Floor & Decor Holdings, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Floor & Decor Holdings, Inc. is a specialty retailer of hard surface flooring and related accessories, with a focus on the fragmented and competitive flooring industry.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Floor & Decor (FND) operates a chain of big-box retail stores primarily in the United States, specializing in hard surface flooring, including tile, wood, laminate, vinyl, and natural stone. They also offer installation materials and accessories.

  • Revenue Distribution:
    • The company’s revenue streams are primarily through direct sales of flooring products to both consumers (DIY) and professionals (PRO).
    • Sales include:
      • Laminate and vinyl plank flooring (largest segment)
      • Tile (second largest segment)
      • Wood
      • Decorative accessories
      • Installation materials
      • Other
  • Industry Trends:
    • The hard-surface flooring industry is highly fragmented and competitive.
    • The trends in home improvement, remodels, and new construction are crucial for business.
    • Consumers continue to look for visually appealing, durable, and cost-effective flooring solutions.
  • Competitive Landscape:
    • FND competes primarily with big box home improvement retailers such as Home Depot and Lowe’s, as well as regional and smaller specialty retailers.
    • The retail flooring industry remains highly competitive, with pricing and selection as key factors.
    • The company also faces competition from online retailers and direct-to-consumer manufacturers
  • What Makes FND Different?
    • FND differentiates itself through specialized product selection, focus on in-stock products, and large warehouse stores.
    • They offer specialized installation materials for different types of flooring.
    • The design center they offer is a big draw for consumers and professionals.
    • They offer a Pro-specific program, which means they give additional features to pros.
  • Margins: FND has relatively high gross margins, primarily because the company is vertically integrated and can therefore control many parts of the supply chain, but they are under pressure because they’ve been focusing on low prices to gain market share.

Financials Deep Dive

  • Revenue: FND has shown consistent revenue growth over the past few years. In 2022, net sales reached $4.28 billion, a solid jump from $3.42 billion in the year prior and $2.9 billion in 2020, and the growth in 2021 was even higher than the average growth over the past few years.
    • The third quarter of 2022 saw sales of $1.14 billion which means $4.412 billion in yearly sales if you keep this momentum
  • Profitability: While revenue growth has been impressive, profitability has faced some pressure due to increased costs and investments in new store openings. The net income was $207.754 million in the latest reports, almost half of the $384 million reported last year, this is most likely due to margin pressures.
    • Adjusted EBITDA was $178 million or 11.8% of the net sales this quarter compared to $292.4 million and 17.1% of the net sales in the same quarter the previous year, showing the contraction of margins.
  • Expenses: FND’s expenses have been affected by an increase in opening costs, but even the non-opening costs have increased in relation to the sales, which is a warning sign about the business.
  • Cashflow: The cashflow from operations was negative $50 million, while it was positive $138 million in the same quarter last year. The main reason for this decline is a massive decrease in payables.
    • The free cash flow was also negative $110 million in this quarter.
    • The free cash flow margin has been constantly negative in the past two years.
    • FND continues to make investments in its business, especially through store openings, and management believes that these investments can lead to increased returns in the future.
  • Debt: Debt-to-EBITDA is less than 3 times, which is a good range, given the cyclical nature of the business, and this debt isn’t posing a risk for now.

Moat Assessment: 2 / 5

FND’s economic moat is narrow mainly due to a combination of a relatively strong distribution network and brand. Their ability to procure new items and offer variety is not unique, but the integration of multiple different aspects of value chain makes it somewhat better than smaller retail competitors. However, the following points cause their moat not to be wide:

  1. Switching costs are low. Customers could switch between similar retailers if they offer lower prices or better products.
  2. Intense competition between big box and small retailers.
  3. Cyclical industry that relies on housing and remodels.
  4. Susceptible to new technologies and e-commerce trends.

Moat Risks and Business Resilience

  • Competition: The threat from both big-box retailers (Home Depot and Lowes) and smaller, specialized retailers.
  • Economic Downturns: Reduced consumer spending on home improvement during economic recessions.
  • Real Estate Costs: Significant capital needed for growth (to build new stores) coupled with high rental prices, which could increase costs and limit profitability.
  • Online Competition: FND does not have a strong enough online presence, and the new generation of customers primarily want to purchase online.
  • Supply chain: Supply chain issues could cause volatility in input costs, thus squeezing the margins.

  • Debt: The high amount of debt could be a risk for the company in times of stress

  • Resilience: FND has a decent brand name and good value proposition, which can help it to recover from temporary downturns.

Understandability: 2 / 5

The business is fairly simple to understand for the basics. However, FND’s accounting methods, specifically regarding lease capitalization and inventory valuation, are very intricate and require time and effort to understand. The relationship between their value and their operating model is also quite complex and requires time to understand. Understanding the nuances of their specific industry also requires experience in the business.

Balance Sheet Health: 4 / 5

The company has a decent balance sheet, with a positive level of net assets, and isn’t in any real trouble when it comes to paying back the debt or maintaining the current levels of debt. However, because the leverage ratio is still relatively high compared to its operating earnings, the rating cannot be a 5.

Recent Concerns and Management Outlook

In the latest earnings calls, the CFO commented that the company is expecting to see flat gross margins in the upcoming quarters, while they are also seeing pressure on the SG&A expenses. This is mainly because the company is choosing lower prices to maintain market share. Management stated that while it is possible for them to improve profitability, it is a bit more difficult because of the increasing inflation and high raw material prices, and is therefore focusing on sales growth. Management is trying to focus on attracting a higher quality and premium customer base to improve margins in the future.

Management also discussed their commitment to opening 20 to 30 new stores in the upcoming year, which means the company will prioritize growth over short-term profitability, because those new stores might have an immediate negative impact on the cash flow.