Home Depot (HD 0.94%) has been an incredible stock to own over time, gaining nearly 300% over the past 10 years. It's the largest home improvement chain in the world, with more than 2,300 stores, and it continues to dominate its industry and demonstrate robust profitability.
However, it's also well-established and has passed its high-growth stage. That leaves room for newcomers to stake out similar territory and become the next big opportunity. Floor & Decor (FND 2.66%) operates a similar model to Home Depot's, but it sells flooring products. It's just getting started, and it has a huge growth runway in new store openings.
Could Floor & Decore it become the next Home Depot?
Growth doesn't have to be complicated
Floor & Decor's growth strategy goes back to the simple, pre-tech consumer goods retailer model: Open new stores, give customers what they want, and they'll keep coming. Using this model, it has demonstrated impressive growth since its founding in 2000 -- and it was still growing briskly leading up to this high-inflation period.
Its warehouse-style stores feature thousands of products related to hard flooring as well as competitive pricing and a customer-oriented focus. It operated 203 stores as of the end of the second quarter, and it sees the opportunity to reach 500 over the next eight years or so. Considering its success so far, that looks like an attainable goal.
Short-term headwinds have hit
While the American consumer is demonstrating resilience thus far despite inflation, some industries are feeling pressure more than others. One area that's struggling right now is housing and related industries, such as home improvement. High interest rates mean expensive mortgages, and that's slowing down housing sales. The broader implications are that businesses which support housing are feeling the impact acutely. Home Depot is feeling this as well, with decreasing total sales and comparable sales.
Floor & Decor sales inched up 4% over last year in the second quarter, but that was all from new stores, of which it opened nine in the quarter. Same-store sales decreased a disappointing 6% from last year, and management is guiding for a similar decrease for the full year. Floor & Decor is highly profitable, with earnings per share of $0.66 in the second quarter, but that was a 13% decrease from last year.
But the long-term story is intact
Every company and industry experiences external headwinds at times. Floor & Decor's performance is reflecting a broader trend, but it's managing through this challenging time, and it has the tools to rebound quickly when circumstances are more favorable.
One area to watch is the operating margin. It was 8.4% in the second quarter, down 1.4 percentage points from last year. It's far off from Home Depot's industry-leading 15.6%, but similar to the operating margin of competitor chain Lowe's.
FND Operating Margin (Quarterly) data by YCharts
As it scales, opening new stores, the operating margin should improve. Home Depot's margin has improved over time and with scale, and Floor & Decor's should as well.
The next Home Depot stock?
So can Floor & Decor become the next Home Depot? It may not be able to reach the same store count or total sales since it works in a much smaller niche. But its stock is likely to deliver huge gains, potentially matching Home Depot's over time.
The shares are up 22% so far this year, beating the market, despite the lower comparable sales and profits. At this price, shares trade at a price-to-earnings ratio of 32. That's not objectively cheap, but it's well below the three-year average of nearly 40.
Floor & Decor has a long growth runway, and it looks priced to buy. If you missed out on Home Depot in its early days, don't miss out on this growth opportunity.
