Costco (COST, Financial) is often regarded as a titan in the global retail industry, with its successful strategies widely emulated. Notably, Home Depot (HD) has adopted every single element from Costco's business model, leading to its own considerable success. Charlie Munger (Trades, Portfolio), the vice chairman of Berkshire Hathaway (BRK.A, Financial) (BRK.B), has pointed out that Floor & Decor (FND, Financial) is smaller retailer that has copied Costco's model. This strategy of drawing inspiration from a successful industry leader bolsters the potential that Berkshire Hathaway sees in its investment in Floor & Decor.
In Berkshire Hathaway's investment portfolio, Floor & Decor Holdings is a relatively modest but notable holding. Although it accounts for just 0.13% of Berkshire Hathaway's overall portfolio, this stake in Floor & Decor is substantial in the broader context, valued at $432.6 million, or nearly 4.5% of the total outstanding shares in the company as of September 2023.
Warehouse-format store with consistently low prices
Floor & Decor has a robust network of 191 warehouse-format stores and six design studios spreading across 36 states in the U.S. Like the expansive layout of stores like Costco, its warehouse-format stores are impressively large, averaging around 79,000 square feet each. This format allows the company to offer a wide range of products at consistently low prices, appealing to a diverse customer base. It categorizes its customers into three primary groups: Buy It Yourself (BIY), Do It Yourself (DIY), and professional installers and commercial businesses, commonly referred to as 'Pro'. What makes Floor & Decor outstanding in the competitive retail landscape is its unique approach to product offerings, with a differentiated assortment of products and consistently low prices, establishing itself as a comprehensive, one-stop destination for flooring projects.
Impressive growth in every single year
In the past ten years, Floor & Decor has demonstrated impressive financial growth, consistently increasing both its topline and bottom line. From 2012 to 2022, the company's revenue experienced a substantial rise, growing from $335 million to $4.26 billion. Simultaneously, its operating profit surged from $26 million to $399.3 million within the same timeframe. The annual growth rate of revenue maintained a steady pace, ranging between 18.6% and 41.2%, while the year-over-year growth rate of operating profit exhibited more variability, oscillating between 4.7% and 59.6%. Notably, throughout this period, both revenue and operating profit consistently increased every single year, with no decline at all.
Gloomy third-quarter results and 2023 guidance
In its recent third-quarter earnings report, Floor & Decor revealed a slight increase in sales, rising 0.9% to $1.1 billion amidst ongoing economic challenges. These challenges include rising interest rates, a significant drop in existing home sales, and a slowdown in high-value discretionary product sales. However, the company experienced a notable 9.3% decrease in comparable store sales. Their earnings per share (EPS) also declined by 14.1% to $0.61, compared to the same period last year.
Reflecting these trends, Floor & Decor has revised its full-year 2023 forecasts downward. The company now expects total sales to be between $4.345 billion and $4.385 billion, down from the previously projected range of $4.460 billion to $4.530 billion. Comparable store sales are anticipated to fall by 7.8% to 8.5%, a steeper decline than the initially estimated 5.5% to 7.0%.
The company's revised earnings per share for fiscal 2023 are projected to be in the range of $2.14 to $2.24, lower than the previous forecast of $2.30 to $2.50 per share. It also adjusted its forecast for fiscal 2023 adjusted EBITDA to be between $535 million and $550 million, down from the earlier estimate of $570 million to $595 million. With the projected depreciation and amortization of $200 million, its operating earnings (EBIT) is estimated to be $335 million to $350 million.
Prudent balance sheet
In the current challenging market environment, it's crucial for businesses to maintain prudence and a robust balance sheet. Floor & Decor is one good example. As of September 2023, the company reported $1.89 billion in equity and $61.63 million in cash, while the biggest obligations were the total capital lease obligations at $1.45 billion, with long-term debt at a relatively modest $197.1 million. A significant aspect of its assets was its inventory, valued at $1.1 billion, underscoring its substantial investment in this area. The debt-to-capital ratio stood at a prudent 50.61%, with an impressive interest coverage ratio of 35.85 times.
Fairly valued now
Over the past decade, Floor & Decor's market valuation has experienced significant fluctuations. From 2017, the company's enterprise value to earnings before interest and taxes (EV/EBIT) ratio has oscillated between 17.67 and 67.25, averaging out at around 37 times. Presently, the company's valuation stands at 30 times its EBIT in the market.
If Floor & Decor generates approximately $335 million in operating earnings in 2023 and is valued at the average EV/EBIT multiple of 37, its enterprise value could be estimated at around $12.4 billion, just 10% higher than its current market capitalization.
Key Takeaway
Floor & Decor has established itself as a notable player in the competitive flooring market by emulating Costco's successful retail model. This strategy involves expansive warehouse-format stores and offering a diverse range of products at consistently low prices. Despite some recent challenges, including revised sales forecasts and a downturn in EPS, Floor & Decor maintains robust financial health. Its minimal leverage and healthy balance sheet position it as a resilient entity in a fluctuating economic environment. Over the past decade, the company's sustained growth, supported by a cautious financial approach, underscores its potential as a sound investment. However, it is important to consider that the calculated intrinsic value is only 10% higher than the current market price, suggesting that the company is fairly valued at the moment.
