Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on Floor & Decor Holdings, Inc. (NYSE: FND)
01 Julio 2024 - 8:00AM
Business Wire
NOTE TO EDITORS: The Following is an
Investment Opinion Issued by Spruce Point Capital
Management
Believes That Floor & Decor’s Ballooning
Capital Expenditures and New Store Operating Costs in Lower Income
and New Geographic Markets Will Severely Impair its Earnings
Potential
Identifies at Least Ten Other Areas of
Misperception That Suggest Floor & Decor’s Challenges Are
Structural and Are Not Cyclical or Easily Fixed
Provides Evidence That Floor & Decor
Recently Made Revisions to Key Revenue Claims, Numerous Omissions
of Past Disclosures, Changes to Accounting Policy Language and
Modifications to Business Practices That Obscure its Growing
Challenges
Provides Evidence That CEO Thomas Taylor
Enjoys Excessive Personal Travel Perks and Has Enacted Three Recent
Stock Sale Programs as Floor & Decor’s Fortunes Sour
Believes the Board, Led by Two Former Linens
‘N Things Executives Who Oversaw a Similar Retail Growth Strategy
Before the Company Restated Financial Results and Went Bankrupt, Is
Ill-Equipped to Safeguard Shareholder Interests
Sees Growing Risk to Earnings From Potential
Tariff Increases Under a Trump Re-election Given That 25% of Sales
are Products Imported From China and a Majority of Products are
Imported From Foreign Countries
Believes Analysts Fail to Include ~$620
million of Supply Chain Finance Debt, Legally Binding Lease
Commitments and Asset Retirement Obligations Which Represent ~$5.75
per Share of Valuation Downside; Sees 40% to 60% Intermediate, and
100% Long-Term, Downside Risk to FND’s Share Price and Expects the
Price to Underperform the Broader Retail Sector
Calls on Warren Buffett and Berkshire
Hathaway to Explain Its Investment Rationale for Owning $480
Million of Floor & Decor Stock Given our Research
Findings
Spruce Point Capital Management, LLC (“Spruce Point” or “we” or
“us”), a New York-based investment management firm that focuses on
forensic research and short-selling, today issued a detailed report
entitled, “Floored By A Bad Investment” that outlines why we
believe shares of Floor & Decor Holdings, Inc. (NYSE: FND)
("Floor & Decor" or the "Company") face up to 40% –60%
intermediate-term downside risk, or $39.75 – $59.65 per share.
Download and view the report by visiting www.SprucePointCap.com for
additional information and exclusive updates.
***
Spruce Point Report
Overview
Founded in 2000 and based in Atlanta, Georgia, Floor & Decor
operates 225 warehouse-format stores and five small design studios
across the U.S. that sell hard surface flooring products,
decorative and installation accessories and products in adjacent
categories in the U.S. The Company operates stores averaging 78,000
square feet and focuses on a target customer base of professional
installers and commercial businesses (“PROs”) and homeowners. It
currently has expansion plans to reach 500 stores. As of the
trailing 12 months ended March 31, 2024, the Company reported
$4,389 million and $224 million of revenues and net income,
respectively.
The concerns we outline in our report include:
- Floor & Decor’s strategy is struggling, and we see
challenges intensifying instead of improving.
- The Company touts that its visually
appealing, customer-friendly large store format with a broad SKU
assessment and everyday low prices are key advantages. Ironically,
this retail business strategy is very similar to one that the
Chairman of the Company’s Board, Norman Axelrod, and its Audit
Committee Chairman, William Giles, touted while they were CEO and
CFO/CAO, respectively, at Linens ‘N Things (NYSE: LIN or
“LIN”). However, once LIN’s store growth fell below 20%, its
sales goals widely missed expectations, margins contracted, and it
was then sold to private equity firm Apollo before it filed for
bankruptcy. Under Axelrod and Giles’ leadership, LIN also restated
its financials for lease and supplier finance accounting, which is
troubling in the context of our observations of Floor & Decor’s
practices in these areas. Floor & Decor had consistently grown
its store count by 20% until 2023 when growth slowed to ~16%. As a
result, management is guiding to 14%-16% store growth in 2024
(blaming it on existing home sales weakness) while now signaling
that 25%-30% of new stores will be smaller format. We believe the
Company’s shift foreshadows a similar disaster that befell
LIN.
- Since our inception, Spruce Point has
repeatedly warned investors to avoid companies like Floor &
Decor that consistently misforecast capital expenditures (“capex”)
and provide inadequate disclosures. At a minimum, we believe
bad forecasting shows that management has a poor handle on its
business and may lack accretive investment opportunities – but
beyond that, it is often an indicator of future disappointment for
investors. Since providing capex guidance in 2016, the Company has
cumulatively underspent by ~$330 million vs. forecast. Only a small
portion of the variance is explained by COVID-19. The Company no
longer regularly discloses the square footage of each new store
opened and the actual breakdown of where its capex was spent, but –
by our estimate – new store capex per square foot was increasing
29% per annum through 2021. Floor & Decor is also extending its
property lease duration in a market where peers are doing the
opposite. In tandem, the Company’s off balance sheet legally
binding lease commitments relative to forward 12-month new store
openings have exploded to 17x, a concerning sign to watch for the
future.
- Our research indicates that regional
differences represent a growing cause for concern as new stores are
being opened in progressively lower median income markets,
geographic challenges to growth are emerging, and new store
operating costs are ballooning. The Company historically
said it does not report results geographically because the regions
have similar economic characteristics. However, since this
disclosure was last made in 2018, we observe that the Company
recently started talking about regional differences on conference
calls. Our research indicates that the Company is weaker in certain
regions, such as the Pacific Northwest, where building foundation
differences result in less tile usage. The Company also appears to
be opening stores in lower income markets. We find that stores
opened in year-to-date 2024 were in zip codes with ~6% lower
average median household incomes than in 2023 and ~10% lower than
the stores opened in 2022. Notably, stores opened in 2022-2023 have
underperformed, and we expect the problem to continue. In
particular, we believe investors should pay close attention to a
recent disclosure regarding new store selling and operating costs.
In 2023, the Company incurred $154.9 million of costs for 30 new
stores, but 60% were opened in H2’23 and 90% post-Q1’23. The true
run-rate cost for the 30 new stores could be almost double or $310
million or $10.3 million per new store. This compares with
historical store and selling operating expense of ~$6 million per
store.
- Floor & Decor made numerous omissions and changes to
financial reporting, accounting policy language, and business
practices that we believe obscure its intensifying problems.
- Recent changes to business
practices: The Company recently modified its sales return
policy with language that we believe makes it more difficult for
customers to return items. Coincidentally, the Company reduced its
sales return allowance by $6 million when overall sales only
increased by $149 million in 2023. In addition, the Company appears
to be staffing stores with fewer workers which may be resulting in
lower customer service and satisfaction.
- Recent disclosure omissions: The
Company has recently made a broad array of changes to disclosures
that should alarm investors. For instance, it no longer 1) reports
“Adjusted EPS,” 2) makes claims about its Total Addressable Market
(“TAM”), or 3) provides a detailed accounting of where historical
capital expenditures were spent. Furthermore, the Company ceased to
provide details of inventory in transit at stores or distribution
centers and no longer says that supply chain relationships allow it
to understand the best places to procure various product
categories.
- Recent changes to accounting policy
language and financial reporting: Floor & Decor
previously reported a material weakness of internal controls
related to financial reporting that it claims was rectified in
2019. Yet, over four years later, the Company continues to warn
about its inability to maintain effective controls and we believe
this presents several key areas of concern. First, the Company has
claimed that e-commerce (recently changed to “connected customer
sales”) is ~19% of total sales. In 2021, we find unexplained
revisions to historical e-commerce sales claims. Second, sales to
PROs are also material to the Company’s business and account for
~40% of sales. However, in 2023, we find unexplained revisions to
reported PROs sales while the Company ceased to provide additional
quantitative metrics such as PROs comparable sales, ticket size,
and volume impact to the PROs business. Finally, the Company also
made changes to accounting policy language concerning inventory
valuation and loyalty points programs that could enable
overstatement to both sales and gross margins.
- Investors should be skeptical of Floor & Decor’s
management given public allegations of deceptive behavior. In
2015, the Floor & Decor management team was embroiled in a
product scandal when a lawsuit alleged it acted unethically in the
sale of formaldehyde-treated wood. The lawsuit claimed the Company
mislabeled flooring as complying with formaldehyde limits following
an employee whistleblower who publicly called out the Company’s
behavior as deceptive. The case was settled in 2016 for $14
million. Management came away from the scandal unscathed and
received pay raises that even included a shocking special bonus for
the CEO. After the lawsuit, nothing changed on the management team.
Today, the Company continues to be led by CEO Thomas Taylor, a
former Home Depot executive who we believe makes excessive and
lavish use of travel perks with the Company aircraft, and Trevor
Lang, who transitioned from CFO to President in November 2022. Mr.
Lang worked at Blockbuster (NYSE: BBI) as VP of Operations Finance
through early 2003. By 2006, after discussions with the SEC,
Blockbuster restated 2003 operating cash flow lower by an
astounding -58%. He later worked at Carter’s Inc. (NYSE: CRI) from
2003-2007, where, as VP of Finance, he was responsible for the
corporate accounting function. Carter’s later issued a non-reliance
opinion on its financials for the period from 2004 to 2009 and
disclosed that the U.S. Attorney’s Office was conducting an inquiry
into the matter. Both Mr. Lang and the Company’s current CFO, Bryan
Langley, also make claims to be CPAs. However, neither executive
has an active or current CPA license, which is referenced as a
false or deceptive practice under the Georgia Code unless a license
is held.
- Through our research, we have identified at least ten areas
of misperception about the Company among investors and we provide
data points to counter these viewpoints:
- Competitive advantage in its large store size format and broad
SKU assortment
- Product differentiation, pricing power, and money being made in
all product categories
- Substantial adjacent product category opportunities
- Supply chain advantages and superior inventory management
- Sustainable visualization technology, design studio, designer
services, and marketing advantages
- Homeowners are stable customers who drive fast growing and high
margin installation services
- No increased competition from distributors
- No increased competitive threats from Lowe’s or Home Depot
- No increased unsecured credit risk to weaker commercial
customers to boost sales
- No greater labor pressures than its peers and no customer
service issues
- We have also identified a growing rift of insider alignment
with shareholders. At its IPO, the Company touted its strong
and long-term comparable store sales growth averaging high double
digits. However, the post-IPO reality has been much worse. In fact,
from 2018 to 2024, comparable store sales growth (“CSS”) averaged
just 6.1%. The dismal performance becomes even more bleak when you
remove the COVID-19 benefit experienced in 2021. Absent 2021, CSS
averaged just 2.5%. The Company’s two private equity sponsors
completely exited before the Company even reached 160 stores, or
~30%, of the 500 stores that the Company currently claims it can
reach. In addition, Floor & Decor’s Founder, George West, also
sold 60% of his holdings by March 2020 and has only retained a
small residual stake diluted by stock issuance. Similarly, CEO
Taylor has reduced his beneficial ownership by 64% since the IPO
but has recently been a particularly aggressive seller.
In fact, CEO Taylor has enacted three
different 10b5-1 sale programs since March 2023 while the General
Counsel and Chairman of the Board have also entered stock sale
programs. The insider selling programs are eye-opening
because 1) the Company received an SEC comment letter in late 2023
questioning its revenue and cost of revenue disclosures, and 2) in
2023, the Company amended and broadened the range of employees
covered under its Clawback Policy for certain types of
misconduct.
- Floor & Decor’s premium valuation is not justified. We
estimate 40% – 60% intermediate and 100% long-term potential
downside risk to Floor & Decor’s share price. We believe
that some investors may be anchoring false hope and an investment
bias to owning FND because Warren Buffett’s Berkshire Hathaway also
has an equity position. Warren Buffett is one of the greatest
investors of all-time and is known as an astute value investor.
However, among Berkshire Hathaway’s $335 billion equity securities
portfolio, a $480 million investment is a rounding error and may
not be getting the proper scrutiny it deserves. In fact, based on
some of Mr. Buffett’s own quotes, investing principles and maxims,
we believe Floor & Decor falls short of a suitable investment.
A majority of sell-side promoters have a neutral/hold/market
perform rating and are waiting to see improvement in the business
but believe the issues are temporary. We believe our research
supports the case that its issues are structural and not cyclical
since its customer profile has changed, competitive intensity has
increased, and new store opening and operating costs have
ballooned. We also believe investors fail to understand that the
Company’s earnings will not be nearly as levered to the upside
given diminished technology and proprietary product advantages,
weakened marketing effectiveness, and long cycles for tile and
floor replacement among other factors. We believe expectations for
a recovery in sales and earnings prospects are way too high,
especially as 2025 comes into focus. Floor & Decor trades at an
industry leading 2.9x and 36x 2024E revenue and EBITDA,
respectively, for no obvious reason. However, the market fails to
include ~$620 million of supply chain finance debt, legally binding
lease commitments and asset retirement obligations in the
valuation. These factors alone account for ~$5.75 per share in
downside. By ascribing a generous 1.5x – 1.9x revenue multiple,
more aligned with a range of home improvement and building product
peers, and using our base case estimates we see 40% – 60% downside
risk in the intermediate term. If our research proves right that
the Company’s problems are more structural than cyclical, and that
the Company’s increased opacity and revenue misstatements are a
harbinger of financial restatement, we fear the Company could be
headed down the path of permanent equity impairment faced by peers
such as Lumber Liquidators and Tile Shop. There is also a growing
risk from Trump’s re-election and rising tariffs given that 25% of
sales are tied to Chinese imports and a majority are from foreign
sources. We expect FND’s share price to underperform both the
retail sector and the broader equity market.
***
Please note that the items summarized in this press release are
expanded upon and supported with data, public filings and records,
and images in Spruce Point’s full report. As a reminder, our full
report, along with its investment disclaimers, can be downloaded
and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point and/or its clients have a short
position in Floor & Decor Holdings, Inc. (NYSE: FND) and owns
derivative securities that stand to net benefit if its share price
falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic
fundamentally-oriented investment manager that focuses on
short-selling, value and special situation investment
opportunities.
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version on businesswire.com: https://www.businesswire.com/news/home/20240701180570/en/
Daniel Oliver Spruce Point Capital Management
doliver@sprucepointcap.com (914) 999-2019