Tile Shop Crashes: Buying Opportunity?

Source: Tile Shop.

Tile Shop (NASDAQ: TTS  ) fell more than 9.3% on Thursday after Credit Suisse reduced its price target for the company due to weak results from competitor Lumber Liquidators (NYSE: LL  ) . Although weaker-than-expected demand in the flooring industry could be a relevant risk factor to consider, short-term volatility could create a buying opportunity for long-term investors in Tile Shop.

Contagion effect: Lumber Liquidators and Tile Shop
Lumber Liquidators announced really concerning news for investors on Wednesday, and the stock fell as much as 20.5% the following day as the market reacted with pessimism -- or even fear -- to the company's lackluster financial performance during the second quarter and reduced guidance for the full year 2014.

Lumber Liquidators announced that total sales during the second quarter increased 2.3% to $263.1 million, while sales at comparable stores crashed by 7.1% during the period, a big disappointment and a reason for concern regarding the health of the business. To put things in perspective, Wall Street analysts were on average forecasting $303.2 million in revenue during the quarter.

Lumber Liquidators expects earnings per share during the quarter to be between $0.59 and $0.61 per share, considerably lower than estimates of $0.90 per share from Wall Street analysts.

In addition, the company reduced its guidance for the full year; Lumber Liquidators expects sales during 2014 to be between $1.05 billion and $1.1 billion, versus a prior guidance in the range of $1.15 billion to $1.2 billion. Management also cut earnings-per-share forecasts to between $2.65 and $3 versus a prior range of $3.25 to $3.60.

Lumber Liquidators blamed its disappointing performance on harsh weather conditions and macroeconomic weakness, while inventory problems during the quarter had a negative impact on sales too.

After learning from weak demand affecting Lumber Liquidators, Credit Suisse cut its price target on Tile Shop from $16 to $18, which fueled a big sell-off of more than 9.3% in the stock on Thursday, and another 7% on Friday.

Buying opportunity?
Flooring demand is quite tied to the real-estate cycle, so Tile Shop and Lumber Liquidators are clearly related as they are both exposed to similar macroeconomic factors. But it's also important to consider the differences between the two companies, especially since Tile Shop outperformed Lumber Liquidators during the first quarter of the year, when both companies were affected by unfriendly weather conditions.

During the quarter ended on March 31, Lumber Liquidators reported a modest increase in sales of 6.9%, to $246.3 million. Sales at comparable stores declined 0.6% overall, including a 13.1% decrease in weather-affected stores and an 8.5% increase in all other stores.

Tile Shop reported a 13.3% increase in sales during the same quarter, to $64.4 million versus $56.8 million in the first quarter of 2013. While comparable-store sales declined 2.3% during the quarter, management remarked on the fact that sales were accelerating as weather conditions improved:

Sales results were affected by harsh winter weather conditions in important Midwest, mid-Atlantic and East Coast markets where the majority of stores are located. Comparable-store sales improved sequentially throughout the quarter as weather challenges subsided, including positive comparable-store sales growth in March. Additionally, stores located in more southern geographies delivered high single digit comparable-store sales growth for the quarter.

Tile Shop has built a solid competitive position due to its deep specialization in ceramic and stone tile, a broad selection of products in that category, and a specialized customer service. According to management, Tile Shop has consistently outperformed the industry over the last several years because of these strengths.

Source: Tile Shop.

Besides, the company still has abundant room for growth. Tile Shop ended the first quarter with a relatively small base of 95 stores in 30 states, and the company is planning to open roughly 13 new stores during the remainder of 2014, ending the year with approximately 108 stores. On a longer-term basis, the company believes it has enough room for more than 400 stores in the U.S., so it is barely getting started when it comes to growth potential.

Source: Tile Shop.

Foolish takeaway
Weakness from Lumber Liquidators may be anticipating harder times to come for Tile Shop, too, as the two companies are exposed to fluctuating industry demand. On the other hand, it all comes down to short-term uncertainty versus long-term opportunity, and Tile Shop is still a dynamic business offering substantial opportunities for growth. The recent dip in Tile Shop could easily turn out to be a buying opportunity for investors.

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