Word and decoration: Buffett isn’t the only reason I love him (FND)

RB Fried

investment thesis

flooring and decorationNew York Stock Exchange: FND) has received a lot of press over the past couple of years after Berkshire Hathaway (BRK.A) (BRK.B) revealed a stake in the specialty hard surface retailer Flooring and accessories. Personally, I believe it was not Warren Buffett himself who started the position at Floor & Decor but more likely one of his portfolio managers. Regardless, the fact that Berkshire has considered Floor & Decor enough to add it to the portfolio is certainly a vote of confidence.

There’s a lot to like about Floor & Decor aside from the fact that Buffett has a stake. Over the past 10 years, the company’s revenue has grown at a compound annual growth rate of 28.7% and earnings per share at a compound annual growth rate of 42.4%. Floor & Decor continues to open additional stores with a goal of 500 total (US) over the next 8-10 years. Currently, Floor & Decor operates 174 warehouses leaving a long runway for growth.

Stocks are down 29% in 2022 compared to the S&P 500 down 13%. From a P/E perspective, Floor & Decor hasn’t been this cheap since 2018, aside from a sudden COVID-induced crash in 2020. Investors with a multi-year time horizon can consider Floor & Decor’s 2022 an opportunity to tap a profitable growth company at a price reasonable.

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The divider

Floor & Decor stands out from the competition by devoting more space to its focus product – hard surface flooring. The company’s 78,000 square feet of warehouse space is entirely dedicated to tile, wood, laminate, vinyl, and natural stone flooring as well as decorative and installation accessories. To put it in perspective, the average Lowe’s (LOW) store has about 115,000 square feet. So, imagine you fill 70% of a Lowe’s store with hardwood floors and you’ll get a pretty good idea of ​​what Floor & Decor looks like.

For those who’ve shopped at Sam’s Club or Costco (COST), what impact does bulk buying have on your wallet? It saves you money. Sam’s and Costco are able to offer cheaper products than the competition because 1) they run a membership model and don’t waste money on expensive advertising, etc… and 2) because they buy in bulk (and offer products in bulk). This is similar to the Floor & Decor model minus the membership fee.

With an average per store space of about 78,000 square feet dedicated to hard surface floors, Floor & Decor has to order a lot of products. And with so many products, pricing is optimized for each item based on the quantity ordered. The result – Floor & Decor is able to offer the widest range (in stock) of products at prices that are competitive, if not cheaper, than their competition.

Dedicated focus on professional clients

One of the main differences between Home Depot (HD) and Lowe’s is Home Depot did a better job of getting a Pro customer. Floor & Decor follows in the footsteps of Home Depot with a special focus on professionals who shop more frequently and spend more per ticket. In fact, continuing to invest in professional and commercial clients is one of the five pillars of growth at Floor & Decor.

A screenshot of the site

Pillars of FND Growth (FND IR website)

The company goes into detail about its strategy and focus on acquiring and retaining Pro customers. This is an excerpt from Floor & Decor’s IR website.

We believe our distinct focus on Pro customers has created a competitive advantage for us and we will continue to drive our net sales growth. We will invest in acquiring and retaining Pro customers due to high cost repeat purchases, loyalty and tendency to refer other potential customers. We’ve made significant investments in the Pro Services regional team, including additional Regional Pro Managers, to better recruit and train the Pro Services team in each store. We’ve also invested in technology, such as integrated CRM, to help us penetrate and grow our Pro business, dedicated phone lines for our Pro clients to call and text, trade credit and open account terms, on-the-job delivery, a website dedicated to Pro clients, a growing and successful professional loyalty program Training on technical flooring installation solutions, and tools to facilitate large commercial jobs provided throughout the store.

A roadmap for growth

I appreciate a company that sets long-term goals for itself and communicates those goals to shareholders. Floor & Decor has communicated the following long-term goals to shareholders:

  • $17 billion in revenue and 500 stores in the US (currently 174 stores) within 8-10 years
  • 20% growth in the number of stores annually
  • At least a compound annual growth rate of 20% 2022-2024
  • Double adjusted operating income between 2021 and 2024 (approximately 25% CAGR)
  • Adjusted EBITDA margin in the mid-teens

CEO Tom Taylor made the following remark during our second quarter 2022 earnings call.

We’re excited to continue partnering with Trevor as we execute on our long-term plan toward $17 billion in sales and 500 stores.

Expect revenue growth

Based on history and using a conservative estimate, I think Floor & Decor has a good chance of generating $15 billion in revenue by 2030 assuming they continue to add 15% to their total store count each year. Reminder, their goal is to add 20% to the total number of stores annually.

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FND expected revenue growth (author’s personal data)

In the above, I divided total revenue by the number of stores open at the end of the year to calculate revenue for each store. From 2016 to 2021, revenue growth per store increased by 7.1% annually. For 2022 and beyond, I’ve assumed total store growth of 15% annually and store sales growth of 3.5%, which is conservative compared to prior years’ actual value of 7.1%. You then multiply the number of stores by each store’s sales to calculate total revenue. This led to a revenue estimate for 2029 of approximately $15 billion which is equivalent to a 19% compound annual growth rate from 2022 to 2029.

evaluation

Floor & Decor invests heavily in capital expenditures to support store expansion and technological advancements. As a result, I will use the multiple market approach for stock value in addition to the historical P/S.

Multiple Market Approach (P/E)

Using a multi-market approach, I reached a 2029 price target of $190 for flooring and decor. It assumed revenue growth of 19.0% (shown above), net margin of 7.5% (slightly below the 5-YR average of 7.6%), annual share dilution of 1%, and a long-term earnings multiple of 20.

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FND net income forecast (author personal data)

Price to sales approach

I usually don’t like using P/S for valuation, but in this case Home Depot and Lowe’s give us a decent guide on the outlook for Floor & Decor. According to Search for Alpha, Home Depot’s 5-YR average P/S is 2.25 compared to Lowe’s 1.32 with an average of 1.78. I used a long-term P/S of 1.78 for this valuation.

Using P/S, you’ve reached your 2029 price target of $225 for flooring and decor.

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FND P/S Rating (author personal data)

Average both methods

With a valuation of $190 using P/E and $225 using P/S, we reach an average valuation of $208 by 2029. Starting at today’s price of $92.25, this equates to a compound annual growth rate of 12.4% which , when compared to the S&P 500 average of 7 to 10% annually, represents a market-beating yield for flooring and décor.

bear case

There is no investment without risk. Here is my bear case for floors and decor.

My bear case relates to rising mortgage rates, slowing new housing construction, and a prolonged recession that has triggered a shift in consumer spending. Two out of three of these fears have already borne fruit. The only thing we are unsure of at this time is whether the current recession will be short-term or long-term. In tough economic times, consumers will save money and be less likely to choose a new home, remodel, or renovation. Floor & Decor’s revenue and profits are sure to take a hit as a result. I don’t think that negates the premise, but it would certainly extend the time needed for it to finish.

conclusion

Floor & Decor is a profitable growth company that offers a different business model compared to some of its publicly traded peers. The company has a strong track record of growing revenue and profits and has set its sights on $17 billion in revenue and 500 stores within the next 8 to 10 years. Management has shown the ability to execute in the past, and I see a reasonable path to $15 billion in revenue by 2030. With an estimated 7-year compound annual growth rate of 12.4%, I believe Floor & Decor has a good opportunity to provide market-beating returns to investors over the long term. the next several years.

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