Buying businesses with demonstrable competitive advantages over peers is an investing strategy that tends to work well over the long run. That's because companies with competitive advantages often possess pricing power, which helps grow their sales and earnings over time.
With a market capitalization of $9.5 billion, a comparison between Floor & Decor (FND 1.06%) and the likes of Home Depot and Lowe's might remind you of the story of David and Goliath. But while its peers may have a size advantage, the hard-surface flooring retailer shows that size isn't everything. Let's elaborate on what I mean.
A company that can't be beat at its own game
In just 23 years in business, Floor & Decor has built itself into an unstoppable specialist within the massive home improvement retail industry. Larger generalist peers typically only allocate a few aisles of store space to hard-surface flooring. This leaves consumers with just a fraction of the options that they would otherwise have at Floor & Decor. That's because the company dedicates the entirety of its average store space of 79,000 square feet to selling more than 4,000 natural stone, vinyl, tile, wood, and laminate flooring products.
Simply put, when customers have more than basic preferences for hard-surface flooring, they turn to Floor & Decor. And product selection isn't the only factor that differentiates the company from its competition: Floor & Decor cuts out brokers, exporters, importers, and wholesalers, eliminating all intermediaries from the sourcing of its products. This direct-to-store approach is how the company can offer the highest-quality products to customers at low prices relative to its competitors. These meaningful competitive advantages are probably why Warren Buffett-led Berkshire Hathaway owns a 4.5% stake in Floor & Decor.
Sales surged higher
| Metric | Q1 2022 | Q1 2023 |
|---|---|---|
| Total Store/Design Studio Count | 171 | 199 |
| Comparable Store Sales Growth Rate | 14.3% | (3.3%) |
| Net Margin | 6.9% | 6.4% |
Data source: Floor & Decor Q1 2023 earnings press release and Floor & Decor Q1 2022 earnings press release.
Floor & Decor's net sales rose by 9.1% year over year to $1.1 billion during the fiscal first quarter ended March 30, 2023. This top-line growth came despite soaring interest rates and high inflation eroding the demand for its products. These factors resulted in a shift in comparable store sales growth from a double-digit clip in the year-ago period to a negative growth rate in the quarter. So how did the company boost its net sales in such a tough environment? As illustrated above, the answer lies within Floor & Decor's double-digit percentage growth rate in its warehouse store and design studio count.
The retailer's diluted earnings per share (EPS) were unchanged at $0.66 for the fiscal first quarter. That's because while net sales grew, total operating expenses increased faster (18.9%) during the quarter. This led to a 50-basis point decline in net margin, so diluted EPS growth lagged net sales growth in the quarter.
With less than half of its target store count built, Floor & Decor should have great growth prospects in its future: Analysts anticipate that the company's diluted EPS will compound by 13.6% annually, which is triple the 4.3% annual earnings growth outlook for its industry peers.
The company is a financial fortress
Floor & Decor looks to have the financial capacity to execute its growth plans. The company's net debt is expected to stand at just $358 million for the current fiscal year. Against the $605 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) that is projected in fiscal year 2023, that is a manageable net debt-to-EBITDA ratio of 0.6. By comparison, Floor & Decor's debt-to-EBITDA rate has averaged 0.9 over the last decade.
Floor & Decor stock offers growth at a reasonable price
Up 31% so far in 2023, Floor & Decor's stock has been on a tear. But the valuation still doesn't appear to be stretched. Floor & Decor's forward price-to-earnings (P/E) ratio of 26.9 is well above the industry average forward P/E ratio of 16.4. But with its outstanding growth potential, the stock is arguably worthy of its premium valuation.
