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Shares of Floor & Decor Holdings Inc (NYSE: FND) fell nearly 5% on Monday, following a critical short report published by Spruce Point Capital Management.

The report has raised significant concerns about the company’s financial health and strategic direction.

Spruce Point’s bearish stance on Floor & Decor

Ben Axler, the founder of Spruce Point Capital, has highlighted several red flags that underpin his bearish outlook on Floor & Decor stock.

According to Axler, the home improvement retailer has been “ceasing disclosures” and “changing some accounting language,” which raises transparency concerns and casts doubt on the integrity of the company’s financial reporting.

The investment firm believes that Floor & Decor is structurally ill-equipped to meet its financial targets, suggesting significant downside potential for the stock. Axler also cites pressure on the home remodelling cycle as a key factor in his negative view of the New York-listed firm.

The report indicates that the home remodelling market is experiencing a downturn, which could further hinder Floor & Decor’s performance. Notably, Floor & Decor does not currently pay a dividend, which may deter income-focused investors who seek regular returns from their investments.

Economic recovery may not benefit Floor & Decor

Axler is also skeptical about Floor & Decor’s ability to benefit from an economic recovery, noting that “their capital expenditures and store operating expenses are growing substantially.”

He warns that these higher costs will continue to weigh on the company’s earnings, making it difficult for Floor & Decor to achieve profitability even in a more favorable economic environment.

In an interview with CNBC, Axler explained that professional contractors prefer larger competitors like Home Depot, Lowe’s, and MSI, leaving Floor & Decor primarily serving homeowners.

This limited customer base could restrict the company’s growth potential and make it more vulnerable to market fluctuations.

Additionally, the company’s debt is growing due to entering into “long-term expensive leases,” further straining its financial health and increasing its risk profile.

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Wall Street’s outlook on Floor & Decor

Currently, Wall Street analysts rate shares of the $10 billion company, based out of Atlanta, Georgia, as “hold.”

This lukewarm sentiment aligns with Spruce Point’s view, emphasizing the stock’s unattractive valuation compared to other home improvement retailers.

On “Money Movers,” Axler elaborated: “We want to be short companies that are poorly positioned with weak management, weak governance, a higher valuation, and leverage that isn’t appreciated. It checks a lot of our boxes.”

Axler draws parallels between Floor & Decor and Linen N’ Things, a big-box retailer that went bankrupt in 2008. He noted that some of Floor & Decor’s board members were previously associated with Linen N’ Things, adding to his concerns about the company’s leadership and strategic direction.

Contrarian view: Warren Buffett’s stake

Despite the negative sentiment from Spruce Point, legendary investor Warren Buffett holds a stake in Floor & Decor through Berkshire Hathaway.

Spruce Point disagrees with Buffett’s assessment, arguing that “transparency is declining” and that FND does not represent a value stock.

Axler suggests that Buffett’s investment might be based on outdated or overly optimistic assumptions about the company’s potential.

Floor & Decor financial performance concerns

The short report comes about two months after Floor & Decor reported a more-than-expected revenue decline of 2.2% to $1.1 billion. The company’s earnings per share also dropped significantly, from 66 cents a year ago to 46 cents.

This financial performance has added to the concerns surrounding the stock, as it indicates potential underlying weaknesses in the company’s business model and market strategy.

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