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  • Writer's pictureGreystone Capital

At Home Group (HOME) – favorable unit economics, long growth runway, cheap valuation

The At Home Group (disclosure: long) represents the opportunity to invest in a differentiated home decor retailer with a strong value prop and efficient business model relegated to mostly brick and mortar sales. While industry incumbents and trends in retail seem to be heading in the opposite direction in terms of strategy, At Home has found an efficient way to run brick and mortar operations by utilizing a ‘self-service’ shopping model, limiting employee count and being selective with their real estate. Furthermore, I believe HOME will be able to compete well against the likes of Wayfair and Amazon among others, and currently sports higher revenue growth rates, higher margins and a longer runway than peers such as TJX, Target, Ross stores and Floor & Decor. Yet despite the above, shares trade at a discount to comps on every relevant metric and are currently available for a price that appears to be too cheap for the fundamentals. If HOME can continue to execute by opening new stores, managing inventory well and keeping employee costs low, there should be the opportunity for revenue growth, margin expansion and multiple expansion moving forward.

It would be important to note that this is a business that survived the pandemic (albeit with some serious damage to the share price), turned over the shareholder base, cleaned up the balance sheet as of Q4 2021 and emerged as a stronger business post-COVID that is set to benefit from any and all stay at home trends as well as the current / ongoing housing boom. I believe the market is overly focused on things like short term margin guidance (possibly under-promised by management), with shares being heavily sold off following the company’s best quarter / year end results (FY2021) since before COVID. Consensus estimates for 2022 and beyond appear to be far off from what I believe the normalized operating environment to be, and as a result provide investors with the opportunity to purchase shares at what seems to be a favorable price.

Brief Business Background

At Home was founded in San Antonio in 1979. Originally called Garden Ridge Corp., the business was a Texas-based retailer for over a decade until going public for the first time in 1995 with 25 stores. During the late 1990s, management projected that the company would operate on a national basis and generate sales in excess of $1 billion by the early 21st century. The impetus for the chain’s rapid expansion during the latter half of the ’90s stemmed from a successful overhaul of the company’s strategy and retail concept during the early part of the decade. Spearheaded by the company’s Chairman and Chief Executive Officer, Armand Shapiro, the changes focused on revamping and organizing the stores floor plan and design. Fast forward to 2004, and through a combination of things including overexpansion and mismanagement, Garden Ridge filed for bankruptcy.

During that lengthy process, now-CEO Lewis ‘Lee’ Bird put together a group and some capital in order to try and acquire Garden Ridge out of bankruptcy. This led to PE firms AEA Investments and CV Starr to acquire Garden Ridge in 2011, appointing Lee Bird as CEO. Fast forward another few years and a re-brand was conducted to the current At Home moniker, and the two PE groups brought HOME public in 2016 at $15/share. Two follow-on secondary offerings bring us to today, where both CV Starr and AEA Investments are no longer involved, having distributed their remaining shares to LPs.

Business Overview

Today, At Home is a leading home decor retailer with 225 stores located in 40 states throughout the US specializing in a wide selection of merchandise at incredibly low prices. HOME’s value proposition consists of their pricing (aiming to sell goods below all competitors) and selection (carrying over 50,000 SKUs), set to fit any room, style and budget. The average store size is greater than 100,000 sq. feet, and the low priced selection is supported by an efficient operating model which includes low rent, low employee costs and direct sourcing of merchandise. Most of HOME’s products consist of unbranded, private label goods that were specifically designed for the company which helps create the broad assortment of products you see throughout the stores.

At Home’s customers are typically women over the age of 40 who enjoy the self service shopping model of browsing and ‘hunting’ for goods similar to the experience at TJX. With an average cost of $15 per item, the customer base consists of all ranges of demographics and socioeconomic backgrounds. While many low price retailers employ frequent markdowns and clearance sales in order to move inventory, 80% of HOME’s product sales occur at full price. This has allowed them to market their ‘everyday low price’ strategy (similar to Walmart) in order to acquire customers and drive store traffic. While I typically prefer businesses with recurring revenue profiles, HOME has a unique model where the majority of their shoppers are repeat customers (as part of their Insider Perks Loyalty Program) who frequent the stores, spend more on each visit, and drive average basket sizes higher.

While HOME successfully rolled out their buy online, pick up in store (BOPIS) model during the pandemic, they have limited ship-from-store options like competitors Amazon and Wayfair. HOME’s intention is to avoid increasing their cost per item by including shipping / last mile delivery, and to those efforts have partnered with both Postmates and PICKUP by rolling out next day delivery in select markets. While it seems the retail industry has been heading in the opposite direction of brick and mortar, HOME’s bulky items would be difficult to ship for competitors from both a cost and handling perspective, and HOME’s customer’s have been willing to trade convenience for the winning combination of price and selection. Although Wayfair remains the 800 lb. Gorilla in the industry, I believe low or ‘off-price’ offerings have successfully competed against the likes of online retailers.

The above characteristics have led HOME to (profitably) achieve a 7-year sales CAGR of 21%, while growing their store footprint and maintaining mid-high teens EBITDA margins. HOME estimates their US footprint to be around 600 stores, providing an extremely long growth runway as they take advantage of the availability of low cost, second generation real estate left behind by often times failed big box incumbents.

Store level unit economics are incredibly favorable, with a two-year average payback period (based on stores opened from four years ago) and adjusted EBITDA margins for mature stores around 26%. Strong year one EBITDA margins combined with stores reaching maturity very quickly helps highlight the benefits of the new store opening strategy. Filling in white space has higher return potential as opposed to comp growth in the 1-1.5% range during the last two years.

HOME Unit Economics

Digging more into the above, HOME boasts an average of $7mm in sales per store, with EBITDA margins around 26%. The stores carry somewhere around $2mm in inventory on average, and have steadily increased turns from 2.3x a few years ago to around 3.0x today. While this may not seem like a large jump (or high amount compared to a TXJ) I believe a key part of the business strategy needs to revolve around managing inventory well for both cash flow purposes and moving the 50,000 SKUs At Home carries. In addition, higher turns will help lead to margin increases. As outlined above, HOME estimates a cost of $4-5mm to fit out second generation stores versus $2-3mm for newbuilds net of sale leaseback proceeds. Year one sales for second generation stores have averaged around $6.0mm while newbuilds come in much higher at $8.0mm. Stores have historically reached maturity quickly allowing for fast payback times and high returns on the initial investment. As mentioned above, with low labor costs per store (around 6% of sales on average) and no online shipping options, HOME can support a much lower cost per item than Amazon, Wayfair or TJX, with no last mile delivery costs to absorb.

I believe as HOME scales, there is the opportunity for significant margin expansion in a number of areas, and the business should begin to see a greater return on their increased marketing spend, hopefully driving more traffic and increased sales volumes. I believe margin expansion can take place by leveraging corporate fixed costs, improving purchasing volumes, achieving fixed cost leverage at the store level, the addition of a second distribution center, improved inventory turns and negotiating better payables terms.

Diving into more detail for each of the above points, management has described the majority of their corporate costs as fixed, which should start to see some leverage from here as the business scales given HOME believes they have the capabilities they need. Purchasing volume improvements can come in the form of lowering costs by increasing purchasing volumes, also leading to supply chain efficiencies of being able to pack/ship in fewer packages. In line with improvements in purchasing volumes, HOME has a program to directly source inventory from manufacturers, which provides a margin uplift versus inventory sourced using purchasing agents. I believe their direct sourcing as a percentage of total merchandise should continue to increase in line with management’s target of 30%. Prior to 2020, HOME operated one distribution center in Texas which the company estimated could support up to 220 stores. The company built a second distribution center last year in Carlisle, PA which is now able to support an additional 100-150 stores. The buildout of the second distribution center, which provided some cost headwinds, should now allow for fixed cost leverage at the distribution level in addition to lower shipping/hauling costs with less distance to travel.

While the above potential improvements are hard to quantify, I don’t view them as overly aggressive assumptions or difficult to achieve over time.

Industry Info

The home decor industry is expected to exceed $200 billion in size by 2024, growing above 3.5% annually. The market is fragmented with around 30% share held by Walmart, TJX, Target and Amazon, with another large percentage held by large retailers such as Bed Bath and Beyond, Costco and others. The majority of market share is held by ‘other’ retailers which is where I believe HOME will continue to make an impact in terms of taking share. All trends in home decor suggest that the majority of consumers prefer shopping in-person, and sales growth rates for various home decor retailers point to ‘value’ offerings holding a strong position within the industry.

One of the more interesting elements of this situation consists of the relatively low brand awareness At Home has in markets where it’s stores are located. The business has a fraction of the unaided brand awareness that TJX, Target or Walmart have (not to mention a fraction of the store base) which can contribute to lower traffic volumes and seasonality in some markets. HOME has nearly 4x’d their marketing spend within the past five years, albeit from a relatively low base, helping to drive engagement and push their sticky loyalty program which now has over 9 million members. While more dollars and resources won’t necessarily lead to more sales on a linear basis, I believe time, increased marketing spend and store maturity should all help increase the brand value moving forward.

I also found it interesting when digging into store fixed costs and potential leverage opportunities there, that older stores have similar comps to younger ones despite the typical retail honeymoon period for new concepts. The oldest stores bring in more revenues than younger ones, which could be explained by a number of things including operating experience (being able to tailor the SKUs / experience to customer preference) as well as adding more regular / loyal customers. As mentioned above, HOME has low brand awareness in markets where they have stores, which would suggest as the years go by, they continue to gain more frequent / loyal customers.

While there is certainly a limit to the number of existing big box stores (especially second generation) in the US, industry estimates of 20,000 ‘as-is’ big box retailers left should provide opportunities as stores close, relocate or sell off certain assets. At Home employs an analytical and quantitative two-pronged approach to site selection, with a real estate team to identify where the best national markets are for retail, and a customer analytics arm which takes data from At Home’s existing stores and lets the company know things like average household income and the number of households near a potential site. This model also analyzes 300 other stores and restaurants in each market to show At Home how it would perform relative to what is located nearby. The model can go as far as predicting the sales at each prospective location studied. In line with the above, because HOME often goes into existing real estate, it has ranked all 20,000 still-operating big boxes in the entire country. So if a Home Depot, Walmart, Target, or Kohl’s were to decide to close a store, At Home can obtain the analytics to decide within two days whether the site would good for a new store. In addition, they are typically one of the first broker calls for stores of that size, given their communicated demand and relationships built over the years.

Lastly, the continued difficult environment for retail should help eliminate certain competition for HOME, including Pier 1, who recently filed for bankruptcy with plans to close 400-450 stores. Add J.C. Penney and Tuesday Morning to the mix for an additional 1,000+ potential locations. While more of a Restoration Hardware competitor, high end design/furniture retailer Ethan Allen is facing similar issues with declining sales, increased promotional activity and supply chain issues (yet still trades at 20x EBITDA). My comment above regarding value offerings in retail ‘winning’ in the current environment points to continued share gains for HOME especially if they can continue to execute their low cost operating model.

Management and Shareholders

As mentioned above, HOME is run by CEO Lewis ‘Lee’ Bird, who has been involved with this business since 2010, and in his current role since 2013. Bird owns around 3% of the business and has extensive experience in the retail and brand management spaces, having previously served as the President of Nike Affiliates, COO of the Gap, and CFO of Old Navy. I’ve been a fan of his ability to execute, capital allocation and focus on new store growth. In addition, Bird has shown a willingness to change what’s not working, make improvements when necessary to drive value, and alter the business strategy (BOPIS, next day delivery) in order to please customers. One largely positive change he brought to HOME was an improvement in the culture and employee morale. Before Bird got involved, HOME employee turnover was extremely high, which has now shifted as Bird instituted things like bonuses, additional time off, tuition reimbursement and improved benefits. While hard to quantify, the I’d peg these improvements as very favorable. In addition, management comp is heavily tied to operating performance including same store sales numbers, adjusted EBITDA growth, and margins.

Also as noted above, AEA Investments, the PE firm who took the company public is no longer involved, nor is CV Starr Investments. There is some large shareholder risk as around 40% of shares are held by three hedge funds and two institutions (Vanguard and Blackrock). CAS Investment Partners and North Peak Capital Management collectively own 26% of the business, so the need for them to exit would likely cause the share price to drop. Both firms have been involved for some time and have likely done very well owning the shares, which would make a potential exit difficult to navigate.

Valuation

At Home’s current footprint is 225 stores, with plans to buy or build an additional 15 stores in 2022. Starting in 2023, management has targeted a new store opening rate of 10% per year. If that target is achieved, the company will have around 330 stores in 2026, taking them about halfway through their estimated US footprint. At what I believe to be a base case revenue per store number of $7.25mm/store (conservative and assumes minimal uplift from the current figures), and 10.5% operating margins in line with 2017-2019 (current operating margins for FY21 came in at 14%), HOME should be able to generate around $250mm in EBIT. At a conservative multiple range of 12-15x, shares would trade between $37 – 46/share, or 37- 74% upside from today’s price. I’d view the above estimates as conservative given the growth runway, potential for margin uplift, and peer valuations where ROSS for example trades at 135x earnings and 55x EBITDA, and the aforementioned Ethan Allen – a declining business by all measures – still trades at 20x EBITDA. My valuation also assumes HOME still carries 3x debt to EBIT, where any turns of debt lower or refinancing (current 2025 notes are being carried at 8.75%) would provide further cost savings in the form of interest expense. The 3x leverage ratio assumption should prove to be way off, as the business is currently levered below 0.5x, and generates enough profitability / FCF excl. growth capex to fund the business model.

However, I believe HOME has the opportunity to exceed the above base case, with certain stores currently averaging >$10mm in revenues. Normalizing these figures as new competition emerges and competitors fully re-open, I’d point to $8-$8.5mm in revenue per store by 2025 within the realm of possibility. In that scenario (what I’d view as a combination base/bull case), at what I believe to be a fair multiple of 20x earnings for a high growth, high margin retailer with a continued long runway, shares would trade north of $70, or 150% higher than today’s price of $28/share. This assumes store openings in line with management’s expectations of 10% per year, low sales per store growth of 3% declining through 2025 and a slight increase in operating margins from management’s guided 9% in 2022.

HOME Valuation

Moving to free cash flow, HOME’s ‘headline’ free cash flow numbers show up as negative given their high capex needs attributed to store growth. However, if they were to pull back the growth investments, I’d peg a normalized free cash flow number in the $75-90mm range, which would allow them to distribute to shareholders or repurchase stock. As discussed above, attacking the white space opportunity remains the best go forward strategy given the return potential, so I’d argue a better way to value the business might be from a store-level owner earnings perspective.

Using the above model as a guide, if HOME can reach a 300 store count by 2025, at $8mm in revenues per store (below my above estimates) and 20% store level EBITDA margins (below the current and historical 26%), HOME would generate around $1.6mm in EBITDA per store. With maintenance capex of 5-6% of revenues and adjusting for some store level working capital, HOME would generate a little over $1.0mm in owner earnings per store. Multiplied by the 300 store count would reflect $300mm in owner earnings potential against a current market cap of $1.8B. I don’t believe my assumptions are overly aggressive nor are investors paying up today for that future growth / earnings power. At 12x that owner earnings number, shares would be trade north of $50.

Helping to create this opportunity was the share price action the day following what I thought was a phenomenal Q4 / FY21 earnings report. HOME beat on revenues and EPS, blew comps out of the water, saw explosive adjusted EBITDA growth, improved margins and reduced leverage, yet shares finished the day DOWN 16%! While investors shouldn’t read too much into one quarter of data or subsequent price action, I found the market’s reaction to be absurd. Digging in a bit deeper, HOME’s limited guidance included a decline in full year 2022 operating margins to 9%, understandable given the state of the world and continued supply chain issues. However, 9% operating margins (or the current freight / supply chain issues) is hardly what I’d consider a normalized operating environment for HOME moving forward, especially with the above potential margin improvements on the horizon.

Lastly, consensus estimates for 2022 include revenue growth of just 3.5%, an EBITDA decline of 22% (!) (including EBITDA margin compression of over 700bps) and SSS declines for the year. Either the market is clearly missing something and HOME is incredibly mispriced, or I’m an idiot and will be completely wrong about the future of the business. Caveat: there is a non-zero chance that I’m wrong.

I like the setup here and believe HOME will reward investors as they continue to deliver over the next few years.

Couple additional data points:

  1. On the Q4 2021 call, Lee Bird outlined a normalized or go-forward operating margin number of 9%. HOME did 9.5% in 2019 (5.9% in 2020 due to COVID), and management stated they are on pace to deliver ‘way above that’ number in 2022 but will likely not end the year that way due to elevated freight costs, which, if normalize will help them deliver on higher operating margins. I thought that was interesting as I’ve modeled for 12% operating margins by 2026 (still below FY2021 numbers).

  2. On the bearish argument of HOME not benefitting as a re-opening play given consumer spend being driven elsewhere:

  3. Management has historically said (and continues to believe) there is a lot more business to be had in their space. With competitors closing and brand awareness rising, management believes as long as they have the SKUs, they will sell them. They even claimed to have ‘left money on the table’ last year.

  4. Management also stated on the Q4 call: “Stimulus is helping, but as you know we may have mentioned before, we found that the stimulus is only like a four week benefit. And it’s like icing on the cake. It’s not the cake. It’s a nice little upside for us. But that is not what’s driving these numbers.”

  5. Given the above, for periods of lessened demand, management believes they can allocate inventory spend and flows effectively given their experience during COVID and their analytical capabilities

  6. The real estate strategy is incredibly flexible as HOME is the first call for empty big box stores, but can also adapt smaller or combined store formats to reach their desired square footage. This has led to managements optimism surrounding their long-term 600 store target which they believe is intact

  7. Some of the adjustments to merchandising that HOME has made include utilizing increased analytics for buying and planning purposes, upgrading the buyer team, and conducting a once per week ‘open to buy’ program to adapt to order volumes, all of which should sustain the high levels of full priced sales (less markdowns) and higher inventory turns

Risks

Execution risk – will have to monitor moving forward in line with operational and margin improvements

Tariffs – direct sourcing will help alleviate issues with Chinese imports, and HOME is diversified among its vendor base

Supply chain disruptions – scale helps here as they are a large buyer, seemingly gaining preference over smaller organizations

Always going to be financially constrained in terms of resources, because they have low sale per square foot and can’t hire additional staff or raise prices in line with inflation / competition – I believe HOME already offers value prices with their EDLP strategy, and the believe the model is set to run using the staffing model they currently have in place

Marking items down a lot because they can’t move SKUs – I believe product consolidation is happening, and turns have improved over the past few years

Perceived lower quality will drive people away – I don’t believe customers are concerned with the stores ‘shopped over’ look, nor the unbranded merchandise

Can’t compete on pricing: Amazon, and Wayfair can typically adjust prices minute by minute, allowing them to better compete with other options – while HOME’s pricing strategy is fixed, I believe the low average item cost provides an opportunity for shoppers of all budgets to participate

Not enough second generation stores to get favorable lease rates – I believe there is somewhat excess supply currently with larger retailers going out of business, thus keeping a lid on rental rates

Price wars where Amazon, in their attempts to buildout a Wayfair like platform decide to irrationally lower prices, causing Wayfair to do the same, which would likely hurt HOME margins (although may benefit HOME long term as other home decor retailers would likely fail) – I do not have a good mitigant for this and it remains a risk

Unit economic deterioration as growth is pursued for the sake of growth – we’ve seen no evidence of this, and management has cautiously scaled back new store openings for 2021 / 2022

Need to hire / invest in order to make BOPIS / e-commerce work – this is a concern of mine and something I’m looking into in greater detail. As of now, management believes they can scale BOPIS and the associated merchandising / website traffic with their current staff footprint


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