The comparison is counterintuitive. On one hand, there is Floor & Decor Holdings Inc. (FND, Financial) with a share price that has dropped precipitously over the past year and is now a potential value trap. On the other hand, Warren Buffett (Trades, Portfolio) of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) is still holding the stock. Buffett bought his shares in the third and fourth quarters of 2021 and the first quarter of 2022, which means he bought most of the position when the price was declining.
Now, we know Buffett likes a discounted share price or at least a fair price for a wonderful company, but is this pushing the strategy too far?
About Floor & Decor
The company specializes in hard surface flooring and related accessories. It does this through 174 warehouse-format stores (as of the end of the second quarter). According to an annual filing, those stores sell “tile, wood, laminate, vinyl, and natural stone flooring along with decorative and installation accessories and adjacent categories.”
The stores are located in 33 states, serving three main customer groups: Pro (professional installers and commercial businesses), DIY (do-it-yourself) and BIY (customers who buy products for professional installation).
These warehouse-format stores average about 78,000 square feet, making them larger than any of its retail flooring competitors’ stores.
Founded in 2000 by Vice Chairman Vincent West, the company is headquartered in Atlanta.
Competition
In its 10-K for 2021, Floor & Decor reported the retail hard surface flooring market is fragmented and competitive. It said, “We face significant competition from large home improvement centers, national and regional specialty flooring chains and independent flooring retailers.”
The company also noted that hard surface products are gaining market share from soft-surface products. Specifically, it reported that over the past decade, hard surface has gone from 44% of market share to 57%. In addition to these two types, there is a third, resilient flooring, which has consistently taken a single-digit market share.
The company does not name any competitors, but they might include Tile Shop Holdings Inc. (TTSH, Financial) and LL Flooring Holdings Inc. (LL, Financial). In addition, I cannot ignore competition from giant non-specialists such as The Home Depot, Inc. (HD, Financial) and Lowes Companies Inc. (LOW, Financial).
This chart, from the annual report, shows how Floor & Decor has outperformed the S&P 500 as well as the S&P 500 Home Improvement Retail Index over the past two and a half years:
The company argues it has numerous competitive advantages and listed them in its March 2022 investor presentation:
Its claims are backed up by an above-average net margin and return on invested capital.
Financial strength
There are, what seem to me, some contradictory indications about Floor & Decor’s financial strength and its 5 out of 10 ranking:
The interest coverage ratio is quite high, signifying the company has a small debt load and lots of operating income to cover its interest expenses. Its debt-to-revenue ratio is favorable; at the end of June 2022, it had $266 million in short and long-term debt and $1.09 billion in revenue. The Altman Z-Score is not high, but it is in the safe zone.
Fortunately, the company does not have a lot of debt because its weighted cost of capital, at 12.56%, is high—and higher than its return on invested capital of 10.37%. That is not good.
Profitability
The company scored a much higher ranking, 9 out of 10, for its profitability:
The light green bars for margins and returns signal that while Floor & Decor’s profitability is above average for the retail cyclical industry, they are not leading the industry. On the plus side, the company has been profitable for every year of the past decade.
Growth
Floor & Decor calls itself a growth company and that is reflected in the full 10 out of 10 ranking it receives:
Rapid growth is shown on the three lines for revenue, Ebitda and earnings per share without non-recurring items. In particular, note that Ebitda and earnings per share without nonrecurring items are growing faster than revenue, a sign the company is effective and efficient.
Free cash flow growth does not show up in the table, so it is necessary to take a closer look, and what is shown is startling:
In reviewing the cash flow statement for the second quarter of 2022, I get a couple of hints as to what is happening (there is no information in either the 10-K or quarterly news release).
First, inventories have soared since the second quarter of 2021, from $25.39 million to $335.97 million, a difference of more than $310 million. Second, borrowings on its revolving line of credit increased to $336.80 million in 2022 from $4.45 million in 2021. At the same time, payment on that line of credit increased from $3.59 million in 2021 to $268.20 million in 2022.
The net result: cash and cash equivalents dropped from $366.09 million in the second quarter of 2021 to $6.12 million in the second quarter of 2022.
One more note about growth—Floor & Decor can be found in GuruFocus’ Fast Growth Screener, making it one of the 53 fastest-growing stocks in the market.
Dividends and share repurchases
The company does not pay a dividend and has been a net issuer of shares since 2017.
Valuation
Floor & Decor receives a high 8 out of 10 score for value, based on the actual price-GF Value ratio and intrinsic value.
The actual share price at the close of trading on Oct. 24 was $69.41 and, as seen below, the GF Value price is $130.40.
Based on the algorithms that determine the GF Value, there is an important warning that this may be a value trap. That is a price that is enticingly low, but could drop to zero if the company fails altogether.
That possibility seems highly unlikely given Floor & Decor’s strength on the key fundamentals. For example, I know it is growing profitably and growing quickly. It has a substantial interest coverage ratio, so there will be no problem covering its interest expenses. I will note again that it repaid $268.20 million of its debt in the second quarter of this year, which provides reasonable liquidity going forward.
One of the most widely used metrics for financial safety or distress is the Altman Z-Score, which provides Floor & Decor with a score of 3.27. That puts it into the safe zone, meaning there is little risk of bankruptcy.
Finally, the share price peaked about Nov. 1, 2021, indicating is has been pulled down by the market-wide slump that began late last year. Bottom line, investors should not place much weight on the value trap warning.
Gurus
The biggest holding of Floor & Decor stock, among the seven gurus who own it, is that of Buffett of Berkshire Hathaway. At the end of June, he owned 4,780,000 shares, representing 4.51% of shares outstanding and 0.10% of Berkshire Hathaway’s assets under management.
Frank Sands (Trades, Portfolio) of Sands Capital Management was not too far behind Buffett, despite reducing his stake by 1.69% in the second quarter. He finished with 4,150,357 shares. And Ron Baron (Trades, Portfolio) of Baron Funds upped his position by 36.52% to a total of 2,654,102 shares.
There is massive institutional interest in Floor & Decor; these professionals owned 97.1% of its shares outstanding. Insiders owned another 0.87%, with CEO Tom Taylor owning 261,559 shares at the end of the first quarter of 2022.
Conclusion
Four and three-quarter million shares is a huge commitment to one company, and Buffett has made it by buying Floor & Decor. The price has slumped significantly, but we know why: The market-wide decline and a short-term inventory problem.
So there are no compelling reasons to get out of the name, and there are important reasons to stay in it. Floor & Decor has enjoyed fast growth in the past and it appears there is more to come, making this a good bet for a man who knows how to be patient.
