Tile Shop: A Stylish Growth Story

Nick is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A checklist for a strong emerging growth stock could look similar to this:

  • Solid and invested management team
  • Disrupting an industry
  • Sustainable advantage
  • Clear vision for continued growth

One stock that meets this criteria is Tile Shop Holdings (NASDAQ: TTS). It offers investors a great opportunity to participate in a growth story that is exhibiting key elements of future success.

Building the foundation

At the core of this growth story is Bob Rucker, CEO and founder, who has spent the past three decades building Tile Shop into one of the country’s largest retailers of specialty tile. He accomplished this while developing relationships with both suppliers and customers, and most recently shareholders, as the Tile Shop IPO’ed in July 2012. This is only the beginning of the story as Rucker and his management team (who still own 25% of the company) have ambitious expansion plans, intending to make the Tile Shop the first nationwide retailer of specialty tile.

A disruptive Force

Most would not consider the remodeling industry ripe for disruption; however, Tile Shop has proven that with a sharp focus on customer service, competitive prices, and a differentiated selection, it can be a disruptive force.

Customer service begins with management in the stores. Strong leadership does not stop in the c-suite but has filtered its way down to the stores. Tile Shop’s approach to store managers is to promote them from within, tie their compensation to store level profitably, and give them the ability to empower their employees.

All of these factors contribute to the average tenure of a store manager of five years with turnover a modest 8% to 10% a year. This consistency of store management is a key factor in customer service. But it doesn’t stop there. The Tile Shop creates room displays, showcasing its store products and hosts free weekly do-it-yourself classes for its customers. All of this focus on customer service seems to be working, 50% of sales in 2012 came from repeat customers.

The great customer experience is further heightened by the competitive pricing and huge selection that the Tile Shop offers. Bob Rucker and his team have developed relationships with quarries and manufacturers of tile around the world, along with its own distribution system, enabling the Tile Shop to control the whole process. This vertical integration allows Tile Shop to cut out the middlemen while giving it the ability to reduce costs and to maintain quality by being able to influence production.

Industry leading disrupter

I see a lot of similarities between Tile Shop and some other small-cap remodeling related companies that have been deriving success by changing the rules of their respective industries: Lumber Liquidators (NYSE: LL), Trex (NYSE: TEX) and Interface (NASDAQ: TILE).

  • Lumber Liquidators has become the largest standalone hardwood floor supplier in the country with its fast expansion of its smaller store concept resulting in a typical store paying for itself in just a couple of months.
  • Trex is the pioneer and market leader in composite decking. By producing a more eco-friendly product than the “traditional” deck, it has watched its share of decks rise across the country.
  • Interface is the leader in modular carpet tiles - easier to install, clean, and replace than traditional carpet. It also produces a more eco-friendly product than the competition which allows Interface to partially protect itself from fluctuating raw material costs.

Tile Shop is arguably showing more promise than these three tremendous growth stories; higher margin and faster revenue growth while maintaining more insider ownership.

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Market Cap</strong></p> </th><th> <p><strong>3-year Revenue Growth Rate</strong></p> </th><th> <p><strong>Gross Margin</strong></p> </th><th> <p><strong>Operating Margin</strong></p> </th><th> <p><strong>Insider Ownership</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Tile Shop</strong></p> </td> <td> <p>$1,388</p> </td> <td> <p>16%</p> </td> <td> <p>72%</p> </td> <td> <p>21%</p> </td> <td> <p>25%</p> </td> </tr> <tr> <td> <p><strong>Lumber Liquidators</strong></p> </td> <td> <p>$2,607</p> </td> <td> <p>14%</p> </td> <td> <p>40%</p> </td> <td> <p>10%</p> </td> <td> <p>5%</p> </td> </tr> <tr> <td> <p><strong>Trex</strong></p> </td> <td> <p>$750</p> </td> <td> <p>4%</p> </td> <td> <p>30%</p> </td> <td> <p>10%</p> </td> <td> <p>5%</p> </td> </tr> <tr> <td> <p><strong>Interface</strong></p> </td> <td> <p>$1,255</p> </td> <td> <p>3%</p> </td> <td> <p>35%</p> </td> <td> <p>8%</p> </td> <td> <p>5%</p> </td> </tr> </tbody> </table>

Source: Author's calculations

Room for growth

The major avenue for growth is simply growing the store footprint, something which Tile Shop has shown the ability to do. Tile Shop has opened over 20 stores since January 2012. With only 77 stores in 25 states (the majority residing in the Midwest and Northeast), it leaves a lot more room for expansion - especially in the West and South.

Tile Shop just finished building its fourth distribution center with plans to build two more in the western half of the country. With each of these distribution centers being able to supply 60 to 80 retail locations, Tile Shop has the ability to serve roughly seven times its current store count.

One reason management is so eager to expand is because stores have terrific economics. An average store investment is approximately $1.4 million, a majority of this cost going to purchasing inventory. These new stores have a payback period of roughly two and half years and more than a 40% return on invested capital.

In addition, same store sales have averaged 8% the past three years; this exhibits the continued success of existing stores. However, what may be most impressive is that this performance has been accomplished with very little marketing.

Tile Shop has built its brand around word of mouth and just recently hired a marketing firm to help it further its brand image as it transitions into new markets. Combined with its strong network of loyal customers, this should facilitate bringing new customers into the stores.

Bottom line

As you may have noticed, I did not mention the housing recovery as a driver of this growth story because I do not think an investment thesis in Tile Shop has to revolve around it. Rather, I see it as a great time for Tile Shop to use this momentum of the recovery and continue its expansion, introducing itself to new markets and customers. I do not believe that Tile Shop will derive success from the housing recovery but rather from its strong leadership, disrupting business model, and customer-oriented focus.

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Nick Pugleasa owns shares of Tile Shop Holdings. The Motley Fool recommends Interface, Lumber Liquidators, and Tile Shop Holdings. The Motley Fool owns shares of Interface, Lumber Liquidators, Terex, and Tile Shop Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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