Floor & Decor (Distributor of hard surface flooring that operates through warehouse-format stores) is up 180% in the last 5 years, crushing the S&P500.
This post is my attempt to analyze the company to its fundamentals, set certain assumptions about the future, and calculate its intrinsic value.
Revenue – let's start with the top line
For a company that's around just over 2 decades, the growth that still comes with it is impressive. Its revenue went from under $800m in 2015 to almost $3.5b in 2021. The average annual growth was 25%, excluding 2021 when it was 41.5% (the main reason for this huge outlier was the 19% price increase)
How does a physical store company grow?
Although this post is related to Floor & Decor, these are the options for most physical stores:
- Increase the number of locations – This is one of the main reasons for its revenue growth as the number of locations increased from 57 in 2015 to 160 in 2021. The management expects to get to 500 stores in the next 8 to 10 years. this is one of the inputs that I use as a guide for my revenue forecast.
- Increase in prices – This is not something that they can do every year and it depends on external factors, such as inflation.
- Sell more through its existing locations – Part of the revenue growth is due to them selling more products.
- Change in consumer preference – The data in their annual report shows that the consumers' preferences for hard surface flooring increased from 50% in 2016 to 57% in 2021. Of course, this can go in both ways, so Floor and Decor could benefit if the trend continues, but in case of a reversal, it can cause the revenue of the company to decline.
Assumption 1: Taking the historical revenue growth and the increase of the number of locations, my revenue forecast in the DCF model is 26% for 2022 and 22% up to year 5. After that, the bigger they are, the more difficult it is to grow, so my growth assumption decreases to 2% in year 10.
Operating margin – Historical and future
Expanding locations and growing revenue are great, but it is even better that they're increasing the operating margin during the same time (7% in 2015 to 10% in 2021). As they're still expanding, they should still benefit from economy of scale. Mainly SG&A costs. In theory, if they run a marketing campaign for 160 stores today and 500 stores in 10 years, the marketing expense should not increase by 315%.
Assumption 2: In my forecast, my assumption is that the operating margin improves to 13%, but it takes them 5 years to do so.
Growth isn't free
As a large part of the growth comes from opening new locations, it's worth mentioning that this does not come free. Yes, they can lease the location and there's no need for a large payment to buy the building, but they need to buy the equipment and especially stack its products. As of 2021, for the 160 locations, they have over $1b in inventories. We can round that down to roughly $6m inventory per location. So growing from 160 to 500 locations will require a lot of capital.
Assumption 3: In my model, I'm assuming a Sales/capital ratio of 1.8 which means, for every $1.8 increase in revenue, I'm expecting them to invest $1 (in equipment or working capital).
The outcome of the DCF model
Running the above-mentioned assumptions about revenue, operating margin, reinvestment, the fair value per share gets to $75.5, while the current share price is $92.82.
The discount rate used is 11.76 (based on WACC).
My thoughts
From a business point of view, this is a great business, it is growing healthy, is improving the margins, and doesn't have significant debt (apart from the capital leases).
Based on the current price, it doesn't offer a lot of margin of safety based on my assumptions (which could definitely be significantly incorrect. If you disagree with them, check the What if part below).
However, this company is also a good example that the market is not always rational. The share price halved from $50/share to $27 with the COVID-19 outburst. Was there uncertainty? Yes, but this seems like an overreaction. What followed was a rally all the way up to almost $150/share, an increase of 400%+ in less than 2 years. This was another overreaction, this time in the opposite direction.
What if?
My assumptions lead to revenue of $15.3b in 10 years from now (an increase of 346%). So, what if my assumptions are significantly wrong? Below you can find a table that takes different revenue forecasts (in 10 years) as well as different operating margins.
| Revenue / Op. margin | 12% | 13% | 14% |
|---|---|---|---|
| 300% ($13.7b) | $58.4 | $66.4 | $74.3 |
| 346% ($15.3b) | $66.4 | $75.5 | $84.6 |
| 400% ($17.2b) | $72.6 | $82.6 | $92.6 |
| 500% ($20.6b) | 83.3 | $94.8 | $106.3 |
There are a few scenarios in which the fair value is higher than the current share price, but the likelihood of the company achieving such high revenue growth and margin of 14% is very, very low.
As always, the goal of these Reddit posts is to provide some information about the company and provide some insights into the way it operates. I'd like to hear your opinion and your view of the company and of its future.
Leave a Reply