As the homebuilding and refurnishing surge continues in the U.S., demand for this company’s products has skyrocketed
Since the beginning of the pandemic, the U.S. housing market has exploded. New homes can’t be built fast enough, and the housing inventory is the shortest it’s been in decades.
Today’s company is at the center of this home-buying trend, and despite the surging demand for its products, rating agencies are still skittish when rating this company’s debt.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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One theme we have discussed many times in the Investors Essential Daily is the At-Home Revolution.
We often talk about how the At-Home Revolution and the surging demand for homes does not simply stop with the demand for homes.
When people are buying these homes, they are then prioritizing their home, making it really feel “like home.”
This trend has translated into impressive demand not just for homes, but for all the items that revolve around renovating homes also.
That has meant contractors and home furnishing retailers, the suppliers to the home, have won tremendously.
One of the companies that is benefiting from this surging demand is Floor & Decor Holdings (FND).
The company is a retailer that sells exactly what its name entitles. It sells tile, wood, and other flooring products for new homes as well as home renovators.
Considering the wave of buying for new homes and renovations for older homes, there is going to be a sustained demand for new flooring.
This has translated into a solid backlog of demand for Floor & Decor Holdings’ products.
Despite the many strong tailwinds currently behind the company that we suspect will last a while, major rating agencies still seem skeptical when rating Floor & Decor Holdings’ debt.
Specifically, S&P gives the company a non-investment grade speculative BB- rating, with the implied assumption of a 10%+ risk of default over the next five years.
The agency actually believes Floor & Decor Holdings has solid risk of default into the near future even with a surge in demand for their products.
This is very different from what we see here at Valens.
Our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of the firm’s true credit risk.
In the below chart, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
As depicted, Floor & Decor Holdings has massive cash liquidity and therefore should have no issues handling its obligations going forward. On top of this, even if the firm did not have access to this capital, cash flows alone exceed all obligations by a wide margin every year up until 2027, when the firm faces material debt maturities.
That said, the firm has an ample runway of time before them to refinance, if needed.
Rather than a name in distress, Floor & Decor Holdings is actually a cash flow machine. This is why S&P’s BB- non-investment grade speculative rating, with a 10%+ risk of default expectation does not make sense.
Using the CCFP analysis, Valens rates Floor & Decor Holdings as an investment grade IG3+ rating. This rating corresponds with a default rate below 1% within the next five years, a more realistic projection once a holistic understanding of the company’s risk is taken into account.
Ultimately, Uniform Accounting and the Credit Cash Flow Prime analysis highlights how Floor & Decor Holdings’ credit risk profile is much safer than what rating agencies believe, especially when considering the surge in demand the company is likely to see going forward.
SUMMARY and Floor & Decor Holdings, Inc. Tearsheett
As the Uniform Accounting tearsheet for Floor & Decor Holdings, Inc. (FND:USA) highlights, the Uniform P/E trades at 43.3x, which is above the global corporate average of 23.7x, but below its historical Uniform P/E of 32.8x.
High P/Es require high EPS growth to sustain them. In the case of Floor & Decor Holdings, the company has recently shown a 6% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that provide very poor guidance or insight in general. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Floor & Decor Holdings Wall Street analyst-driven forecast is a 17% and 8% EPS growth in 2021 and 2022, respectively.
Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Floor & Decor Holdings’s $112.6 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow by 19% annually over the next three years. What Wall Street analysts expect for Floor & Decor Holdings’ earnings growth is above the requirement in 2021 & 2022.
Furthermore, the company’s earning power is 4x the corporate average. Also, cash flows and cash on hand are 10x its total obligations—including debt maturities, capex maintenance, and dividends. However, intrinsic credit risk is 100bps above the risk free rate. Together, this signals a moderate credit risk.
To conclude, Floor & Decor Holdings’s Uniform earnings growth is in line with its peer averages, but the company is trading above its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research