Floor & Decor (FND 31.79, +6.21, +24.28%), a recent IPO (April 2017) and a retailer
of hard surface flooring, is trading higher after reporting strong Q3 results
Revenue and EPS came in better than expected and same store comps were +11.1%, which was quite robust. However, it was not all good news as the guidance for Q4 was a bit disappointing as revenue and EPS are expected to come in below market expectations. And the most noticeable part of the guidance is FND expecting comps to be flat to up 2%.
However, the thing to understand about FND is that it's lapping some huge results from last year in Q4, which benefited from a big increase in sales from its Houston area stores following Hurricane Harvey. Comps in 4Q17 were +24.4% and sales in its Houston market increased over 100% due to Hurricane Harvey. On the call, management said it's assuming its Houston market stores will see a comp decline in the mid-40% range. Non-Houston comps are expected to remain strong, in the +9-10.5% range. So don’t be overly concerned about that headline comp figure.
Turning to other areas, a big part of FND's growth trajectory is new store growth. FND currently has fewer than 100 stores, but they have a goal of getting to 400+ locations over the longer term. They are currently opening stores at roughly a 20% clip in 2018 and that's expected again in 2019. In Q3, FND opened seven stores, including six in new markets. FND is focusing more on densely populated areas, particularly in the Northeast (Boston, Long Island etc.) and West Coast (Seattle).
Another big part of its growth strategy is to gain market share and management sees significant market share gain opportunities. Its brand awareness is still low, so there is a lot of room to grow in this regard as they improve marketing and enter new geographic markets. Boosting online sales is another key goal.
So why has the stock been under pressure in recent months?
- Retailers have been under pressure recently on concerns over rising rates. However, we think FND's weakness is more related to the impact of Chinese tariffs. The concern is that tariffs will force FND to raise prices to customers. FND is known as a value retailer, so there is debate over whether its customers will be amenable to the higher prices.
- We can tell this is a big concern as the first two questions during the Q&A on the call this morning were related to tariffs. FND says it has made strides in mitigating the risk from tariffs. Specifically, it has negotiated lower costs from Chinese suppliers, it has switched to some other countries where it makes sense and FND will increase prices to customers if needed but that's a last resort.
- As for the timing, the 10% tariff in Q4 should not impact margins, but the real concern is the 25% tariff possibility in January 2019. So investors have been nervous.
In sum, investors have a right to be worried about the impact of
tariffs on FND as half of what it sells is sourced from China. And FND is known
for its cheaper prices relative to its competitors as a result of its large
scale and its ability to cut out the middleman and direct source. Its
customers, which tend to be value-based, are sensitive to price increases.
With that said, the big decline in the stock price in recent months seems to have discounted this risk to some extent. FND may be worth a look as a turnaround play. The fact that the stock is up today despite the downside guidance for Q4 tells us there is a lot of negative sentiment already priced in here. However, tariffs are difficult to predict and how well FND is able to manage this headwind is still an unknown at this point.