Is This Buffett Stock About To Plunge?

Spruce Point Capital has earned a reputation for highlighting companies with high downside risks that are potential shorts. Remarkably, they have spotted a highly bearish opportunity in Buffett’s Berkshire Hathaway portfolio.

Their attention has honed in on Floor & Decor, which Spruce Point believes has expanded too aggressively and is now entering markets with lower median incomes that will not sustain current margins. Worse still, the expansion has resulted in high capital expenditures and raised questions about market saturation.

Spruce Point further believes that new stores are opening in markets that are already well-served by competitors, potentially leading to cannibalization rather than organic growth. So what does the future hold and if they are right how low could Spruce Point Capital go?

Key Points

• Floor & Decor’s high debt-to-equity ratio and inconsistent free cash flow pose significant risks.
• The company’s rapid expansion into lower-income markets and areas already well-served by competitors raises concerns about sustaining profit margins.
• Nineteen analysts have lowered their guidance, and significant insider selling indicates a lack of confidence in the company’s future.

Why Could Could Floor & Decor Plunge?

A key concern for investors, according to Spruce Point, is the company’s high debt levels and potential liquidity issues. They argue that the company’s debt-to-equity ratio is excessive and poses a significant risk if there is any downturn in the housing market or a further slowdown in consumer spending.

Moreover, the company’s free cash flow has been inconsistent and future financial obligations may not be met without taking on further debt.

It’s notable that 19 analysts have revised their guidance lower for the upcoming period, suggesting that Spruce Point is not alone in their contention that Floor & Decor may have serious challenges up ahead.

Concerns are growing broadly that the company’s supply chain and inventory management systems are not as strong as they appear. If true, higher costs and lower margins are likely to be reported in coming quarters, especially as the company continues to scale. Spruce Point has highlighted discrepancies in inventory turnover rates and questionable overstocking issues that may hurt profitability.

How Low Could Floor & Decor Stock Go?

Spruce Point argues that Floor & Decor’s market share gains have been largely driven by aggressive pricing, which is likely not be sustainable in the long term. In a highly competitive market with established players like Home Depot and Lowe’s exerting significant pressure, the downside risk is as much as 47.5% in their view.

To add to the short thesis, Spruce Point also points to significant insider selling as a red flag. Are insiders increasingly bearish on their own firm?

It’s very possible that they are acutely aware that a substantial portion of revenue increases are attributed to store openings rather than same-store sales growth, which has shown signs of deceleration.

Finally, Spruce Point recognizes that while Buffett has a long position, it is minuscule in the order of his overall portfolio, and so shouldn’t be revered as it might if it were a larger holding.

The bottom line is Floor & Decor trades at a 45x multiple, which is very high, has increasingly bearish sentiment from analysts downgrades, risks margin compression in future quarters, features insider selling and is now the subject of a short report. All in all, an opportunity it seems for the bears to capitalize on the downside but if you do, consider managing risk carefully with a stop loss.