Description

• At Home’s (HOME) short-term survival is no longer in doubt, as the company’s results exceeded expectations for curbside pickup when stores were closed, and sales have surged since May 1  post reopening.

• Our estimates based on credit card data imply that HOME stores are most likely comping positively, which we do not believe the market is pricing in appropriately

• HOME is an internet resistant business model that cannot be undercut by Amazon (AMZN) or Wayfair (W) due to a low cost structure and extreme cost efficiency – the Costco of Home Decor

• Variant perception: HOME was actually taking share pre-Covid, despite posting same store sale declines due to temporary declines in the overall Home Décor category in 2019

• HOME should improve operations and results with experience and scale, and we believe we are on the precipice of witnessing that

• We believe that HOME shares will be up over 700% over the next five years with the potential for much of those gains to come over the next 12 months as the company becomes viewed as a winner from the pandemic and investors start to once again anticipate the future success of the company.

Business Background:

HOME is a home décor retailer. The company operates extremely large (105K average sq. ft) bare bones/ self-service stores.  For those unfamiliar with HOME, picture a Costco with home décor. The goods are mostly bulky items, and the items are not full furniture sets like bedroom sets or matching chairs and couches.  At Home’s value proposition to consumers is the best selection at extremely competitive prices.  HOME is able to keep prices low through a combination of low rents (just $6 per sq. ft on average) and extremely low labor costs (largely self-service, typically 3-5 employees work at the store at any one time) that allows consumers to come and buy in a self-service environment.  The selection cannot be beat.  For example, we counted seven rows of throw pillows in one store. HOME currently operates 212 stores in the U.S., and we believe the TAM in the U.S. and Canada is 700 stores.

HOME’s survival is no longer in doubt and it seems to be becoming a beneficiary of the Pandemic, with recent sales comping positively:

HOME’s stock price was down 80% from its 2018 peak prior to the pandemic beginning due to investor disappointment in 2019. HOME had limited internet operations prior to covid. They had just started to roll out the buy online, pickup in store (BOPIS) capability. They have rapidly rolled out BOPIS amidst the pandemic to more than half of their stores.  While HOME’s balance sheet can likely withstand a strong recession, it wasn’t designed to have its stores shuttered for months.  HOME orders several months in advance, and while inventory turns are not high, 20% of the company’s sales are seasonal. Some product would face steep markdowns upon reopening, and some new product would need to be ordered. HOME seemed ill prepared for the coming storm, once the pandemic hit, HOME was forced to close stores.  The programs from the Fed and U.S. government designed to help companies that could possibly help all seemed to be just barely out of reach for HOME.  The 12 stores that HOME owned, the proceeds of any sales could be claimed by the asset backed debt holders.  Worse yet, while the stores would be closed, HOME would still have to keep four employees per store to take delivery of orders coming in, and this is likely more than other retailers had to maintain. As a result, it was likely that HOME would have a liquidity crunch if all its vendors demanded payment on their receivables and would not give credit for new orders.  Additionally, if HOME were to survive the pandemic, it would likely face a recession selling a category (home décor) that traditionally has underperformed in previous recessions.  HOME’s predicament did not seem insurmountable, but it was clearly in a tough spot.  On March 18th, HOME’s stock price hit an all-time low of $1.20 per share.

How HOME responded to the pandemic was impressive.  Besides furloughing most of its store employees, the biggest move it made was that it started offering curbside pickup.  From the standpoint of a company that previously sold zero online, the results were exceptional; yet sales still fell about 80% YoY according to credit card data.  However, the 20% of sales more than made up for the store employee costs, and it also cleared some inventory and converted that to cash.  Just this little bit of sales was likely enough to significantly reduce near-term bankruptcy risk.  Additionally, we believe HOME was able to defer some rent as most retailers did. 

Sales trends when HOME began to reopen stores were a pleasant surprise.  Sales jumped according to credit card data. According to our credit card data, stores that were open are comping up at least single digits, and potentially in the double digits. We use a wide range because while the credit card data is correlated, we have seen a range between comping up 5% and 80%, so it is difficult to determine where HOME actually is comping given the wide range in the data. The increase in sales came despite some stores still being closed--so what happened?  It seems to us that consumer discretionary spending was severely curtailed in areas like travel and restaurants and a lot of that money flowed to home décor.  With consumers stuck in their houses, it’s no surprise that home décor would perform well.  Below is a rough look at consumer spending across various categories - the money has to go somewhere.

The recent surge in sales for HOME, combined with the curbside pickup sales, clearly removes any risk of bankruptcy and likely turns the company into a beneficiary of the current environment.  The pandemic has also removed a competitor for HOME, as Pier One, which had a lot of nearby locations, is now closing all stores.

The company also seems to be very confident in their fiscal strength, as HOME recently signed a new lease for the Rego Center in Queens, which is the most successful discount shopping center in the country.  We believe the Rego Center will be the company’s highest rent store, despite getting what appears to be a fairly substantial discount.

At Home’s model is internet resistant:

If you look at a HOME store it essentially looks like a shipping warehouse, but HOME saves on shipping those items because the customer comes to stores.  The items HOME sells are bulky items priced on average at about $15, which makes them inefficient to ship to customers - even for a company like Amazon with its own delivery network.

Wayfair is the obvious leader in online home décor.  Wayfair fulfills in two ways. First through its drop ship network (i.e., the goods are drop shipped directly from a manufacturer to the consumer) and second through its CastleGate fulfillment centers.  Drop shipping directly from the supplier is done for the vast majority of Wayfair’s slower moving SKUs.   

The major disadvantage to drop shipping from the supplier to the consumer vs At Home’s system is time and cost.  Since goods are sold from the supplier to the customer, they cannot be consolidated into a single parcel.  So in addition to the operating costs of the supplier’s warehouse and operations, the cost of shipping via UPS or FedEx is typically $8 per item.  The cost of delivering larger items which cannot be sent via UPS or FedEx is much higher.  Making matters worse, breakage and damage rates in the high single digit percentages and return rates in the mid-single digit percentages further worsen the economics.  At Home’s average item is ~$15, so clearly $8 of shipping plus another $1.50 of breakage and returns leaves far too little to cover the supplier’s own costs, let alone to cover Wayfair’s costs and margins.  (Of course Wayfair makes its model work by charging higher prices and focusing on higher ticket items where the shipping costs represent a smaller percentage of the total costs.) 

Wayfair’s CastleGate model is a more direct competitor to At Home.  With CastleGate, the supplier forward positions inventory in a Wayfair warehouse located near major cities.  At the warehouse, Wayfair opens the case, packs, picks individual items per customer orders them and (to the extent possible without creating breakage issues say by packing paperweights with china) repacks those orders into individual customer packages.  These packages are then loaded onto trucks, brought to cross docking facilities to be loaded on last mile delivery vehicles and finally delivered to the customer’s home.  In most markets, smaller parcels are delivered by UPS or Fedex.  Larger parcels are either delivered by third parties or delivered by Wayfair’s own to the home delivery service. 

Even with the help of robotics, storing items from suppliers, picking individual items as customers order them, repackaging them in groups, and loading them onto trucks is labor and space intensive.  While Wayfair’s costs of sourcing product and getting it to its CastleGate facilities are roughly the same as At Home’s costs of sourcing product and getting it to their stores, Wayfair’s CastleGate facilities are more expensive to operate per item than At Home .  The details behind this estimate, based on our conversations with several former Wayfair and Amazon employees, are shown in the table below.  

Furthermore, unlike At Home, Wayfair must pay for last mile delivery, which adds ~$5.00 per order to the cost or about 8% of a $65 order (much more if the item cannot be shipped via UPS/ FedEx and must be delivered), has higher damage rates of about 7% vs At Home’s shrink of about 1.5% and has mid-single digit returns which probably cost the company 3-4% of revenue.  Wayfair also does not have the benefit of stores, the physical presence of which drives traffic, meaning Wayfair has higher marketing costs.   

All told, Wayfair is a wonderful model for consumers who value selection and convenience, but for the low priced, fragile, bulky, heavy items that At Home traffics, Wayfair’s model is fundamentally more costly than At Home’s. This means that for consumers who care about price and still want a great selection, At Home is clearly the superior choice.  

Over time, Wayfair will gain further efficiencies by investing in things like robotics to lower its CastleGate facility operating costs. At Home will also gain efficiencies by using robotics to reduce in-store labor.  

Now for Amazon. Right now, Amazon is behind Wayfair in this category with roughly the same volume, but growing slower and a much worse consumer experience.  Amazon does not have a great selection because it hasn’t invested in building the relationships with suppliers.  It does not have great delivery because it has not invested in the capabilities to handle large and bulky items, to manage breakage, or to provide a great last mile experience.  It also is organized around delivering on prime promise and two-day delivery, which means that it doesn’t optimize its inventory for consolidation into a single box, but instead distributes the long tail of SKUs across their many DCs.  This means that for many lower dollar priced items, (e.g.) a $12 frame, Amazon is likely going to incur substantial expedited (air) freight costs to fulfill within two days from a DC in another city.  Amazon also doesn’t have great merchandizing in home decor because it is set up to handle search queries instead of browse queries (home décor shoppers shop by browsing which stimulates the creative mind).  That said, we think that Amazon is trying to make a push into this category and is investing in working to close these gaps.  Essentially, Amazon is trying to build another Wayfair.  If Amazon is successful enough to challenge Wayfair, this may lead to a pricing war between these two behemoths with an uncertain outcome that would be a negative for At Home as margins would likely be pressured. The medium/ longer term outcome, would be acceptable as At Home would still pick up incremental sales from the many other home décor retailers who would fail, given At Home is still the most efficient home décor retailer. Clearly, this is one of the largest risks to the investment, and one we do not see as likely, but are monitoring carefully.   

More on HOME’s Low Cost Model:

At Home runs a highly streamlined model for delivering home décor to consumers.  This model, allows it to operate at lower costs than either online retailers or big box retailer and to pass on lower prices to consumers while sustaining good margins (similar to Costco).

At Home buys product by the containerload from suppliers (often in Asia).  While it might not buy a full container of one item from a specific supplier, it will usually buy a full container at a time from a given supplier (that supplier might make multiple items).  In the circumstances when it cannot build a full container from a given supplier, it will usually consolidate inventory in Asia. 

The full containers are then shipped via sea to Los Angeles.  From Los Angeles the goods are shipped via rail to the company’s cross dock facility in Plano, Texas.  The cross-dock facility is fully automated and has no storage.  Items are packed in store level quantities by the manufacturer so that the cross-dock facility does not need to open any boxes or pick any items.  For example, a buyer might purchase vases in boxes of four.  Stores might then be sent some number of boxes, each containing four vases, depending on that stores volume in that sort of item.  

Stores typically receive 2-3 truckloads of goods per week.  Upon arrival at the store, the goods are unloaded from the truck into a back room which has only enough room for one truckload, then are immediately taken from the back room out onto the shelf.  Because the goods are ordered from suppliers who are dedicated to a category, the stores receive truck loads that have a meaningful quantity of goods for a specific category.  This grouping of items allows the stores to be efficient from a labor perspective by bringing large quantities of similar goods and putting them out all at one time.  

Other than markdowns, which are done twice per year, and inventory count, which is done once per year, the act of carrying the goods from the back of the store to the store shelves is the only reason that an At Home employee will touch the goods.  From the store shelves, consumers pick the goods, and bring them home. 

By contrast, a big box store operates a more labor-intensive fulfillment process.  For a big box store, the goods are cross docked to regional distribution centers. There, they are stocked and then later picked up and repacked on a truck for delivery to a store. In the store, they are often stocked in a back room, and then picked up again to be put on the store shelf.  This process creates a lot of additional touches and labor, including unpacking the truck in the regional DC, putting away the items in the regional DC, picking the items up in the regional DC, packing the truck in the regional DC, unpacking the items into the store’s back room, and finally picking the items in the store’s back room and bringing them to the front of the store.  In addition, store employees at big box stores must replenish shelves from the back room as items are sold vs as they are received.  This means that store employees put items out on display in smaller quantities, which adds labor cost and requires manufacturers to assemble items into smaller case packs, which adds packaging costs and bulk from a shipping perspective.  

Furthermore, big box store shoppers have higher expectations for the appearance of the store, whereas At Home shoppers are more tolerant of a more “shopped over” look.  This further reduces the labor cost of the store operations. (The source for this comparison to big box retailers is conversations with former employees of big box retailers comparing and contrasting the models.)

At Home’s highly streamlined process relative to other retailers allows it to run its stores with ~6% labor costs (before taxes, benefits and bonuses) while most other retailers run at twice that. This allows At Home to run at 20%+ store level adjusted EBITDA margins. 

As compared to online retailers, the At Home operating cost model is even more pronounced.  

HOME was actually gaining share pre-Covid despite posting negative comps:

At Home sells home décor.  In essence, this is all the various decorative items in a home except the major furniture items.  In the living room, it would be all the decorative items except the large sofa and TV stand table (end tables, area rugs, clocks, frames, mirrors, etc.).  

The Census classifies retailers like At Home under NAICS code 442 (furniture and home furnishings stores).  This classification captures a $114 billion dollar industry, which is broader than what At Home offers as it includes large furniture items (sofas, dining tables, beds etc.) as well as other home furnishings such as tile and hard flooring.  However, this category code is also narrower than At Home’s industry as it excludes the sales of items At Home sells made in the club, mass, department, hardware, and dollar/ variety store and online channels, which are categorized separately.  

Still, despite its imperfections, we think that NAICS 442 is a reasonable proxy for At Home’s industry and has the benefit of being frequently and consistently measured by the Census in the retail sales report.  Using this data from the Census, we can put At Home’s recent sales performance into the context of the industry.  

The graph below shows at Home’s comparable store sales vs the industry sales (SIC 442) since FY2015 (ended Jan 2015).  HOME was gaining share previous to the 2nd half of 2019.  That share gain is more impressive when cannibalization of stores from increased store count we believe the impact of this was approximately 1% per year, the growth in competitor store counts, which we believe was around 1.3% per year.

So what happened in the past two quarters?  We believe that the company’s weak comps were the result of an overly promotional Christmas environment and a Thanksgiving that fell later in the year.  The commentary on the home décor market were echoed by other retailers on their calls.  The differences between HOME’s sales and the NAICS data was likely the result of the differences in product categories. We believe furniture was much less affected by the late Thanksgiving and weak holiday sales.  Weakness was likely also exasperated by Bed Bath & Beyond getting extremely promotional as their business struggles.   

At Home has the opportunity to significantly improve margins:

HOME’s margins were under pressure in recent years from a combination of deleverage from sales, markdowns, adding a second distribution center, as well as increases in freight and tariffs, which added up to ~300 basis points of margin declines - the bulk of this should be recoverable.  At Home is an advantaged business winning in the marketplace due to the previous efficiencies we outlined. As At Home grows and develops, we think the business is likely to become  more efficient which should free up substantial economics to a) restore margins to FY2019 and prior levels b) offset further competitive pressures and c) improve the value proposition to consumers thereby driving more sales.  

We have identified a number of opportunities for margin leverage over the next five years vs FY2020:

1. Merchandise purchasing scale - 400-600bps:
   Based on conversations with merchants in the category as well as with At Home’s management, we think that there is a potential to reduce first cost by 10-15% if the company doubled its purchase volume of a given SKU.  However, everyone we spoke to was careful to stress that the savings vary by item, current volume and category.  Given that first cost is ~40% of retail cost, this savings translates into 400-600bps of margin opportunity.  In addition to this savings, there will be supply chain savings by purchasing at greater volumes, such as having to consolidate fewer containers, which are also meaningful.  

2. Corporate expense leverage - 250bps:

In FY 2019, the company spent $90 million on corporate costs representing 7.5% of sales.  This $90 million of cost has increased from $30 million of cost at the time of the IPO and thus far the company has had no leverage on this line.  However, in our discussions with management, they were adamant that from here there is substantial opportunity to leverage corporate costs as they have most of the capabilities (except certain online capabilities) that they need.  Management described 80% of the $90 million of costs as fixed and 20% as “semifixed.” 

3. Store fixed cost leverage due to same store sales growth – 325bps:

Management reports that the comparable store sales of their older stores are similar to the comparable store sales of their younger stores. As a result, their oldest stores have the most sales.  Similarly if you grouped stores by vintage year, you would see rising sales by year.  We confirmed the tendency of the stores to have larger volumes as they age with one district manager who oversaw 12 stores.  He reported that he had a diverse range of store locations, varying in size and socioeconomic levels, and the only variable that affected volume was number of years in business.  We think the tendency of the stores to grow with time means that stores get more profitable with time and is a result of the stores adding more regular and loyal customers 

We’ve confirmed this latter point by using credit card data in order to construct cohort curves for new At Home shoppers (as compared to other home furnishings retailers). 

The data shows a group of first time customers who spend $100 at At Home in quarter one and then spend ~$10 per quarter at At Home every quarter going forward, resulting in a layercake business as older cohorts don’t degrade particularly fast but newer cohorts add additional “layers” of customers. 
At Home’s cohort profile is very similar to that of Wayfair, and better than that of Pier 1, Pottery Barn, West Elm, and Williams Sonoma. While consumers who shop At Home tend to return, as shown by the cohort curves, At Home’s brand awareness in markets where it has stores is quite weak. 

Putting together the loyal customer cohort curves with the low awareness, we can arrive at a hypothesis that stores tend to have increasing sales as they age. Over time, they gather more loyal customers as customers discover the store.  Moreover, this trend would seem likely to continue given the low level of awareness of the stores.  

Owing to At Home’s low labor model, and the high incremental margins on home décor retailing, we estimate that while it takes ~40bps of sales growth in a store to match wage inflation, every 100bps of growth beyond that adds ~30bps to the company’s overall margins.  If the company can grow same store sales by 2.5% per annum compounded over the next 5 years, the company would have ~325bps of operating leverage. 

4. Leverage second distribution center (DC) - 200bps:
   As described above, the company is incurring a mix of startup costs and higher fixed costs related to the opening of its second distribution center in FY 2020. This is a 90-100bp headwind to margins this year.  As the company adds additional stores, the fixed operating costs of the second DC will fall as a percent of sales, therefore yielding ~90-100bps of savings. 
   In addition to these savings, we think the average distance from DC to store is around 1,000 miles in FY2020.  The second DC should reduce the average distance to a store by ~350 miles,.  If the company can reduce its average hauling distance from a store’s DC by 250 miles, the company will save ~110 bps as a percent of revenue in trucking costs. 
   Combining the benefit of lower hauling miles with better DC fixed cost absorption yields ~200bps of savings.    

5. Normalized Markdowns - 75bps:

The company has ~75bps of margin headwinds this year due to the impact of higher than planned markdowns.  Assuming a more normal year, without this issue, margins should be ~75bps better.

6. Competitive price response to tariffs – 75bps: 

The company anticipates a 25bp impact from tariffs this year and a 75bp impact fully loaded.  However, this impact will likely prove transient over time as the tariffs should ultimately lead to either price increases or supply chain adjustments.  

7. Direct sourcing – 50bps:
   The company has a program to source directly vs through using purchasing agents.  In FY 2019, the company sourced about 10% of its merchandise directly.  Over time, the company believes it can source 30% of its merchandise directly.  Items sourced directly have several hundred bps in higher margins than items sourced through agents.  Assuming a 20ppt increase in product sourced directly at a 250bp savings, direct sourcing ought to save ~50bps over the next few years.  

8. Buy online, pick up in store/ other online initiatives – difficult to determine, but helpful:

At Home has very ittle online presence, but we believe that is changing.  In FY2019, the company introduced the ability for consumers to find a store which carriers a particular item.  In FY2020, the company is testing buy online, pick up in store (BOPIS). We are optimistic for At Home’s ability to serve consumers in an omnichannel fashion, though we do not think it is necessary for its success. Because BOPIS avoids the cost of last mile delivery, BOPIS would allow cost conscious consumers to have some of the convenience of online shopping while still enjoying a price well below what an online retailer like Wayfair can offer, and thus may prove to be an important growth leg.  

Buy online ship from store will likely require a shipping charge yielding a price point closer to Wayfair’s.   However, to the extent this channel of distribution can exist on At Home’s existing infrastructure  and drive incremental sales by offering another choice to the consumer, it might also be an impactful boost to the business. 
In sum, while the opportunities to develop an omnichannel capability are unclear, it seems likely that there will be some positive benefit.

9. Improve inventory turns:
   In year-round categories, larger scale should allow the company to re-order by the containerload more frequently, while stocking less inventory depth on the store shelves, and thus reducing total inventory.  The company has a five-year goal of increasing its inventory turns from 2x to 3x. 

10. Improve payable terms:

The company’s days payable are up 11 days yoy and the company claims that this is a consequence of a deliberate effort to improve its terms of trade with its suppliers.  In order to help suppliers to accommodate them, At Home set up a facility with Wells Fargo, allowing suppliers to borrow against their At Home receivables.  Management believes that there is further opportunity to get better terms of trade over time.  

11. Misc other opportunities:
    Lastly, At Home is still a fairly new business.  Current management took over in FY2013 when the company had 51 stores.  In FY2015, the company rebranded itself “At Home” from Garden Ridge and reached 81 stores.  There is a great deal about the business that has not yet been optimized.  Management sees opportunity to:

1. Regionalize the assortment

2. Regionalize discounting

3. Improve the efficiency of ad spend (e.g. by getting to a scale that allows for national media) 

4. Distribute certain categories from a centralized DC.  

5. Continue to reinvent the merchandising of the categories.

6. Leverage the learnings from its Insider Perks program and Store Credit Card program with Synchrony.  

This simply is a young and improving business with comparatively low-hanging fruit for improvement.  

The opportunities which we can quantify add up to a 14.75% opportunity for margin improvement, with additional opportunity stemming from the more difficult to quantify opportunities.  

During FY2013-2019, At Home generated a roughly 10.5% operating margin.  Under the current accounting standards, that would be a 9.5% operating margin.  In FY2020, At Home is forecasting an operating margin of ~6.75%.  Deducting the full impact of the tariffs from this margin yields a “run rate” operating margin of ~6.25% in FY2020.  

In order to get back to a 9.5% operating income margin consistent with its past, At Home will need to allow ~325 basis points of its profit improvement potential to fall to the bottom line.  Assuming that everything goes according to plan, this will leave 1,150+ bps available to reinvest in a combination of price, quality, corporate capabilities, marketing, or for excess profits to fall to the bottom line.  While competition will continue to intensify as it does in all retail categories over time, this 11.5% reinvestment capacity is quite substantial and provides a lot of margin of safety to the overall thesis, as well as potential for meaningful upside.   

Valuation:

In FY2019, the company averaged ~165 stores and generated $7.1 million of revenue per stores.  If in FY2025 (ended Jan 2025) the company operates 330 stores and those stores generate $7.5 million per store, then the company as a whole will generate $2.475bn of sales.  

If the company can restore its margins to FY2019 levels of 9.5%, adjusted for accounting standard ASC 842, then it will generate ~$235 million of EBIT.  Assuming the company operates with 3x debt/ ebit, the company will have $705 of debt which at 6% will cost ~$42 million per year in interest, leaving $193 million of pretax profits or ~$155 million of net income.  We believe that HOME should be free cash flow positive over this time and the resulting buyback should make FY2025 EPS ~$2.70. At this point, HOME would still have room to double its store base.  We believe that a multiple of 15X and thus a price target of $40.50, up roughly 8 fold from today’s price is possible in 5 years.

The recent boost in sales could lead to EPS of over $1.00 share in run rate EPS this year.  If this occurs, much of the gains we expect for At Home shares could be front end loaded over the next 6-12 months.

Catalyst

Announcement of rebound in store sales

Improved operations leading to margin growth

A return to store growth