Specialty flooring retailer Floor & Decor (NYSE:FND) missed analysts' expectations in Q2 FY2023, with revenue up 4.23% year on year to $1.14 billion. Unfortunately, the company's full-year revenue guidance also came in lower than expected. Floor & Decor made a GAAP profit of $71.5 million, down from its profit of $81.8 million in the same quarter last year.
Floor And Decor (FND) Q2 FY2023 Highlights:
- Revenue: $1.14 billion vs analyst estimates of $1.15 billion (1.15% miss)
- EPS: $0.66 vs analyst estimates of $0.65 (1.2% beat)
- The company dropped revenue guidance for the full year from $4.68 billion to $4.5 billion at the midpoint, a 3.95% decrease
- Free Cash Flow of $86.6 million is up from -$102 million in the same quarter last year
- Gross Margin (GAAP): 42.2%, up from 40.7% in the same quarter last year
- Same-Store Sales were down 6% year on year
- Store Locations: 203 at quarter end, increasing by 29 over the last 12 months
Operating large, warehouse-style stores, Floor & Decor (NYSE:FND) is a specialty retailer that specializes in hard flooring surfaces for the home such as tiles, hardwood, stone, and laminates.
While other home improvement retailers sell flooring products in addition to a whole host of other categories such as paint, appliances, lumber, and even plants, Floor & Decor is focused largely
The core customer is both the do-it-yourself (DIY) homeowner as well as the professional contractor. The DIY shopper values the ability to touch and feel products as well as the helpful sales associates trained strictly in flooring. For the professional contractor, Floor & Decor’s vast selection and high in-stock positions mean they don’t have to shop around to find everything they need, allowing them to maximize time devoted to their projects. There are also loyalty programs and volume discounts for Pros.
The company has a vertically integrated business model, which means they control every aspect of the supply chain from product development to procurement to distribution. Since Floor & Decor deals directly with manufacturers (competitors often use buying agents and middlemen), they can keep prices extremely competitive. It also allows the company to introduce new products and respond to trends in a more timely manner.
Home improvement retailers serve the maintenance and repair needs of do-it-yourself homeowners as well as professional contractors. Home is where the heart is, so any homeowner will want to keep that home in good shape by maintaining the yard, fixing leaks, or improving lighting fixtures, for example. Home improvement stores win with depth and breadth of product, in-store consultations for customers who need help, and services that cater to professionals. It is hard for non-focused retailers and e-commerce competitors to match these. However, the research, convenience, and prices of online platforms means they can’t be fully written off, either.
Competitors offering flooring products and materials include LL Flooring (NYSE:LL), Tile Shop (NASDAQ:TTSH), Home Depot (NYSE:HD), and Lowe’s (NYSE:LOW).Sales Growth
Floor And Decor is a mid-sized retailer, which sometimes brings disadvantages compared to larger competitors benefiting from better economies of scale. On the other hand, it has an edge over smaller competitors with fewer resources and can still flex higher growth rates than its larger counterparts because it's growing off a smaller base.
As you can see below, the company's annualized revenue growth rate of 23.9% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) has been exceptional as it's added more brick-and-mortar locations and increased sales at existing, established stores.
This quarter, Floor And Decor grew its revenue by 4.23% year on year, falling short of Wall Street's estimates.
Looking ahead, the analysts covering the company expect sales to grow 14.7% over the next 12 months.
Number of Stores
When a retailer like Floor And Decor is opening new stores, it usually means that demand is greater than supply and it's investing for growth. Since last year, Floor And Decor's store count increased by 29 locations, or by 16.7%, to 203 total retail locations in the most recently reported quarter.
Taking a step back, the company has opened new stores rapidly over the last eight quarters, averaging 18.3% annual growth in its physical footprint. This store growth is much higher than other retailers. With a growing store base and demand, revenue growth can come from multiple vectors: sales from new stores, sales from e-commerce, or increased foot traffic and higher sales per customer at existing stores.
Same-Store Sales
Floor And Decor's demand within its existing stores has generally risen over the last two years but lagged behind the broader consumer retail sector. On average, the company's same-store sales have grown by 6.65% year on year. With positive same-store sales growth amid an increasing physical footprint of stores, Floor And Decor is reaching more customers and growing sales.
In the latest quarter, Floor And Decor's same-store sales fell 6% year on year. This decline was a reversal from the 9.2% year-on-year increase it had posted 12 months ago. A one quarter hiccup isn't material for the long-term prospects of a business, but we'll keep a close eye on the company to see if any unfavorable trends emerge.
Gross Margin & Pricing Power
Gross profit margins are an important measure of a retailer's pricing power, product differentiation, and negotiating leverage. They also show us how much money a retailer gets to keep after paying for the goods it sells, and if the gross margin is high, it increases the likelihood of more operating profits.
As you can see below, Floor And Decor has averaged a healthy 41.4% gross margin over the last two years. This means that the company makes $0.42 cents for every $1 in revenue before accounting for its operating expenses. 
In Q2, Floor And Decor's gross profit margin was 42.2%, marking a 1.6 percentage point increase from 40.7% in the same quarter last year. This margin expansion was comforting to see as it could signal that the company was operating in a less competitive environment with higher pricing power, less pressure to discount products, and more stable input costs (such as distribution costs to move products).
Operating Margin
Operating margin is a key profitability metric for retailers because it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
In Q2, Floor And Decor generated an operating profit margin of 8.36%, down 1.4 percentage points year on year. Conversely, the company's gross margin actually increased, so we can assume that the reduction was driven by poor cost controls or weaker operating leverage on fixed costs.
Floor And Decor has managed its expenses well over the last eight quarters, producing an average operating margin of 8.86% during that time. This level of profitability is higher than the broader consumer retail sector. During that same time, Floor And Decor's operating margin (on average) fell 0 percentage points lower year on year.EPS
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q2, Floor And Decor reported EPS at $0.66, down from $0.76 in the same quarter a year ago. This print beat Wall Street's estimates by 1.2%, a welcome development that should delight shareholders.
Between 2020 and 2023, Floor And Decor's adjusted diluted EPS grew 74.3%, translating into a remarkable 24.8% average annual growth rate. This EPS growth is materially higher than its revenue growth over the same period, indicating that Floor And Decor has excelled in managing its expenses (leading to higher profitability), bought back a healthy chunk of its outstanding shares (leading to higher PER share earnings), or did some combination of both.
Cash Is King
Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.
Floor And Decor's free cash flow came in at $86.6 million in Q2, representing a 7.62% margin and flipping from cash flow negative in the same quarter last year to cash flow positive. This was an awesome development for the business.
Over the last eight quarters, Floor And Decor's free cash flow margin has averaged negative 5.01%, poor for the consumer retail sector. This weak margin stems from its capital-intensive business model, loose cost controls, and demanding reinvestment strategy.
Meanwhile, Floor And Decor's shareholders should feel optimistic as the company's free cash flow margin has grown by an average of 12.4 percentage points year on year during the same time. This result is a good sign for the business.Return on Invested Capital (ROIC)
Floor And Decor's subpar returns on capital may signal a need for future borrowing or capital raising to fund growth. Its five-year average return on invested capital (ROIC) is 10.1%, low compared to the best retail companies that consistently pump out 25%+.
We like to track ROIC because it tells us how much return (profit) a company makes on the money it invests into its business, shedding light on its prospects and its management team's decision-making prowess. ROIC can also be used as a tool to benchmark a company's performance versus its peers, and just like how we focus on long-term investment returns, we care more about analyzing a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from Floor And Decor's Q2 Results
Sporting a market capitalization of $11.9 billion, more than $4.17 million in cash on hand, and positive free cash flow over the last 12 months, we believe that Floor And Decor is attractively positioned to invest in growth.
We struggled to find many strong positives in these results. The company's full-year revenue, same-store sales, and adjusted EBITDA guidance were lowered and missed analysts' expectations. Overall, this was a mediocre quarter for Floor & Decor. The company is down 6.87% on the results and currently trades at $103.35 per share.
Is Now The Time?
Floor And Decor may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. We think Floor And Decor is a solid business. We'd expect growth rates to moderate from here, but its revenue growth has been exceptional over the last three years. And while its cash burn raises the question of whether or not it can sustainably maintain its growth, the good news is its extraordinarily high rate of new stores openings has fueled revenue growth and increased brand equity, and its gross margins indicate a healthy starting point for the overall profitability of the business.
There are definitely things to like about Floor And Decor and there's no doubt it's a bit of a market darling, at least for some investors. But when considering the company against the backdrop of the consumer retail landscape, it seems there's a lot of optimism already priced in. We wonder whether there might be better opportunities elsewhere right now.
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