There have been two crosswinds when it comes to 1-800-Flowers.com (FLWS) stock. There’s an obvious qualitative case, given the collapse of rival FTD Companies (FTDCQ). 1-800-Flowers and FTD aren’t quite a duopoly, as there are other competitors, including The Wonderful Company’s Teleflora. But FTD’s declining revenue, combined with a disastrous acquisition, led to its bankruptcy this year – and an opportunity for 1-800-Flowers.com to take share.
That’s already played out in recent years. Indeed, while FTD sales have eroded, 1-800-Flowers posted revenue growth of 8.4% in fiscal 2019 (ending June) on top of a 3.7% organic increase last year. It’s guiding for another 6-7% in organic revenue growth in fiscal 2020. The company’s 2014 acquisition of Harry & David has been an obvious winner, helping drive consistent growth in the company’s Gourmet Food & Gift Basket segments. And BloomNet wire service has an opportunity to take advantage of a wounded FTD going forward.
But there’s been a long-running fundamental concern underlying those share gains. Between FTD’s decline and a strong macro picture, the external environment seems exceedingly favorable for FLWS. And yet profits really haven’t done much at all:
source: author from FLWS press releases. FY15 figure as reported with ‘annualized’ Harry & David figures. FY17 excludes modest contribution from Fannie May. FY20 figure at midpoint of guidance. FY21 is announced $100 million target
The FY21 target of $100 million, if hit, only suggests annual Adjusted EBITDA growth of 3.8% over six years in a strong economy. The sale of the Fannie May chocolate business has had a minor impact, but management told me on a call last year that margins already were deteriorating ahead of the sale. FLWS also picked up Shari’s Berries last month as part of the FTD bankruptcy, which should contribute to FY21 profits, and had ~$10 million in incremental synergies from the Harry & David acquisition coming after FY16. Those synergies drive about half of the profit increase over the six years – yet even with their help margins haven’t moved, as FLWS has struggled to drive operating leverage.
The battle between qualitative optimism and fundamental skepticism mostly has been won by bulls, with two notable exceptions. FLWS has tanked after each of its last two fiscal Q4 reports due to disappointing forward guidance, most recently last month:
To be fair, 1-800-Flowers did top its original FY18 outlook, and seems to guide conservatively. An FY21 target of $100 million remains intact. And I’ve long been too bearish on FLWS (and took an ill-advised stab at FTD on its way down).
That said, even with a 23% decline from pre-earnings levels, FLWS looks awfully expensive. Valuation isn’t necessarily prohibitive, to be sure, but when accounting for two key concerns it’s tough to see much fundamental upside left. The qualitative case admittedly has won so far, but it remains to be seen whether it will do so again.
The Leverage Problem
Thank you. That’s helpful. And then — so thinking longer term here, I mean FTD has been having problems for a couple of years now. It just hasn’t been all of a sudden, it’s been a gradual deterioration of their business. And if you look back at your FY16 EBITDA, I think you did about $86 million of FY16 EBITDA. And here we are next year expecting 7% to 10% lower than that, a couple of years later, three years later your EBITDA is about 7% to 10% lower than a few years ago. So granted your top line growth is accelerating pretty steadily, so that’s good, but it strikes me that you’re spending more to get that top line growth. So you’re getting the growth, but your profitability is deteriorating…
– analyst Linda Bolton-Weiser on the Q4 FY18 conference call
…then let’s just address kind of the elephant in the room on the forward guide, especially EBITDA, which is what’s hurting you today. So, you guys have made several hundred millions of dollars of investments in tech in the last few years. Obviously, you guys have taken significant marketing share and accelerated your revenue. There’s no doubt about that. You’ve got FTD, kind of, in pieces now, although there are some obviously, concerns that Nexus will be maybe a more rational and reasonable player against you guys. So just how do we view the long term, sort of, balance between growth? Do we return to a improving or a leverage situation you guys used to generate about, 30 basis points to 70 basis points of margin expansion a year?
– analyst Dan Kurnos on the Q4 FY19 conference call
Both questions to go to the fundamental case here: when, exactly, does FLWS’ profit growth benefit from the sea change in its industry? Adjusted EBITDA margins were 6.9% in fiscal 2015 – and guided to 6.6% in fiscal 2021.
FLWS management has come up with several explanations for the lack of operating leverage – and there are legitimate issues. FY19 guidance disappointed as the company had to reinstate bonus targets after a disappointing year, which provided a headwind in the high-single-digit-million range, per commentary. Labor costs are an issue: 1-800-Flowers hires literally thousands of seasonal workers, and is facing rising minimum wages for its year-round workforce. Management told me last year that in Columbus, Ohio, the company faces heavy competition from Amazon (AMZN), which is aggressively hiring itself.
Transportation costs have spiked: commentary on the Q1 FY19 call suggested a 30-40% increase in fiscal 2018. An increasingly desperate FTD ramped up its promotional spending and discounting. The sale of Fannie May probably hit the bottom line by $4 million or so.
Still, the bonus step-up only really impacted year-over-year comparisons for FY19. The bonuses generally returned to normal; the outlier was a poor FY18, not a particularly strong FY19. In that context, 4% year-over-year growth last year isn’t impressive, especially since FY18 EBITDA took a ~$4M hit from an operational issue at Cheryl’s Cookies in Q2 FY18.
Pro forma for synergies, FY15 Adjusted EBITDA was $90 million. FY20 profits are guided to about the same level. That’s with a competitor imploding and a favorable macroeconomic backdrop. Year-over-year comparative impacts matter, but they don’t necessarily explain the longer-term leverage problem.
Nor are they necessarily going anywhere. Tight labor markets seem to be here for the foreseeable future, and the same is true for transportation costs, much of which FLWS has mitigated per recent commentary. For those costs to ease, the economy has to turn. That’s important, because 1-800-Flowers is more cyclical than one might think.
The Cyclical Concern
The floral business seems reasonably defensive, at least in a mild recession. That’s not necessarily the case. FLWS’ consolidated Adjusted EBITDA fell by half between FY08 and FY10. Floral revenues declined 21% over the two years.
FLWS’ cyclical exposure now might be even more severe. 49% of segment-level profit in FY19 came from the Gourmet Foods & Gift Baskets business. Far and away the biggest contributor in the segment is Harry & David, given that the business represented over one-third of total pro forma revenue upon its acquisition in September 2014.
Fruit baskets that cost close to $100 all-in for six pears and two apples plus some cheese, nuts, and crackers are the definition of a cyclical business. And Harry & David actually went bankrupt not long after the financial crisis, though there’s some debate as to how much of the blame goes to debt created by a leveraged buyout.
Cyclical stocks certainly have caught a bid this year after being among the biggest (and earliest) victims of the Q4 sell-off. But valuations in the category clearly still show a market pricing in a macro upcycle much closer to the end than to the beginning. That doesn’t necessarily look like the case for FLWS.
And both the leverage and cyclical concerns are amplified by the margin structure here. Again, guidance suggests Adjusted EBITDA margins of just 6.6%. Free cash flow margins are under 4%. FLWS has talked up investing behind the business to capture share amid FTD’s troubles, but marketing and sales spend actually leveraged modestly last year, even with higher bonus payouts. Thus those low margins don’t necessarily seem to be temporarily depressed by market dynamics; they’re at least in the ballpark of the sustainable figure going forward here.
A cyclical company with sub-7% margins seems at significant risk when the economy turns – or when fears of that turn rise. To be sure, FLWS hasn’t necessarily traded that way: the stock in fact held up reasonably well during last year’s sell-off, though a strong earnings report in November certainly helped. But the cyclical risk seems more real than investors have realized of late. If that changes, it does seem like, at this valuation, 1-800-Flowers has to deliver the growth its qualitative story promises. It really hasn’t done so yet.
The Valuation Problem
Meanwhile, even after the post-earnings sell-off, it’s not as if FLWS is cheap. Pro forma for Shari’s Berries, enterprise value is right at $900 million. That’s ~10x the midpoint of FY20 EBITDA guidance. It’s ~9x the FY21 target, which requires double-digit growth next year, a notable acceleration from post-crisis performance.
EV/FCF based on guidance is right at 20x. P/E backing out the cash is likely higher. Even looking to FY21, FLWS still is getting high-teen multiples if it hits a target that seems like a potential reach, at least at the moment.
Those multiples don’t sound aggressive, particularly in this market. Direct peers, with FTD’s demise, are essentially impossible to find. But it’s worth noting that the obviously core Harry & David was acquired for ~5x EBITDA (pre-synergies). And from a broad standpoint there is no shortage of late-cycle names available at much lower multiples (on any of those bases) across the board. I’d be loath to pay 20x guided free cash flow at this point in the cycle unless a business had significant operating leverage. 1-800-Flowers increasingly doesn’t look like one of those businesses – which suggests investors even at $15 are taking on significant cyclical risk for only reasonable bottom-line growth even in a blue-sky scenario, or something close.
The Case to Buy
There is a simple answer to those detailed concerns, admittedly: buy the business, not the stock. After all, an investor could (and I did) make the same exact case a year ago. Even with the post-Q4 plunge, FLWS has gained 22%, handily outpacing the market.
And 1-800-Flowers still has some levers to pull. There should be ~$100 million in cash on the balance sheet by the end of FY20, and management has talked up the possibility of M&A. It’s not clear who could really be a transformative target at this point, but there is cash that can be put to work, increasing ROIC and providing a catalyst to bottom-line growth.
BloomNet has a huge opportunity to take share from struggling FTD. Last year’s growth was mostly driven by orders, but CEO Chris McCann said on the Q2 call that the summer offered an opportunity to renegotiate contracts – and potentially pull customers from FTD’s wire service. That is a much higher-margin business, accounting for 15% of revenue last year but over 20% of profit. Growth there can help consolidated margins and provide some of the leverage for which investors and analysts have been looking.
Meanwhile, as management noted in response to Kurnos on the Q4 FY19 call, FLWS is driving some leverage this year. Organic revenue is expected to grow 6-7% – but Adjusted EBITDA 8-10%. That’s obviously not quite what investors were looking for, given the post-earnings sell-off, but it’s progress. FY21 targets suggest more progress, and it does seem like 1-800-Flowers.com management guides somewhat conservatively. (That said, guidance was cut twice in fiscal 2018, so I’d be careful in baking in higher-than-expected profit performance just yet.)
Again, buy the business, not the stock. That’s generally been very good advice for most of this bull market, and it’s been good advice relative to FLWS, which has gained 66% over the past three years and 127% over the past five. If some (some, not all) of the fundamental concerns here can be assuaged, it can be good advice again. And it’s worth repeating: I’ve been wrong so far.
Still, the fundamental case here does look weak. And at a certain point that may well matter. I don’t mind taking on cyclical risk – but there are higher-leverage ways to do so. It seems strange that, given the performance of FLWS over the past five years, this still seems like a bit of a ‘show me’ story. But it does, and the sell-off after Q4 earnings suggests that investors, at least for now, haven’t been shown enough.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.