I reduced my investment rating for tile retailer Tile Shop Holdings, Inc. (NASDAQ:TTSH) stock from a Buy to a Hold, as TTSH’s results were weak and the company’s short-term outlook was negative. But Tile Shop has enhanced its product portfolio, which should pay off in the future when the housing market turns around. As such, I have a Neutral view of TTSH that translates into a Hold rating.
TTSH’s growth engines were the focus of my May 26, 2024 write-up. This article reviews Tile Shop’s financial results for the second quarter of the year and highlights the company’s new product offerings.
Near-Term Prospects Are Unfavorable
Tile Shop’s latest quarterly financial performance was poor, and the company might struggle to deliver a good set of results in the short term. There are headwinds for the housing market in the form of sky-high home prices which will hurt demand for the home improvement sector (including tile retailers).
TTSH saw its net profit decrease by -76.0% YoY and -37.8% QoQ to $1.22 million in Q2 2024. The company’s top line decreased by -7.3 YoY to $91.4 million for the second quarter of this year, and it suffered from a -6.9% YoY same-store sales contraction in the recent quarter. The net margin for Tile Shop narrowed by -3.9 percentage points YoY and -0.5 percentage points QoQ to 1.3% for the latest quarter.
In its Q2 2024 earnings press release, Tile Shop mentioned that the “softness in existing home sales and resulting lower traffic in our stores” have hurt its top line performance. On the other hand, higher “rent expenses”, “software licensing costs” and “digital advertising expenditures” were a drag on TTSH’s bottom line as disclosed in the release of its results. Furthermore, the company’s profitability is likely to have been impacted by negative operating leverage effects relating to top line contraction.
Moving forward, it is likely that TTSH’s performance will remain weak for the near term. In other words, I think it will take more time for the company to achieve top line expansion and margin improvement again, which isn’t likely to happen this year as explained below.
Tile Shop didn’t offer any specific quantitative financial guidance, but the company indicated at its Q2 2024 results briefing last month that “external headwinds persist.”
Notably, TTSH’s tile retailer peer Floor & Decor Holdings, Inc. (FND) lowered the mid-point of its FY 2024 revenue and EPS guidance by -5.1% and -13.2% to $4,445 million and $1.65, respectively in August. This implies that Floor & Decor is anticipating a slowdown in its revenue growth from +3.5% in FY 2023 to +0.7% for FY 2024, and a -37.6% drop in its EPS this year.
At its second quarter analyst call on August 1, FND noted that its updated full-year financial guidance assumes that “existing home sales and business trends remain relatively unchanged from current levels (Q2 2024) for the remainder of the year (2H 2024).” This is similar to Tile Shop’s view that “external headwinds persist” as mentioned above.
In particular, Floor & Decor emphasized at the company’s latest quarterly analyst briefing that “housing affordability remains a hurdle for most buyers” considering “record high home prices.”
The most recent housing market metrics support my view that Tile Shop’s short-term outlook remains challenging. According to Bankrate’s August 22, 2024, article, the “median sale price for existing homes” rose by +4.2% YoY to $422,600 for July this year representing the “highest July median” in history. In my opinion, existing home sales will likely remain sluggish going forward, as elevated home prices could offset any positives associated with potential rate cuts to a considerable extent.
I have made the decision to reduce my rating for TTSH to a Hold, as it will be difficult for the company’s shares to outperform when the company’s near-term business prospects are weak.
But Product Portfolio Optimization Initiatives Should Bear Fruit In The Mid-To-Long Term
It is inevitable that Tile Shop’s short-term results are impacted by the housing market’s weakness. But TTSH still has a reasonably good chance of returning to positive revenue growth and margin expansion in due course, when the residential property market stabilizes and the company gets its product strategy right. This is why I think that a Sell rating for Tile Shop will be harsh and unjustified.
In my earlier May 26, 2024, update, I noted that TTSH “is targeting price-conscious clients with new product offerings.” It is a good thing for Tile Shop to reach out to a wider spectrum of consumers by tweaking its product portfolio.
Tile Shop’s recent disclosures suggest that the company continues to make the necessary changes to its product portfolio to prepare itself for an eventual recovery in the housing market and home improvement industry.
In the early part of the prior month, Tile Shop announced that the company has collaborated with “celebrity designer Nikki Chu” to come up with a “new collection of globally inspired tiles exclusively for” the company. It is reasonable to think that exclusive product offerings that are rolled out in partnership with highly-regarded designers will help to attract more people to visit TTSH’s stores.
Separately, TTSH shared at its most recent quarterly earnings call that it launched its “enhanced line of private label installation products sold under the Superior brand name” in Q2 2024. This involves the addition of new offerings like “thinsets” to its private label products branded as Superior.
The company disclosed in its second quarter results release that its “recent actions to enhance our Superior line of installation products” are “showing promising early results.” This implies that Tile Shop’s product portfolio tweaks and new offerings have been well-received by clients.
In a nutshell, Tile Shop has been making relevant moves to expand its addressable market with new products, which bodes well for the company’s long-term prospects. The “Nikki Chu” tile collection will appeal to customers pursuing unique products, while value-focused clients will naturally be attracted to TTSH’s new Superior brand of private label offerings.
Conclusion
My rating for TTSH is a Hold now. On one hand, I am concerned that demand for Tile Shop’s products will continue to be weak in the near future as home prices remain elevated. On the other hand, I am impressed with how Tile Shop has been broadening its product portfolio to boost its long-term growth prospects.
With regard to valuations, TTSH is now trading at 1.06 times trailing twelve months’ Enterprise Value-to-Sales or EV/S.
FND is currently valued by the market at a higher 2.9 times trailing twelve months’ EV/S metric, but Floor & Decor deserves a valuation premium for being more than 10 times as large as TTSH in terms of yearly revenue. As such, FND is not an appropriate peer comparable for Tile Shop with regard to valuations, considering the difference in size between the two.
TTSH’s current EV/S multiple is roughly on par with its three-year and five-year average EV/S ratios of 1.07 times and 1.08 times, respectively as per S&P Capital IQ. Therefore, it is reasonable to refer to Tile Shop’s shares as fairly valued based on a historical valuation comparison.
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