Is Floor and Decor a Short?

Home improvement chain Floor and Decor (NYSE:FND) has had its share of challenges as spending on home projects has waned in recent years.

Despite attempting to grow its presence nationwide while delivering value via low pricing, the company has seen its share prices fall considerably in the past year.

Recently, investment firm Spruce Point Capital Management released a research brief indicating a downside of up to 60% for FND shares. If the firm is correct, this could make FND a prime target for short-sellers.

On the other side of this argument is Warren Buffett’s Berkshire Hathaway, which owns about 4.3% of Floor and Decor.

Though a tiny holding by Berkshire’s standards at just $464 million, this stake suggests that the stock displays the long-term value potential that appeals to Buffett and his team.

Who is right on Floor and Decor, and should investors consider shorting the stock?

Examining Spruce Point Capital’s Bear Case

One of the key negatives Spruce Point identified in its research has to do with the company’s growth strategy.

While Floor and Decor continues to open new stores, the investment firm found that new stores were being opened in areas with lower incomes than established stores. This raises questions about the long-term value of the new stores and how much they can add to the company’s overall revenues.

Another major problem Spruce Point found in its analysis was around $620 million of debt that the market may not be pricing into current FND prices.

This debt, stemming from supply chain financing, leasing activity and the cost of retiring assets, is believed to reduce the value of each FND share by about $5.75.

Political risks also factored into the investment firm’s analysis, as the increasingly likely re-election of Donald Trump has the potential to raise FND’s input costs under a stricter tariff regime.

According to Spruce Point, about a quarter of the company’s sales involve Chinese imports. With the former president touting a 60% tariff on all Chinese goods as part of his re-election campaign platform, Floor and Decor may very well face much higher costs over the next four years if such a tariff is enacted.

Other Key Challenges

Beyond the difficulties identified by Spruce Point Capital, Floor and Decor also has some challenges that were readily apparent from the company’s own reporting.

Foremost among these has been a radical slowdown in revenue growth as home improvement spending patterns normalized from the 2020-21 era.

In Q2 of 2021, the quarter before Berkshire Hathaway bought its first FND shares, the company reported its highest-ever year-over-year revenue growth rate of 86.2%. Though not as high, double-digit revenue growth prevailed through the end of 2022.

Beginning in 2023, though, the company’s revenue growth began to decay rapidly. As of Q1 of this year, revenue growth had turned slightly into the red at -2.3%.

Though analysts still expect revenues to grow at 7.7% over the coming 12 months, it’s clear that Floor and Decor has largely exhausted its ability to deliver rapid growth for the time being.

Net income growth has followed a similar downward trend, though it turned negative much earlier and has fallen much further into the red than revenue growth.

The last quarter for which FND posted a year-over-year increase in net income was Q1 of 2023. In Q1 of this year, net income contracted by more than 30% compared to the year-ago quarter.

For the trailing 12 months, the company has generated net income of $224 million on revenues of $4.39 billion.

Looking forward, analysts expect a further contraction in earnings per share of 2.5% over the coming year.

Is FND Overvalued?

It’s also worth mentioning that Floor and Decor is trading at value multiples that may set it up for a selloff.

At 51.3x forward earnings and 2.4x sales, the stock commands a premium pricing that requires substantial growth to sustain.

If the company cannot reignite its growth story soon, it’s quite possible that the market will continue to price its shares at progressively lower levels to reflect a plateau in revenue and earnings for the time being.

The Bull Case for Floor and Decor

Despite a very compelling bear case for the stock, it’s also important to take into account the positives Floor and Decor has to offer.

One of the major pluses of the company is its operating cash flow, which is considerably higher than its net income. At $4.23 per share in the last fiscal year, cash flow was more than double earnings per share.

This also somewhat mitigates the problem with FND’s valuation, as the stock trades at a reasonably healthy multiple of 23.1x cash flow.

Although Spruce Point identified additional debts that may not be fully factored into the market’s pricing of FND, it’s worth noting that the company’s self-reported long-term debt obligations are fairly low.

With a stated debt-to-equity ratio of 0.1, Floor and Decor still has room to borrow the money needed to finance future growth.

Coupled with the fact that the company is still at least modestly profitable, it doesn’t seem likely that it will face a financial crisis anytime in the immediate future.

There is also a decent argument to be made for management’s growth strategy in the long run. Although growth has run out of gas at the moment, Floor and Decor operates as a low-cost flooring provider with tight price controls and an efficiently run supply chain. This allows it to deliver competitive pricing to its customers.

By expanding its number of stores, the chain hopes to become a go-to flooring option for both professionals and DIY homeowners.

Though inflation and a slowdown in home improvement spending have hurt the chain, it’s very possible that it will re-establish growth in the future as it continues to expand.

Finally, it’s worth mentioning that Spruce Point Capital projects prices well below what other firms foresee for the stock.

The median target price for the stock stands at $110 per share and represents an upside of almost 17% over the most recent price.

Though Floor and Decor clearly has its issues and risks, there are still many analysts who are convinced of the company’s long-term value.

Is Floor and Decor a Short?

Floor and Decor has a high risk to reward ratio implying serious downside risk, but it’s hard to argue it’s a compelling long-term short.

With that said, the decision to short a stock is always a complex one, as short-selling is an inherently risky investment strategy.

There is a strong argument that a combination of weak growth fundamentals and risk that hasn’t been appropriately priced in by the market may well set FND up for at least some further downward pressure on share prices.

Short interest in FND has also been growing over multiple years. At the end of 2021, short interest in Floor and Decor amounted to just $330 million. As of mid-June, that number stood at $1.79 billion.

The stock’s price has also been declining steadily for quite some time, a trend that will, no doubt, reassure potential short-sellers.

With YTD, 3-month and 1-month returns of -15.7%, -21.3% and -21.4%, respectively, FND shares have established a strong and sustained downward pattern.

Given that analysts expect earnings to slip even further in the coming year, there is at least a chance for this pattern to continue.

The problem, though, is that there’s no immediate catalyst for a dramatic selloff. Share prices have been slipping for long enough that they may already have reached something close to a natural equilibrium point.

If management can deliver the single-digit revenue growth analysts expect over the next year, it may be enough to at least hold shares close to their current level.

Over the long run, there is enough of a growth argument for Floor and Decor that shorting it now may be unnecessarily risky.

Ultimately, the stock looks like more of a hold than a sell right now. Shorting a stock that has already been trending downward for so long may be tempting, but the downside could outweigh the upside in this case.

The caveat here has to do with the political risks outlined by Spruce Point’s research. If a 60% tariff were levied against all Chinese imports, Floor and Decor is very likely to suffer as it was forced to ratchet up its prices.

This eventuality, however, requires both the re-election of the former president and his following through on a deeply economically risky campaign promise. Though such developments could set the stage for a significant further selloff in FND, it isn’t certain enough to make short-selling seem like an attractive choice just yet.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.