Description

National Vision is the leading discount eyewear retailer in the US

National Vision provides eye exams and sells glasses / contacts at 1,350 US stores across two brands (America’s Best and Eyeglass World). The company employs optometrists at each location to administer the exams, after which lenses are customized at four large-scale, in-house labs. EYE focuses on the value segment of the market: core offer is two pairs of glasses + an eye exam for $80, which we estimate is >50% cheaper than even other discount players. Given discount focus, 2/3 of EYE customers don’t have vision insurance (vs. 1/3 for competitors), though insured customer mix has steadily grown since IPO.

By retail sales EYE is the #2 player in the industry after EssilorLuxottica, which owns Lenscrafters and PearleVision and focuses on higher-income consumers.

Eyewear retail is an attractive, growing market with high recurring revenues

The US eyewear market has historically grown 3% / year and will continue to grow for a long time as the US population ages and increased screen time damages eyes. Our eyes deteriorate over time, so customers need to buy new glasses every 2 – 3 years regardless of economic conditions. This leads to a very predictable, recurring revenue business: EYE had positive YoY comps in every quarter from 2002 – 2019. EYE comps remained positive from 2007 – 2009 despite the Great Recession, as a pullback from low-income uninsured consumers was offset by higher-income insured consumers trading down from premium-priced chains.

National Vision has an advantaged position in a fragmented market

The US optical retail market is highly fragmented. >50% of the market is independent “mom & pops” owned by individual optometrists, and the top 5 players have just 30% share. National Vision has consistently taken share in this market by offering lower prices / superior value, which is difficult to replicate given following competitive advantages:

• Bulk purchasing: EYE’s scale gives it better pricing on lenses & frames, particularly on private label frames (>50% of sales)
• Low-cost real estate: retail footprint is generally in low-cost strip malls next to other discount retailers (TJ Maxx, Dollar Tree, etc)
• Centralized labs: EYE customizes lenses to fit frames at four large in-house processing labs that are cheaper than small in-store or large outsourced labs that competitors use
• Direct optometrist employment: discount competitors (e.g. Wal-Mart, Costco) typically grant concessions to optometrists that independently operate shops-in-shops
• But National Vision directly hires doctors and as a result controls their schedules. EYE optometrists see 3x more patients per hour (and are paid more) as a result
• Optometrists prefer the stability of direct employment over independent work, particularly new grads (who often have >$250k in debt)
• Regulations in some states make a direct employment model hard to operate, EYE has spent the last 25 years building this model

E-commerce penetration in the glasses category is low (just 10%) and slow-growing (~50 bps per year). There are significant barriers to e-commerce adoption including:

• Eye exams: most patients get an eye exam before buying glasses to ensure their prescription hasn't changed. The convenience advantage of online is limited since customer still needs to drive to the exam
• Fit: since patients wear their glasses every day they prioritize both alignment of lenses over their eyes and comfort of the frames on their faces. The correct fit is difficult to judge online

Track record supports continued comps / footprint growth

EYE management believes it can more than double "core" store footprint to >2,000 stores. This implies 6 stores per 1mm people across the US, a level that's already been reached in Florida (which is still growing store count >10% / year) and almost reached in Arizona / Utah.

National Vision's track record of high-ROIC reinvestment is strong and gives us conviction in continued growth:

• Company has consistently grown footprint 6% per year for 15 years, and <0.5% of stores close each year so failure rate is low
• Unit economics are excellent: mature store-level ROICs are >35%, company-wide ROICs are in mid-20%s and growth since 2015 has all been internally-financed
• Comps averaged 5% / year from 2002 – 2019, and were >5% in each of 2013 - 2019
• CEO has been in role since 2003 and oversaw footprint >3x growth

Through combo of footprint and comps EYE >doubled market share from 2012 - 2021, but company is still just 5% of the market. There is a long runway to grow through share gains, mainly from subscale, unsophisticated indies.

Remote optometry push will solve staffing shortages and make EYE an even better business

Optometrist retirements accelerated during the pandemic, creating a doctor shortage felt across the industry. EYE increased doctor pay to boost recruiting / retention, but it still has some "dim" (not enough doctors) and "dark" (no doctors at all) stores. This shortage hurts both margins and comps (due to exam capacity limitations).

In response EYE is rolling out "remote exam" capabilities, which will allow a doctor sitting at home to test in-store patients using video conferencing and in-store equipment. Private player My Eyelab (150 stores) successfully pivoted to this model (all its stores are remote), and Luxottica is testing remote as well.

The remote model will drive EYE comps and margin improvements from two perspectives:

• Remote flexibility is attractive to doctors, and increases recruiting / retention without boosting pay
• Ability to see patients at multiple stores reduces doctor downtime and increases patients seen per hour

Evidence so far is attractive: stores that EYE has equipped with Remote thus far have seen a "double-digit" comps uplift, which leads to significant EBITDA growth given >60% gross margins. We believe the remote model will be difficult for small chains / independents with limited scale and IT capabilities to copy, further enhancing EYE’s scale advantage.

Temporary headwinds depressed National Vision margins…

Core store margins are down 350 bps vs. 2019 levels, driven by multiple factors:

• Optometrist costs: after a wave of doctors retired during COVID, company is boosting doctor pay to improve recruiting / retention and solve capacity issues
• Remote investments: EYE is buying remote equipment and has teams going to every store for training / implementation
• Electronic Health Record implementation: EYE locations (surprisingly) still use largely paper-based records. A nationwide rollout of EHR systems will depress profitability in 2023
• Product cost inflation: lens / frame suppliers have increased prices, but EYE (as a value player) hasn't passed through all of cost increase
• Poor macro: inflation's impact on EYE's lower-income consumers depressed comps and deleveraged fixed costs, and trade-down offset typically takes a few quarters to kick in

…but company has a clear path to restoring pre-COVID profitability

National Vision has multiple levers to recover lost margins:

• Lapping Remote / EHR implementation: end of remote & EHR implementation costs will drive 100 bps of margin expansion
• Price increases: In March 2023 CEO said "we haven't exhausted the pricing lever at all, and we think that there is more we have there if we need it"
• Leveraging corporate overhead: corporate SG&A as a % of sales is up 100 bps vs. 2019 as company invests in growth initiatives like Remote
• Remote productivity benefit: 2022 remote stores saw a "double-digit" comp lift after equipping remote, and EYE is rolling out a similar number of remote stores in 2023
• Given double-digit comp lift and >60% incremental margins, we believe increasing remote penetration by just 20% will add nearly 100 bps to margins

Company guided to "MSD" adjusted EBIT margins in 2025 vs. 2.7% in 2023 guidance and 6.5 - 7.0% pre-COVID. But management is clear that margins will continue to expand beyond that, and they plan to reach pre-COVID margin levels after 2025. Further, new EYE stores take 5 years to mature, and there is significant latent EBITDA growth in model given >25% of stores were built in last 5 years. At IPO the company estimated that immature store maturation could contribute $50mm in incremental EBITDA, and it has a similar number of immature stores today. The store maturation impact alone is significant relative to $153mm in 2023 consensus EBITDA.

Inflation + tough 2023 comp crushed the stock…

As mentioned above margin performance was poor in 2022, and company guided for further deterioration in 2023. On top of that, comps were down 8% in 2022, a shock for what was historically a stable company. These factors created a narrative that doctor wage inflation has "structurally impaired" EYE's model, and will lead to lower growth / margins going forward. But we believe the margin hit is temporary and the shift to remote care increases EYE's scale advantage. Similarly, we believe the poor comp performance is temporary. The negative 8% comp in 2022 was in context of a massive, stimulus-boosted 23% comp in 2021: 2022 SSS were actually a 2.5% CAGR vs. 2019 (despite eye exam capacity constraints).

EYE stock dropped 40% after Q4 '22 earnings when company guided to another YoY margin decline and just a 0 - 3% comp in 2023. But it’s worth noting 1) execs all got 2023 RSUs struck two days after Q4 earnings 2) this was new CFO's first quarter, so there was significant incentive to guide conservatively.

…and negative Walmart news created another leg down

~10% of EBITDA today is from a long-running partnership where EYE operates “shop-in-shops” for Walmart at 230 Walmart locations. This partnership began in the 1990s and was National Vision’s original business before the America’s Best brand was acquired in 2005. National Vision has operated these stores under three-year contracts, the most recent of which renewed in July 2020.

On July 26, 2023, National Vision announced Walmart was ending this partnership – with contract officially ending in February 2024. This surprised the market, which was bullish on a contract renewal after WMT granted EYE five additional stores in the 2020 renewal. Despite fact that WMT deal is just 10% of EBITDA, EYE Enterprise Value was down nearly 20% on the news.

While the Walmart contract loss was a surprise, we believe the actual EBITDA loss may be less than the 10% management disclosed. EYE has prepared for loss of the Walmart deal for years by building America’s Best / Eyeglass World stores near their Walmart shop-in-shops. Today we estimate that 50% of shop-in-shops have a (now competing) EYE store within 5 miles, and 70% have an EYE store within 10 miles. Further, we understand that the Walmart – National Vision contract allowed National Vision to keep access to customer contact info – post-deal termination we believe EYE will aggressively market to these customers to convert them over to its freestanding stores. While it’s difficult to size, we believe some proportion of the 10% EBITDA loss will be offset by EYE “recapturing” these consumers at their own stores (with no capex and an >60% incremental margin).

A PE (or possibly strategic) buyout seems plausible at this price

Optical retail is a popular investment for PE funds, EYE itself was owned by Berkshire Partners and then KKR from 2005 – 2017 (KKR deal in 2014 was at 12x EBITDA). There have been multiple recent PE buyouts of large retail chains at 13 – 17x EBITDA – most notably Goldman’s $2.7bn acquisition of MyEyeDr in 2019 (17x EBITDA). There is also a history of strategic M&A in optical retail, mainly from EssilorLuxottica but also from VSP, which acquired Visionworks in 2019.

National Vision’s board chairman is a Berkshire Partners MD who was involved with the 2005 acquisition, and CEO has been in place since 2003 – it seems likely EYE would be open to a buyout. The Board Chairman recently bought stock that increased his stake 30% (his 3rd-ever insider buy), and CEO recently made a small buy as well – we believe their incentives line up well with shareholders.

Risk / reward skew is highly attractive after negative Walmart news

Our base case assumes store count and comp growth through 2025 plus management’s “mid-single digit” EBIT margin guidance (100 bps below 2019). At discount retail peers’ current 13.0x EBITDA multiple that implies >50% upside.

Downside is limited at <20% even in a punitive bear case assuming all of:

• Multiple compression to 10.0x EBITDA
• Just 150 bps of margin recovery (vs. 300 bps in base case)
• Comp performance 200 bps below LT average

Management has noted that the “MSD” 2025 EBIT margin guidance is just a start… margins were 6 – 8% pre-COVID and company plans to get back there. Combining that with a 15.0x EBITDA multiple (in-line with M&A comps and pre-COVID multiple) implies >80% upside.

Downside Risks:

Deteriorating customer satisfaction and high churn

Critics often describe EYE’s “2 pairs + an eye exam for $80” offer as a misleading “bait-and-switch” given just 20% of customers take the offer and the rest buy add-ons that bring total price closer to (but still below) discount peers. America’s Best locations have poor Yelp reviews, with many reviewers criticizing the busy stores and misleading prices.

However, these complaints have been around for a very long time – some older stores have “bait and switch” Yelp reviews from the early 2010s. Yet over this period EYE has doubled its store count, comped at 5% per year and doubled market share. While there are complaints consumers clearly find the concept attractive relative to peers.

Continued margin headwinds from optometrist shortage

Management blamed the optometrist shortages for both lower margins (higher doctor compensation) and lower comps (due to exam capacity constraints) in 2023. The company is solving these issues through its remote exam initiative, but it’s possible that rising pay at competitors have made EYE a structurally less attractive place to work. EYE optometrists see more patients per hour than other chains given discount focus, so maintaining a pay premium vs. peers is key to recruitment / retention. Maintaining this pay premium may be a drag on margins over time.

Accelerating Luxottica competition in the US discount space

Historically Luxottica’s retail presence was all premium through high-end retailers like Lenscrafters. But in mid-2021 Luxottica acquired GrandVision, a leading discount player based in Europe. Near-term risk is minimal (GrandVision’s US footprint is just 10% the size of EYE) but it’s something to watch longer-term given Luxottica’s vertical integration into frames, lenses and vision insurance.

DISCLAIMER

As of the publication date of this report, the author has long positions in EYE and stands to realize gains in the event the stock increases. Following publication of the report, the author may transact in securities of EYE. All content in this report represents the opinions of the author who has obtained all information within this report from sources they believe to be accurate and reliable. However, such information is presented “as is,” without warranty of any kind – whether express or implied. 

Catalyst

Margin and comps recovery in 2H 2023 - 2025 as remote investments / cost pressures ease and macro recovers