer of the business in the long haul, valuations remained a bit demanding for me, as the outlook for 2023 was still a bit cautious as well. While interest rates were still high that year, interest rates moved lower in the fourth quarter for 2023, creating some optimism into 2024 among investors, as the outlook for 2024 looks very soft. Consequently, this does not instill much confidence for the shares at this price point.
Floor & Decor describes itself as a disruptive, and high growth specialty retailer with a unique business model. Strong execution and a large total addressable market ("TAM") drives great market potential, estimated at over $50 billion per annum here.
Floor & Decor is characterized by large and visible inspiring stores, everyday low pricing, connected customer experience, direct sourcing, expert associates, and broad-based assortment, among others.
Focusing on tile, wood and stone floors, among others, Floor & Decor's typical store measures up to 80,000 square feet, as the great size and broad assortment does not only cater to homeowners, but caters to professional and commercial clients as well.
The company operated 83 stores in 2017, the year in which the business went public. Average store sales exceeded $16 million, at the time being a near $1.4 billion business. The company went public and shares immediately traded around the $30 mark, all while earnings power was stuck around $0.70 per share, resulting in demanding valuations by all means.
With spending on homes, and home prices as well, on the rise during the pandemic, shares of Floor & Decor saw a major rally to highs around $150 late in 2021.
This was backed up by a business which grew sales by 41% that year, to $3.4 billion. Operating margins equaled 9.9% of sales, which meant that earnings came in at nearly $2.50 per share, although just modest growth was seen in 2022. This resulted in nosebleed valuations, in fact higher multiples than seen at the time of the public offering.
Amidst the impact of higher interest rates, shares fell to the $60s during 2022, arguably creating some appeal, although I was a bit cautious at $70 early in 2023. This came as the company saw earnings stuck around $2.70 per share, but we were still finding ourselves in a rising interest rate environment at the time, all while the company incurred modest net debt as well. Shares were trading at a mid-twenty times earnings multiple, while the business faced a tougher 2023.
With shares of Floor & Decor seemingly still stuck around $80 last fall, the shares then rallied about 50% since that point in time to highs of $120, levels last seen in 2021.
Fast forwarding to February of this year, Floor & Decor posted a 3.5% increase in full year sales to $4.41 billion, yet fourth quarter sales were dead flat at $1.05 billion. This does not say much as the company keeps opening new stores, with fourth quarter comparable sales down 9% and change. After opening 31 stores during the year, a 221 store count pretty much implies that average sales per store come in around $20 million, quite frankly showing modest growth compared to 2017, after two tougher years.
Full year operating margins fell 2 full points to 7.3% of sales despite higher gross margins, amidst higher store opening costs as no less than 14 stores were opened during the final quarter alone. All of this made that full year earnings per share were down 18% to $2.28 per share, with fourth quarter earnings per share down 47% to $0.34 per share.
In fact, the worsening economics show up in the 2024 guidance, a year in which sales are seen up to $4.60-$4.77 billion, with comparable sales declines seen between minus 2% and minus 5.5%.
Despite the pressure on earnings and large net capital investment requirements, net debt has come down to $162 million, being very modest in relation to a more than half a billion EBITDA number. Amidst all these trends, 2024 earnings are seen between $1.75 and $2.05 per share, as more margin pressure is anticipated.
After guiding for another year of earnings declines, multiples are demanding based on share price of $120 per share, for a >60 times multiple. Given the inflationary times, it is noteworthy that pricing is not very strong, but that the vast majority of comparable sales declines are actually the result of lower volumes.
Based on the current earnings performance, it is very clear that expectations are very demanding, so we have to look at the potential numbers. If the housing market sees a big recovery, I see no reason why sales should not come in around $5-$6 billion in the near to medium term, as historical operating margins of 8-10% at the midpoint of both metrics yield pre-tax earnings of around half a billion dollars, equal to about $3 per share.
Even in such a scenario, Floor & Decor Holdings, Inc. multiples remain very demanding at 40 times, undoubtedly driven by the potential of the franchise over time, yet clearly the risk-reward does not appear to have improved a lot amidst rising share prices, and softening operating performance.
Even if Floor & Decor Holdings, Inc. can grow to 500 stores over time (which arguably will take beyond 2030), current multiples are somewhat demanding. In such a case, I see no reason why sales could not approximate $10 billion by 2030, as superior margins near 10% could drive operating earnings around a billion dollars, for unleveraged earnings of around $700 million, close to $7 per share.
Even in such a case, shares already trade at a market multiple based on earnings five years in time, which requires real execution. Given all of this, I remain very cautious here, and while shares might be a dangerous short, the long appeal is far from seen here.