Elevator Pitch
Tile Shop Holdings, Inc. (NASDAQ:TTSH) shares are rated as a Buy.
My prior article published on March 6, 2024 analyzed Tile Shop’s financial results for the final quarter of last year. The current update focuses on the key growth drivers for TTSH.
I stick with a Buy rating for Tile Shop, as I have a positive view of the growth outlook for the company’s e-commerce channel and its new product offerings.
Online Sales Channel Has Potential For Expansion
My opinion is that Tile Shop’s e-commerce business boasts good growth potential.
The company operated 142 stores in the US as of March 31, 2024 according to its Q1 2024 earnings release. At its earlier FY 2023 earnings call in end-February this year, TTSH revealed that “we do not intend to open any new stores during 2024.” I think that it is a prudent move to pause on capital-intensive store network expansion in uncertain economic times like these. Instead, it makes a lot of sense for Tile Shop to grow an asset-light, high-margin sales channel like e-commerce.
Tile Shop doesn’t break down its revenue by distribution channel. But TTSH disclosed at its most recent Q1 2024 earnings briefing that its online sales are now roughly equivalent to the revenue contribution from “one of our larger stores.” Considering that TTSH currently runs more than 100 stores of varying sizes, it is reasonable to assume that Tile Shop’s current online sales won’t exceed a low single-digit percentage of its top line.
In terms of positive growth momentum, it is worthy of note that TTSH’s online sales rose by a significant +25% YoY in the first quarter of this year. At the company’s first quarter results briefing, Tile Shop highlighted that “we continue to invest in our e-commerce capabilities” and this puts the company in a good position to capitalize on strong e-commerce demand.
As such, there is still lots of room for a further expansion of TTSH’s e-commerce business.
Targeting Price-Conscious Clients With New Products
In its FY 2023 10-K filing, Tile Shop describes itself as a company that sells “high-quality products to our customers, who are primarily homeowners and professionals.” As economic conditions become more challenging and customers tighten their purse strings, it is necessary for businesses to adapt and meet the needs of price-conscious clients. This is exactly what TTSH has done.
With regards to the company’s homeowner clients, TTSH has recently launched “competitively priced tile products to appeal to customers seeking to complete a smaller remodel project on a budget” as per its comments at the Q1 results briefing. Tile Shop has referred to the new client segment that it aims to serve with the new offerings as the “middle market customer.” Assuming that the economy remains weak, it is likely that an increasing number of Tile Shop’s existing and potential clients will fall into this “middle market customer” category.
In that respect, Tile Shop has made the right move to optimize the company’s product portfolio to meet the needs of certain homeowners who intend to allocate a lower amount of funds to renovation projects.
With respect to Tile Shop’s professional customers, TTSH has also taken actions to remain relevant in the eyes of these clients who are also placing a greater emphasis on pricing. At its Q1 2024 earnings briefing, Tile Shop announced that it was “excited to relaunch our private label line” with quality comparable to “the top brands” at “exceptional price points” with its professional clients in mind.
TTSH already has an existing loyalty program catering to its professional clients that offers discounted products. On top of that, Tile Shop’s new private label offerings will also play a key role in helping the company to retain its budget-conscious professional customers.
Downside Is Protected By Strong Financial Position And Cost Discipline
In the preceding sections, I wrote about Tile Shop’s upside pertaining to product and channel growth drivers. It is also equally important to be concerned about the downside for the company.
I hold the view that the downside for TTSH is limited by the company’s financial strength and expense management.
Tile Shop is debt-free with its cash position as of end-Q1 2024 accounting for roughly 8% of its market capitalization. The company also generated positive operating cash flow and free cash flow of $18.6 million and $15.9 million, respectively in the first quarter of this year.
When it comes to cost optimization, TTSH stressed at its most recent quarterly earnings call that “we continue to actively pursue a number of expense management initiatives focused on reducing controllable expenses.” As a reference, Tile Shop managed to lower its SG&A (Selling, General & Administrative) costs by -6% YoY for Q1 2024.
Key Risks To Consider
There are two major risk factors that investors should watch.
A key risk is that Tile Shop’s new product offerings fail to gain traction with customers due to competition or a change in client preferences.
Another key risk is that TTSH becomes too aggressive with its investments relating to e-commerce, which hurts the company’s profitability.
Closing Thoughts
The market currently values TTSH at a trailing twelve months’ EV/EBITDA multiple of 12 times (source: S&P Capital IQ). In contrast, Tile Shop’s all-time midpoint (average of historical peak and historical trough) EV/EBITDA ratio and its peer Floor & Decor Holdings’ (FND) current EV/EBITDA metric are relatively higher at 18 times and 28 times, respectively as per S&P Capital IQ data.
I take the view that Tile Shop is deserving of more demanding valuations, as the company’s product and channel growth initiatives deliver results
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