Tile Shop Stock: A Mispriced Security (NASDAQ:TTSH)

Thesis

I’ve developed my thesis for Tile Store (NASDAQ:TTSH) across the worth/earnings framework to easily break down the potential upside for buyers.

• Worth: Tile Store trades at a big low cost to comps following occasions unrelated to underlying enterprise operations. After a shock de-listing announcement from the board in October 2019, the inventory fell 66% in a day, erasing ~$100mm in fairness worth. Based mostly on the comp set at present, there may be nearly 3x upside potential in Tile Store from re-rating to friends.
• Earnings: With considerably increased product margins in comparison with friends within the flooring trade, continued deal with streamlining SG&A could also be key in tapping into the working leverage capabilities. If OPEX efficiencies drive EBITDA margin uplift, I consider Tile Store can re-rate to friends.

Enterprise / Trade Overview

The Tile Store is a specialty retailer with a selected focus on pure stone and man-made tiles. They provide over 6,000 merchandise from around the globe with the bulk being offered underneath two proprietary manufacturers, Rush River and Fired Earth. Tile merchandise, equipment, and instruments are bought from a worldwide community of suppliers whereas the corporate manufactures its personal setting & upkeep supplies. Tile Store has grown revenues at an annual fee of two.8% over the previous 5 years relative to trade progress of 1.3% in the identical interval. 2x the trade progress could be chalked as much as two particular aggressive benefits for Tile Store:

• Broad Product Assortment & Engaging Pricing: 6,000 totally different merchandise which can be priced attractively as a result of their economies of scale, direct tile buying, and manufacturing of setting & upkeep supplies in-house. Tile Store ranks #1 in the industry by way of pricing.
• Buyer Expertise: By working solely in tile, workers are educated completely on this area of interest permitting them to ship a better high quality buyer expertise. Tile Store differentiates itself from the competitors by allocating nearly all of retailer house to showrooms with as much as 50 totally different vignettes of distinct rooms in a house. Couple the in-store expertise with a web site geared towards product & set up training, sampling, and a easy ordering course of; The Tile Store locations itself to win prospects in an area the place tile purchases immediately from owners are comparatively rare.

The retail flooring market is a extremely fragmented trade. Flooring & Decor (FND) is the biggest participant making up 8.8% of the income whereas massive nationwide house enchancment facilities like Residence Depot (HD) and Lowe’s (LOW) garner vital market share as effectively. The vast majority of gross sales are generated by native specialty flooring retailers, factory-direct shops, and single-site shops.

The flooring trade is closely influenced by housing begins and per capita disposable revenue whereas different key drivers embody the buyer confidence index, the worth of personal nonresidential development, and personal spending on house enhancements. IBIS World expects the overall flooring trade to contract by 1.3% annually over the following 5 years which can erode the overall earnings potential for Tile Store:

Even with the overall flooring trade anticipated to say no over the following 5 years, it’s anticipated that tile will continue increasing in recognition taking trade share from hardwood and carpet.

Thesis Assist

Worth

In line with my evaluation, Tile Store trades at a big low cost to truthful worth largely attributed to three fundamental causes.

First, the inventory has handled margin contraction in recent times pushed by the disastrous implementation of a brand new enterprise useful resource system in 2019 and extra not too long ago inflationary pressures that have been mismanaged. I’ll contact extra on these factors within the earnings part.

Second, in late 2019 two activist buyers, Peter Kamin and Peter Jacullo, pushed the board into asserting the de-listing from the Nasdaq with their reasoning being cost-cutting initiatives from lowered reporting and disclosure necessities. As a result of mutual funds and different institutional buyers have rules against owning OTC-traded stocks, the worth drop was exacerbated. It is because massive institutional buyers with such guidelines have been required to promote the inventory forcing downward worth stress. Following the inventory worth rout, the 2 Peters elevated their complete stake from 17% to 30% of the excellent shares which was quickly adopted by shareholder fits. I consider it’ll take time to rebuild public confidence within the inventory following these occasions however based mostly on underlying enterprise operations The Tile Store is mispriced.

Lastly, Tile Store has no sell-side analyst protection at present. The shortage of protection permits for higher mispricing of the inventory as it’s off of most buyers’ radars. This creates a possibility previous to the corporate garnering protection sooner or later which can spark a re-rating nearer to its peer group. (Re-rating on this case means the market can pay a better EV/EBITDA a number of for the inventory and that a number of could also be extra comparable with Tile Store’s peer group sooner or later.)

Beneath is the comp set for The Tile Store:

Based mostly solely on the comp set and assuming EBITDA progress transferring ahead (see earnings part under), Tile Store has a 2.8x upside.

To get one other sense of valuation I ran a 10-year DCF with conservative progress and margin estimates and elevated perpetual CAPEX spending relative to years 1-10:

Based mostly on the DCF I performed above, Tile Store at present has a 2.4x upside.

Utilizing a mix of comps and the DCF, I consider Tile Store at present trades at a 62% low cost to truthful worth.

Earnings

Whereas the market could also be discounting Tile Store at present, earnings progress is significant to the return profile.

Margins

In current historical past, Tile Store has skilled margin contraction pushed by a disastrous ERP implementation in 2019 and mismanagement of pricing through the inflationary uptick. The ERP transition impaired typical retailer operations resulting in EBITDA margins contracting to their lowest ranges on report by the tip of the yr (10.2%). Whereas restoration was underway, margins declined YoY in 2022 as a result of conservative worth hikes amid a difficult macro setting on the identical time stock costs skyrocketed.

With administration signaling to international freight costs coming down and powerful skilled demand supporting additional worth hikes, we are going to see gross margins elevate in 2023. A historic common of ~4 stock turns a yr might enable Tile Store to replenish extra attractively priced stock shortly. Holding OPEX fixed from 2022 as a % of gross sales, we must always see 250 – 350 foundation factors in EBITDA margin uplift from gross margins alone.

Following COVID, administration was in a position to focus extensively on retailer effectivity since headcount was slashed and retailer hours have been lowered considerably. Throughout that point, The Tile Store has successfully operated shops with fewer workers and targeted their incentive structure to reward employees based mostly on efficiency correctly.

As a result of Tile Store works intently with designers to place out specialty merchandise and features, their SG&A prices will stay elevated in comparison with friends although they’ve a superior product margin. With that in thoughts, I nonetheless consider Tile Store can obtain an 18% EBITDA margin by 2025 based mostly on gross margins normalizing, retailer effectivity, and a correct incentive construction.

Progress

At the same time as retailer depend remained stagnant for the previous 4 years, Tile Store achieved report income in 2023 and comparable retailer gross sales grew 5.1% yearly as a result of its broad product assortment, aggressive costs, and skilled worker base.

Tile Store is reigniting progress by way of 2 new retailer openings and new product launches in 2023. As administration continues specializing in professional sales to assist constant income and resilient coverings equivalent to tile and vinyl proceed to grow as a % of the overall flooring market, I can confidently challenge secure income progress for the enterprise transferring ahead.

Dangers

With a place in Tile Store, there are 3 fundamental dangers I constantly keep cognizant of:

• Macro Situations: Declining housing begins and discretionary revenue could also be vital headwinds for the complete flooring trade. These tendencies shall be key to comply with however a mitigant to an total flooring decline is the particular progress of tile and vinyl.
• Competitors: Particularly, Residence Depot and Lowes could also be worrisome as their immense economies of scale might enable them to cost extra attractively. The mitigant to aggressive dangers lies inside their provider relationships and the deal with the particular tile/vinyl area of interest.
• Public Notion: Following the de-listing scare, it was truthful for markets to low cost the inventory. Whereas I do not consider there may be additional danger round de-listing and board volatility, I do consider the inventory might take time to be observed particularly with no sell-side protection. Prolonged time to be observed by market members might result in an erosion of IRR.

What Traders Must Consider

I consider there are a choose few factors buyers must consider in to get comfy with this funding.

• Administration can efficiently move costs to prospects with out demand destruction
• Professionals and people proceed to search out worth in a tile/vinyl-focused retailer as a result of experience, pricing, and assortment
• Tile & vinyl progress will outweigh total flooring headwinds
• Peter Jacullo and Peter Kamin proceed returning capital to shareholders

If these factors come to fruition coupled with the present worth the enterprise trades at, Tile Store has glorious return potential.

Abstract

Tile Store is buying and selling at a big low cost to friends and truthful worth. Margin enlargement may be very believable by way of gross margin normalization and continued retailer effectivity. Mix that with regular progress prospects and I consider the market is considerably discounting future earnings potential for the corporate.

Tile Store has a wholesome steadiness sheet particularly as the corporate plans to pay down a good portion of the JPMorgan (JPM) facility ($45.4mm drawn at EOY ’22) in accordance with the final earnings name. Stock ranges remained elevated at yr’s finish however ought to normalize as provide chain points alleviate. With vital EBITDA potential, I am not frightened about present money ranges ($6mm) as the corporate is producing constant money stream. It is also reassuring understanding the corporate owns 4 out of its 5 distribution facilities giving them optionality for sale-leasebacks in the event that they ever received into a troublesome spot.

As a shareholder, I like having Peter Kamin and Peter Jacullo on the helm. They’re clearly targeted on returning capital to shareholders by way of the particular dividend in 2021 and the share buyback in 2022. The present CEO, Cabell Lolmaugh can be a long-term Tile Store retailer operator targeted on retailer effectivity. Whereas the current mispricing amid the inflationary setting is seen as a blunder, I consider long-term that is the precise workforce to execute and the precise workforce to return capital to shareholders.