Tile Shop Stock: A Mixed View (NASDAQ:TTSH)

Elevator Pitch

My investment rating for Tile Shop Holdings, Inc.’s (NASDAQ:TTSH) shares is a Hold.

I did a review of Tile Shop’s financial results for the second quarter of the current year in a prior August 11, 2022 article. The focus of my latest update for TTSH is the key metrics relating to company’s most recent Q3 2022 earnings.

After evaluating Tile Shop in different areas such as buybacks, store network expansion, gross profitability, and new products, I think that Tile Shop is deserving of a Hold rating reflecting my neutral view of its shares.

New Stores

Tile Shop published its Q3 2022 financial results press release on November 3, 2022 last week. One key metric that caught my eye was TTSH’s store count. Tile Shop’s total number of stores remained unchanged at 143 for the past one year.

In fact, the last time TTSH opened a new store was in February 2021, which was located in Wayne, New Jersey. Instead, Tile Shop has been making tweaks to improve the performance the company’s existing stores during this period, and it has paid off. Q3 2022 was the sixth quarter running that TTSH has managed to achieve positive YoY top line growth, and this happened in the absence of new store openings.

Looking ahead, Tile Shop is ready to open new stores again. TTSH revealed at the company’s Q3 2022 earnings call that it is only targeting two additional stores next year. Tile Shop has considered both the current economic environment and opportunities to extract further value from its existing stores in setting a reasonable target for new store openings in 2023.

If TTSH is too aggressive in expanding its store network and the economy weakens substantially going forward, this will leave the company in a difficult situation. Also, Tile Shop mentioned at its recent quarterly investor briefing that “conversion rates, discretionary discounting practices and shrink losses” are some of the areas that TTSH continues to work on at its current stores.

I like Tile Shop’s current approach. On one hand, it is trying its best to increase the operating efficiency and profitability of its existing stores. On the other hand, it is looking at opening new stores in a very cautious manner.

New Product

In my earlier August 2022 update for TTSH, I mentioned that “new products like luxury vinyl tiles could help to expand Tile Shop’s top line in the long term.”

It is good to see that Tile Shop has made good progress in extending the reach of its new product, luxury vinyl tiles. TTSH revealed at its third quarter results briefing that luxury vinyl tiles accounted for under 10% of its total product mix in Q3 2022 following the pilot launch.

There is lots of room for luxury vinyl tiles to grow in the future. Notably, Tile Shop emphasized at the company’s Q3 2022 investor call that the company now offers “a healthy assortment” of luxury vinyl tiles after its official launch in end-Oct, as compared to the “single count SKUs for the pilot.” As such, it is reasonable to assume that Tile Shop’s sales of luxury vinyl tiles will increase significantly in Q4 2022 and beyond.

Profitability

Gross profit margin for Tile Shop expanded by a healthy +50 basis points QoQ from 66.0% in the second quarter of 2022 to 66.5% for the most recent quarter.

Unfortunately, TTSH might not be able to sustain its profitability improvement for subsequent quarters. One key thing to note is that European countries typically make up about 30%-50% of Tile Shop’s sourcing as per management comments at its Q3 earnings briefing. In other words, the high energy prices in Europe might be a drag on Tile Shop’s future profitability assuming that it isn’t able to shift part of its sourcing away from Europe to other markets.

It is also worth noting that TTSH acknowledged at its third quarter results call that “inflationary cost pressures continue” and mentioned that “we do expect some continued pressure on the gross margin.” This is reflected in the sell-side’s consensus financial projections (source: S&P Capital IQ) which indicate that Tile Shop’s gross profit margin should contract by -0.7 percentage points QoQ to 65.8% in the final quarter of this year.

Shareholder Capital Return

Tile Shop previously disclosed a new $30 million share buyback program in mid-August 2022. The company completed its share repurchase program by early-November 2022, having spent $30.2 million to buy back 7.8 million shares for an average price of $3.87.

However, it doesn’t seem that TTSH intends to execute on share repurchases in a significant manner anytime soon. In response to a question at the company’s Q3 2022 earnings call regarding whether Tile Shop is “still looking to kind of do those buybacks you’ve been doing in the past”, TTSH responded by saying “not at this point.”

This is somewhat of a disappointment for two reason. One reason is that Tile Shop doesn’t pay a dividend now, and the absence of share buybacks mean that TTSH isn’t returning any excess capital to shareholders in the near term. Another reason is that this also sends a signal that management probably thinks that TTSH’s current valuations aren’t sufficiently attractive to warrant buybacks.

Closing Thoughts

I leave my Hold rating for Tile Shop unchanged. I have a mixed view of TTSH, considering various factors like new stores, new products, profitability and shareholder capital return.