Floor & Decor: Munger's Costco 2.0 (Part 1)
A Brick-and-Mortar Supermarket with SaaS-like ARR and NVDIA-lite Growth? Unbelievable.
Highlights of this report
FND is a SaaS-based Tech company masquerading as a brick-and-mortar retail store chain.
Its substantial business moats gives the company a rare “build-it-and-they-will-come” growth model and practically unlimited reinvestment runway.
NVDIA is widely considered to have persistent 25%-30% earnings growth in its windshield. So does FND, despite selling flooring tiles instead of AI-powering GPUs.
Charlie Munger called FND an imitator of Costco’s “wonderful business” in his Acquired interview last year.
Table of Contents (Part 1):
1. Moats: SaaS-like ARR with NVDIA-lite Growth
2. AI-generated summary of this report (500 words)
3. FND’s Absolutely Massive LT Growth Runway
4. FND Stores: Home Depot, But Only Sells Hard Surface Flooring
5. Saas-Like ARR Model: Pro/Enterprise Customers (40% B2B Sales)
6. LVMH: Laminate & Vinyl Making Headway (Industry Sales Mix & Growth Trends)
7. Understanding FND’s Growth Model: New Store Unit Economics
8. Part 2: Growth, Valuation, Risk, Macro"What you want to find is a business with a sustainable competitive advantage. That means that a business has a product or service that is protected from competition. There are all sorts of ways to do that, but one of the best is to be a low-cost producer." — Warren Buffett
“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” — Warren Buffett
Moats: SaaS-like ARR with NVDIA-lite Growth
In a recent Acquired interview, the late Charlie Munger referred to Floor & Decor as being an imitator of Costco. This is incredible praise from Munger, for several reasons.
COST 0.00%↑ has a widely appreciated “wonderful” membership business model. While its bread-and-butter business is in Retail, it actually generates the bulk of its profits from its membership program. The idea is simple — Costco requires you to buy a paid membership in order to shop at their stores. This is worth doing as Costco’s products are frequently cheaper than at competitors, and customers enjoy net savings despite the cost of the membership.
On top of that, Costco’s large format stores are known for being a one-stop-shop supermarket with nearly anything customers could possibly want. This combination makes it ideal for customers who love scoring a bargain when buying things in bulk. Multiplying that by hundreds of customers per store daily gives Costco incredible economies of scale.
Costco subsequently leverages onto such high purchase volumes by squeezing suppliers on price due to their economies of scale (i.e. low cost moat). However, rather than keeping the margins for themselves, they pass the savings onto customers. This creates a flywheel effect — Costco passes savings onto customers, drawing more customers, giving Costco greater economies of scale resulting in lower unit costs, which can then be passed onto customers as further savings. This is an incredibly powerful flywheel in the commoditized Retail industry, where low prices reign supreme.
However, while this flywheel keeps Costco’s prices competitive vs. peers, it also means that Costco doesn’t actually outperform in terms of retail profits. Where they really make their money is in membership sales, which are necessary for customers to shop at Costco. This is somewhat akin to how some FSC airlines generate the bulk of their profits from their air mile programs, rather than their actual airline business. And because Costco’s persistently low prices themselves represent a moat in the commoditized Retail industry, it gave their membership business model a long reinvestment runway for many decades.
Unfortunately for Costco investors, this reinvestment runway has since tapered, as Costco has pretty much already saturated most of its capacity for incremental store growth in the USA (3% store growth in 2024). There have been other copycats of this membership business model in the Retail industry (e.g. Home Depot), but HD 0.00%↑ has also already saturated its market (5% store growth in 2024). So while the membership business remains a wonderful business model, neither Costco nor HD have the same kind of growth opportunity to persistently reinvest their profits at historically high rates of return.
Floor & Decor FND 0.00%↑ is actually one such company which has a similar membership business model — but has far from saturated its future growth runway (15% store growth in 2024). Like HD, FND operates in the home improvement space; however unlike HD, FND almost exclusively sells hard surface flooring products (e.g. wood, tile, vinyl flooring).
FND’s 75,000 sqft large-format warehouse stores are about 25% smaller than the average HD store at 100,000 sqft. However, they only carry one specific category of home improvement products (flooring). This stands in stark contrast to HD stores, which carry pretty much every home improvement product category you can imagine.
This makes FND a market leader in the US flooring retail industry, as their stores carry a much larger SKU assortment than anyone else, which in turn attracts bulk buyers of flooring products. This gives FND the same kind of economies of scale as Costco, and thus the same economic flywheels as Costco.
On top of that, FND also has direct supplier relationships with its international suppliers. This cuts out the middleman distributors from FND’s supply chain and allows FND to keep those margins — thus giving them a low-cost moat from smaller competitors, which generates savings that they can pass on to customers (ala Costco). A slightly outdated 2018 FND initiation report by Morgan Stanley revealed that FND had lower average prices than at Home Depot and Lowe’s at the time:
The current depressive sentiment surrounding FND’s valuation is due to the recent rapid interest rate hikes. FND’s sales are highly correlated to the Existing Homes Sales macro indicator (EHS), which basically represents housing turnover. EHS has recently been deteriorating in the face of relentless rate hikes — and with the Fed more or less ruling out any reduction in interest rates until June, things admittedly don’t look good for FND’s short-term performance.
Having said that, FND clearly isn’t worried about cash flow in the short-term, and its Costco moat story is also very much more concerned with the longer-term. FND’s management had previously stated a LT goal to eventually get to 500 stores by 2030 (from 207 stores currently) — which should theoretically more than double their current sales. We’ll dive into the nitty gritty of the feasibility of this goal in this Part 1 report and next week’s Part 2.
While the shorter-term outlook admittedly isn’t great for FND, nothing has disrupted its “Costco business model” as a longer-term concern. As Buffett puts it, this is a classic “be greedy when others are fearful” situation concerning a “wonderful business at a fair price”. The fact that its shares are still trading at 40x trailing PE in the face of such macro headwinds says something about the confidence that markets are assigning towards FND’s moat and future growth runway.
This Part 1 report will be a FND business analysis primer, which will provide a detailed overview of FND’s operations and business model. By the end of this report, you should obtain an intimate understanding of FND’s business levers, and why its moats are almost nigh impenetrable. I.e. why Munger calls FND an imitator of Costco.
In next week’s Part 2 report, we’ll flesh out the FND analysis with a financial deep-dive, estimate its future growth potential, discern the appropriateness of its current valuation of 40x trailing PE, and gain a better understanding of the short-term macro risks that are presenting FND with trough-cycle conditions and opportunities.
FND’s business model is simple to understand, with highly transparent growth levers and a super long reinvestment runway that is resistant to competition. In other words, a moat. A wonderful business, indeed.
“These B2B customers tend to be much stickier than B2C customers, shop in much larger quantities, and are less price elastic when the sale is accompanied with good service. For these reasons, they represent stickier, less lumpy and more predictable recurring revenue — which leads to lower customer churn and more reliable growth. If you’re familiar with the Retail industry, you’ll know that this is why Buffett likes companies in the Branded Retail sector.”
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AI-Generated Summary (500 words)
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