1-800-Flowers (FLWS) is the leader in the floral online sales industry. We like the company for being in the front run of early technological adoptions within their industry. From taking advantage of toll-free numbers to reach their targeted market, to early adoption of e-commerce, the company quickly adapted to changing consumer behaviors.
After posting third-quarter results, the company surprised analysts by beating expectations in revenues and EPS. Revenues increased 12% YoY and adjusted net loss was $0.14 per share, beating consensus EPS of negative $0.18. The stock priced soared afterward, surpassing its 52-week high:
The momentum on this stock is strong. However, from a valuation standpoint, we believe FLWS is overpriced. On a comparable basis, we couldn’t find pure-play public companies dedicated to the floral business. However, we can get an idea about what multiples investors are willing to pay for a business like FLWS, by looking at an old M&A deal in which FTD Companies acquired ProFlowers for $430M.
Going through the numbers
Ironically, FLWS’ main revenue contributor is not flower arrangements but complementary products such as gift baskets and food products (wines, chocolates, gourmet popcorn, etc.):
Source: company filings
From a business model point of view, it makes sense that the company has diversified its main revenue source to include gift baskets and complimentary food items. Just by itself, flower arrangements are not that expensive (just the flowers). Upselling customers by offering complementary products is a good marketing strategy. There are emotions attached when sending flowers to that special someone. It should make an impression. Sending flowers with extra perks adds to the significance of the gift. For FLWS, that revenue contribution should provide incremental profits as a higher dollar amount can be charged, reducing the cost of delivery.
The big jump in revenue from the Food and Gift Basket segment in 2015 was the consequence of the acquisition of Harry and David, for which the company spent $132M. Harry and David is a specialty retailer and producer of branded premium gift-quality fruit and gourmet food products. The acquisition more than doubled the number of SKUs from 4,400 in 2014 to 8,200 in 2015. The number of SKUs in 2019 was 11,300.
From a profitability point of view, increasing the importance of the Food & Gift basket segment in the business makes sense:
Source: company filings
From the table above we can see that Food & Gift Baskets has higher gross margins and operating income margins. Increased contribution margins from this segment have increased the profitability of the business as a whole, which accelerated with the acquisition of Harry and David:
Source: company filings
Operating income margin for the consolidated results has increased from 1.8% in 2010 to 3.6% in 2019. At the same time, COGS as a percent of sales has decreased from 60.6% to 57.9%. The reduction in COGS could be the result of added scale plus economies of scale, as the company increases its upselling opportunities by having more gift options to offer.
Strong Balance Sheet
We believe businesses with strong balance sheets are an essential quality to have right now. In that area, FLWS passes the test. The company has a solid balance sheet, reporting $232M in cash. Total debt plus long-term operating leases totaled $152M. FLWS has plenty of liquidity to sustain current headwinds due to the COVID-19 pandemic. Their $100M term loan is due on May 2024, so they still have plenty of time to repay their debt.
Their second quarter (October through December) generates 50% of total sales for the year, due to the Thanksgiving and Holiday season. The company starts ramping up inventory in their first quarter (July through September) in preparation for upcoming sales. That should give management time to adjust inventory levels if they see worsening economic conditions, which could help preserve liquidity.
The strong momentum behind the share price can be attributed to management reaffirming guidance for their full 2020 fiscal year, which ends in June. Their third quarter showed impressive growth rates across all three operating segments. Food & Gift Baskets revenues increased by 27.1%. Their Consumer Floral segment saw revenue growth of 5.4% helped by a strong Valentine’s Day season, and BloomNet was up 7.9% compared to the prior-year period.
The spread of COVID-19 brought some challenges and benefits to their business. On the negative side, they saw some restrictions on deliveries to hospitals for get-well occasions, which impacted their consumer floral segment. That headwind was offset by an increase in demand for gift baskets, as their customers find a way to express their feelings during hard times:
Importantly, we saw our customer demand grow throughout the quarter and accelerate into our current fiscal fourth quarter in Harry & David, Cheryl’s Cookies, The Popcorn Factory, 1-800-Baskets, Wolferman’s Bakery, Stockyards, and Simply Chocolate.
So our food brands started to perform well as soon as the crisis started to hit and have just really accelerated since then. – Q3 call
The strong demand for their products will depend on how quickly the economy reopens and how quickly people can get back to work. High levels of unemployment are not positive for a business like FLWS, which could be considered a discretionary item.
New Startups are the biggest risks
There is a new business model emerging within the industry called farm-to-table. Under this new model, customers would directly connect with farmers all over the world, eliminating the need for the middle-man. One company working under the farm-to-table model is called The Bouqs:
The supply chain is overly complex. There are farmers, exporters, importers, wholesalers, florists, and then there are order gatherers. Everyone marks up the product and takes a chunk. Everyone takes time, which creates waste and obfuscates where the flowers come from.
Transparency and providing people with a direct connection to the farmer were core to our brand, so we led with those values. And when customers received the flowers, they’d actually see the customs stamps from Ecuador, and they said, “Wow! This is for real!”- Fast Company article
The appeal of this model is transparency. These companies are offering flat pricing for their products including delivery and avoid upselling their customers. That simplifies the ordering process.
Also, Amazon (NASDAQ:AMZN) offers two-day shipping on a wide variety of flower arrangements. That could put added pressure to FLWS and push them to once again adapt their business model to changing consumer behaviors.
We believe shares in FLWS are overpriced. They are currently trading above their sector median and their 5-year historical averages.
In 2014, FTD Companies (which went bankrupt in 2019) purchased competitor ProFlowers for $430M. The deal is old but does give us a clue as to what multiples were paid:
The mean and median multiples for the selected companies were 1.0x and 0.8x, respectively, in the case of total enterprise value/revenue for the LTM ended March 31, 2014, 0.9x and 0.8x, respectively, in the case of total enterprise value/revenue for each of the calendar years 2014 and 2015, 10.8x and 10.2x, respectively, in the case of total enterprise value/adjusted EBITDA for the LTM ended March 31, 2014, 10.0x and 9.9x, respectively, in the case of total enterprise value/adjusted EBITDA for the calendar year 2014 and 8.2x and 8.7x, respectively, in the case of total enterprise value/adjusted EBITDA for the calendar year 2015. – Merger proxy (emphasis added)
In this case, FTD thought a fair multiple to pay for a business like ProFlowers (which delivered floral arrangements and gift baskets) was between 8 to 10 times EV/EBITDA.
Analysts are expecting the following EBITDA numbers for 2020 and 2021:
If we apply an EV/EBITDA multiple of 10x to 2021 EBITDA numbers, we get a per-share value for FLWS of $17. With price trading at $22 at the time of this writing, FLWS is trading above our estimate of intrinsic value.
We don’t have enough conviction to recommend shares in FLWS. The strong momentum behind their shares is also dangerous for investors to initiate a short position.
Even if COVID-19 doesn’t have an impact on their business, there are still uncertainties about how the industry is going to evolve. The farm-to-table business model is going to increase competition. Amazon is also a presence that cannot be ignored. The good news is that FLWS and its management team have a lot of experience in adapting to changing environments. Their experience plays in their favor.
However, with shares reaching 52-week highs, we believe risks have increased, as expectations need to remain high for shares to continue its upward trend.
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.