Floor & Decor Holdings (FND +0.26%) may not have an appealing value proposition at first glance. The hard flooring business has numerous competitors, including Home Depot and Lowe's. And with Global Market Insights forecasting a 3% compound annual growth rate for the industry over the next nine years, such stocks would probably have limited appeal to investors.
Nonetheless, Floor & Decor competes aggressively with the home improvement giants within its particular segments of hard flooring and home decor. That may make Floor & Decor a retail stock you want on your watch list for three reasons.
1. Floor & Decor's competitive advantage
Floor & Decor stands out in its seemingly boring industry by taking a deep dive into its specific areas. With hard flooring and decor, it offers vast product selections that Home Depot and Lowe's cannot match in the relatively small amount of space their stores devote to those specialties.
It has also built critical supplier relationships. It buys from the source, eliminating costly intermediaries in the supply chain. It then buys in large quantities, allowing it to benefit from bulk discounts it can pass on to the customer. This builds a virtuous cycle as it adds stores, buying more and presumably increasing the size of the bulk discounts.
On the customer side, it offers free design services and finance, storage, delivery, and installation. Hence, it serves as a one-stop shop that most competitors would struggle to match. These trends may have induced Warren Buffett's team at Berkshire Hathaway to open a position. It now holds almost 4.8 million shares.
2. An expanding footprint
As mentioned before, Floor & Decor continues to add locations. Like Home Depot, it started in Atlanta and has set out to expand its footprint in the U.S. It now boasts over 200 locations and five design studios in 36 states.
This continues at a steady pace since it had planned 32 additional locations for 2023, 12 of which it added in the first half of the year. Assuming it meets that goal, it will increase the number of stores by 17% in a single year. Such expansions bode well for a stock's long-term trajectory if the history of Home Depot and Lowe's is any indication.
Still, Floor & Decor faces short-term struggles in a sluggish economy. In the first half of 2023, net sales rose 7% year over year to $2.3 billion. Its pace of expansion kept this number positive as same-store sales dropped 5% during that period.
Moreover, higher operating expenses weighed on margins, and net income fell 6% to $143 million as a result. That is well below the double-digit growth of past years and may help explain why the stock has fallen by almost 20% since the early August earnings announcement despite rising 30% this year.
NYSE: FND
Key Data Points
Indeed, its price-to-earnings (P/E) ratio of 34 is below historical averages, likely speaking to its growth potential. But with the company predicting about 6% net sales growth at the midpoint for 2023, investors will have to be patient.
3. Residential real estate trends
That patience may pay off in the form of a residential housing shortage. The U.S. home supply inventory is now at 3.3 months. This is below historical averages, which hovered above four months for most of the last decade, indicating a shortage.
Another trend is the sudden glut of office space available thanks to the work-from-home trend. Thus, developers have begun converting these offices into residential spaces. Working from home also means that more homes need home offices, which also tends to bolster residential construction.
Admittedly, higher interest rates are likely slowing this trend now. But the rate hikes could end soon, and as developers seek to meet demand, it likely plays into the hands of Floor & Decor investors who are patient.
Making sense of Floor & Decor stock
Ultimately, Floor & Decor should serve investors well as it expands nationwide. Its deep dives into hard flooring and decor specialties make it competitive.
Though its net sales growth has slowed amid higher interest rates, a residential home shortage bodes well for the company as the market seeks to correct that imbalance. If the interest rate increases end soon and perhaps reverse, the company should prosper as its footprint expands and the stock of residential property rises.
