Floor & Decor Holdings Inc. (FND, Financial) has long been one of my favorite retail stocks, but the company is facing some headwinds this year.
Company profile
Floor & Decor operates warehouse-format stores that sell hard surface flooring and related accessories. Among the flooring products it sells are tile, hardwood flooring, luxury vinyl tile, laminate and natural stone. It also sells wall tiles, installation materials as well as some adjacent categories such as countertops, vanities, bathroom fixtures, shower doors and faucets.
At the end of September, it had 207 warehouse stores and five design studios across 36 states. The company also sells its products online through its e-commerce platform. In addition, it owns Spartan Surfaces, a commercial distributor of hard-surface flooring.
Valuation
Floor & Décor currently trades at 21.8 times the 2024 consensus Ebitda of $577.5 million and 17.7 times the 2025 consensus of $708.3 million.
From an Ebitdar perspective, it trades at 11.7 times my 2024 projections and about 8.7 times my 2025 projections.
It trades at a forward price-earnings ratio of 45.50 compared to the 2024 consensus of $2.17 and just at 36.4 times the 2025 consensus of $2.83.
Revenue is expected to grow 2.5% in 2024 to $4.38 billion, then accelerate to 8.4% this year and then 16% in 2025.
Opportunities and risks
Floor & Decor has become a leader in the hard-surface flooring space by offering the widest selection of flooring at the lowest prices. Its stores typically have close to 80,000 square feet of selling space compared to 3,000 to 5,000 square feet at a big-box home improvement retailer like Home Depot (HD, Financial) or Lowe's (LOW, Financial) and up to 20,000 square feet for the typical specialty flooring retailer. When customers walk into one of its stores, they just have more options that are immediately available and displayed in a pleasing and aesthetic way.
Meanwhile, its direct sourcing model combined with its scale allows it to offer the best prices to customers as well. It has over 240 suppliers in 24 countries and it avoids middlemen brokers and distributors, which most independent specialty flooring stores use. It is also notable the company stocks its stores based on regional tastes, so its assortment in Miami will be different than what it offers in Boston.
One of the biggest opportunities for Floor & Décor is store expansion as it continues to grow out its store base. With just over 200 stores, it still has plenty of room to expand. By comparison, LL Holdings (LL, Financial) had 443 stores at the end of September, while Home Depot had 2,333 locations at the end of October. It likely will not be able to carry as many stores as Home Depot, but it should be able to expand to at least 500 to 600 locations.
With more stores should also come increased brand awareness. The company already has a strong reputation among pros, but it still lacks some brand awareness among consumers. As its store count grows and its existing stores mature, brand awareness should also grow and help with sales. Stores five years and older typically do $26 million in sales and $6.1 million in four-wall Ebitda.
Meanwhile, the company continues to benefit from the shift from carpet to hard surface flooring. Hard surface flooring has been gaining share from carpet for the past decade as is expected to continue to do so. Hardwood and tile remain popular, but the advent of luxury vinyl tile - which replicates the look of wood, stone and tile with increased durability and a generally cheaper price - has been the big grower in the flooring industry. At the end of 2022, hard surface flooring was about 55% of the market by volume, up from just over 35% in 2012. Expect hard surface flooring to continue to take market share in the years ahead, which will benefit Floor & Decor.
Expansion into adjacent categories is another potential opportunity. This is a small part of the company's business, but being able to sell an entire project should add some additional growth. Right now, these categories are still a very small part of Floor & Decor's business.
Finally, commercial flooring is another big market that Floor & Decor is just beginning to penetrate. Its purchase of Spartan Surface for up to $90 million in consideration in 2021 got it into the commercial space, and this is one area that has been growing strongly. While Floor & Decor's overall revenue rose just under 1% in the third quarter, commercial sales rose 47.5%, albeit off a much smaller base. This is a large market where the company has plenty of runway to grow and take share.
When it comes to risks, housing turnover has been a headwind. With nearly 80% of homeowners locked into mortgage rates below 5% and nearly 60% under 4%, housing movement has been slow. Housing turnover is usually a positive for Floor & Decor, as new floors is one of the more common projects that new homeowner undertake after buying a house.
However, the company is more tied to the remodel market. High interest rates have hindered that market as well, and following growth in the market in 2023, the repair and remodel market is expected to see declines in 2024, according to the Joint Center for Housing Studies of Harvard University.
With the Federal Reserve set to cut rates three times in 2024, home equity loans rates should trend lower, which could help with this market later in the year. At this point, though, projections are still for the remodel market continuing to worsen as we head through the year.
Higher ocean freight costs could also become an issue. Drought issues impacting the Panama Canal and Red Sea routes being diverted because of Yemeni Houthis rebels has cause containership rates to soar. Ocean freight rates had come down, but this tailwind will likely turn into a headwind that could impact Floor & Decor's gross margins.
Conclusion
When you look at the potential of Floor & Decor, you can see a retailer generating upwards of $3 billion in adjusted Ebitda around full maturity, which shows the type of long-term upside the company has. This is a differentiated retail concept whose large stock-keeping unit count, depth of inventory, direct sourcing and creative displays create a competitive moat around the business.
In the near term, though, the company is facing a tough housing environment and the repair and remodel market it is focused on could be in for a difficult year in 2024. Higher ocean freight rates only add to its headwinds. While its valuation from an Ebitdar basis is not overly high, the stock has been on a strong run since November and faces some difficult macro challenges in 2024.
If the stock pulls back, it could become an attractive option for long-term investors to take a look at, as I think it is one of the best long-term stories in retail.
