Floor & Decor (FND) has seen a very strong IPO as shares quickly jumped to $30 in its first regular trading session. This move came after the IPO price had already been raised to $21 per share, some four dollars above the midpoint of the preliminary offering range.
While I like nearly everything about the business, the valuation is a concern for me with shares trading at +50 times estimated earnings this year. This makes me naturally cautious after the big run higher. That being said, F&D will be on my watchlist as any serious pullback towards the low twenties could be used as an entry point in my eyes.
Hard Surface Floor Store
Floor & Decor was founded in 2000 and has grown to become a specialty retailer of hard surface floors, currently operating 72 stores across 17 states. The company offers tiles, wood, laminate and natural stones, installation accessories and other services, providing its clients with a one-stop solution.
Besides the do-it-yourself customers, F&D is appealing to professional installers as well as the selection of inventory is very large, with the typical store averaging at 72,000 square feet. This is far greater than most of its competitors as the company typically has sufficient inventory at hand to deliver immediately.
This breadth of assortment and timely delivery is very appealing to customers in combination with the competitive pricing. Being in business for 17 years now, F&D is still relatively small. In the long run, that is in the coming 15 years, F&D sees the potential to expand to a store base of 400 across the nation.
Another big plus is the nature of the products being sold. As floors represent a pretty permanent purchase, many consumers like to see the product first, as the heavy weight does not make it easy to order online. If the company can deliver on its growth ambitions, it has the potential to become a giant in the estimated $10 billion US hard surface flooring market.
The Offering & Valuation
F&D sold 8.8 million shares for $21 apiece, raising $185 million in gross proceeds in the process. Following the offering there are 92.3 million shares outstanding which value equity at $1.94 billion at the offer price.
The company operates with $390 million in net debt ahead of the offering, as this net debt load will fall towards $220 million after taking into account the offering proceeds. That values the business at nearly $2.2 billion at the offer price. As shares have risen to $30 in regular trading, the total value of the business has risen towards $3 billion.
F&D has delivered on impressive growth through a combination of store openings and organic sales growth. Sales grew to $1.05 billion in 2016, triple the sales reported back in 2012. The company has grown comparable sales at a rate between 11 and 22% each year between 2012 and 2016, being a truly remarkable achievement. The company reported a very impressive 19.4% comparable growth number for 2016 (driven by a 14.7% increase in transactions) and opened another 12 stores to end the year with 70 stores.
F&D posted operating profits of $69 million last year, for margins of 6.6% of sales, which is similar to the margins posted in 2015 despite a continuation of very rapid growth. The lack of margin progress results from a $10.5 million litigation settlement charge taken last year. If not for that charge, pre-tax margins would have risen by nearly a point.
The company posted an adjusted EBITDA number of $108 million in 2016, for a 2 times leverage ratio based on the net debt position following the public offering. As EBITDA is growing rather quickly, leverage is not a key concern for investors going forward.
The company started the first quarter of 2017 on a solid note. Comparable sales were up by 12.8% according to the preliminary results. This remains of course an impressive achievement in this retail environment although it does mark a slowdown from the growth numbers reported for all of 2016. Sales are seen at roughly $306 million this past quarter, or annualized at $1.2 billion.
Factoring in seasonable factors based on this historic data is hard to do given that the business has grown so rapidly. The 30% year-on-year growth rate suggests that revenues might come in at $1.3 billion this year. First quarter margins are seen at 6.9%, up a point compared to the same quarter last year.
If we assume that margins can improve towards 7% on revenues of $1.3 billion, operating earnings might come in at $91 million this year. Applying a reasonable cost of debt on a net debt load of $220 million following the IPO, I see pre-tax earnings at $82 million. This yields an after-tax number of $53 million if we assume a 35% tax rate, equivalent to $0.57 per share. This reveals that the market has become very enthusiastic about the prospects for the company. At $30 per share, the company now trades at a +50 times earnings multiple.
Great Story, Too Pricey For Me
I like literally all the aspects of the company except for the valuation. With unit growth and comparable sales growth being very strong, and the potential market being very large as well, there is a clear pathway for continued growth. The issue is that the valuation is very cheap based on the current performance.
Let’s evaluate the prospects if we work with a potential store base of 400 some 15 years from now. An average store currently generates about $17 million in sales per year, as this number could rise to $25 million by 2032 if we assume 2.5% inflation/growth. A more ambitious 4% inflation/growth number results in sales of $30 million per store in that year. That suggests that a store base of 400 could yield sales of $10-$12 billion by 2032.
If that number is realistic and margins of 7.5% can be achieved, I arrive at an after-tax profit number of $540 million if the company can finance this growth path without incurring debt or issuing shares. Such an achievement could yield after-tax earnings of $6 per share which combined with a market valuation multiple could easily justify a $100 per share valuation in 2032. Note that this is still 15 years from now, as such an achievement would result in a decent compounded annual growth rate of 8%, which is decent but not spectacular.
For the near term, the momentum is likely to remain strong on the back of a housing market and remodeling market, but note that there are some risks as well. Perhaps the biggest risk is the fact that 70% of goods are imported (mostly from China), which could be a big issue if (boarder) tax/regulation changes.
You get the point. I am not a buyer after this run, but will keep an eye on the business as the underlying business seems very strong and the long-term potential remains immense.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.