The Tile Shop: Powerful Business, Damaged Price, Big Opportunity

In matters of the heart, the course of true love never did run smooth.That's a fair analogy to the current housing market, which is continuing to rebound from a deep recession, but not as smoothly or evenly as initially expected. However, according to Bloomberg, the purchases of previously owned U.S. homes rose more than projected in May, a sign the industry is stabilizing after a weather depressed quarter. 

(Source: The Economist) 

Because the housing recovery is still in its early stages, a bumpy road does not mean the end of recovery. And that's important for Tile Shop Hldgs  (NASDAQ: TTS  ) because despite a potential slow-down in its business, the long-term story is still intact. With housing prices still far below their all-time highs, there's a lot more room for the kind of home remodeling that Tile Shop's business niche serves. 

Huge price drop

Source: Google Finance. A 63% drop in price signals a buying opportunity.

Shares of Tile Shop have fallen 63% since their high a year ago. Much of the drop has been due to a short-attack that proved inconsequential to the business, and due to Lumber Liquidator's  (NYSE: LL  )   recent earnings shortfall. Despite not having yet released their earnings, Tile Shop is being sold under the assumption that its results will be as drastic as Lumber Liquidator's despite the fact that Lumber Liquidators had a company-specific inventory problem and a shortfall in product. The market's assumption appears to be overly harsh; despite a different business and different obstacles, the market has already found Tile Shop guilty by association without trial (Tile Shop's earnings will be announced the week of July 28). Yes, the housing industry affects them both, but they are not the same company––what might be mistakes for one could prove to be sources of strength and managerial execution for the other––and cannot fairly be treated as such. 

The business remains strong
Is Tile Shop's business worth 63% less than it was a year ago?The best investments occur when a business remains strong while the stock price plummets. Tile Shop provides its customers with superior customer service, selection, and precise know-how that one-size fits all box stores like Home Depot  (NYSE: HD  ) and Lowe's  (NYSE: LOW  )  can't. Home Depot and Lowe's are still excellent businesses with growing year-over-year revenues that will do well in a healthy housing market because their brands signify "home repair," and most people are loyal to what they already know.

Net Income Growth 2013 2012 2011
Home Depot 18.7% 16.7% 16.3%

Lowe's

16.6% 6.5%

-8%

However, Tile Shop offers the distinction of being focused specifically on tile, and that kind of focus cannot be replicated by the do-it-all stores like Home Depot and Lowe's. A less fine-tuned selection of tile is not a reason to sell the big names, but whenever competitors like Tile Shop begin succeeding in a niche market, owners of the big-box stores should keep an eye on their tile revenue to see if they are losing significant market share to the young upstart.

Tile Shop also has an advantage over Lumber Liquidators in terms of potential remodeling revenue because tiles don't just go on floors: they can also be installed in kitchens and bathrooms, garages and back-yard walkways, giving Tile Shop customers more ways than one of upgrading their home besides floor-remodeling. And the more the Tile Shop's revenue grows, the more the stock price will follow, despite the short-term panic. 

So what?
Often the best investments are in companies that are temporarily priced as though they were about to go out of business. But with Tile Shop, the opposite is true: they are rapidly building their national store base, taking business from a highly fragmented industry with increased economies of scale and with a huge growth runway ahead of them. The pace is picking up, not slowing down, with an additional 20 stores expected in 2014. And since tiles add value to homes, the accompanying housing market recovery will provide a substantial support system, no matter how uneven it might be. Think in terms of years rather than months and you will see more clearly the tremendous potential in this investment. With the recent crash in stock price and horrific expectations already priced in, Tile Shop is offering a lucrative risk-reward profile. 

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