Description

Business overview, TAM, Competitive Landscape

National Vision (“EYE”) is one of the largest optical retailers in the U.S., with 1,354 retail stores across five brands and 16 consumer websites as of December 31, 2022. The relevant / growth brands are America’s Best Contacts & Eyeglasses (905 stores today -> 1,300 store opportunity) and Eyeglass World (136 stores today -> 850 store opportunity). EYE positions itself as the lowest price provider, with its offer for 2 pair of eyeglasses + eye exam for $79.99 (recently increased from $69.99 after ~15 years). EYE is able to operate as the lowest cost provider given the higher productivity of its optometrists (on average doing 3 eye exams per hour, vs industry average at 1), as EYE leverages technicians to do a lot of the upfront data collection and generic work. 

Attractive characteristics to EYE’s industry / business model:

• Large, defensive, and growing industry: $44bn US optical care market, steady growing ~4% (from 2001-2019), given aging population and increased eye strain from computer/tablet/mobile screens.

• Fragmented market, with 60% comprised of independents.

Note: Luxottica Retail comprised of ~1k LensCrafters stores in North America

• Non-discretionary, medical necessity = stable SSS growth -> eyeglasses / contacts can be deferred slightly, but only for so long (similar to tires).
  • Evidence: EYE has had 72 consecutive quarters of positive same store sales (from 2002 to 2019), up until the Pandemic, averaging 5% SSS (almost entirely traffic driven), with 2014-2019 tracking above that.
  • Consumers typically purchase a new pair of glasses every 2-2.5 years.

• Amazon/e-com insulated given eye exams cannot be done online.       
  • 80% of eyeglass/contacts sales are tied to an eye exam -> optometrist availability is key to the model.
  • Online penetration is low in eye-care industry. For EYE omni-channel and e-commerce platforms, which include “buy-in-store and ship-to home” transactions, represented 11.2% and 10.5% of 2022 and 2021 fiscal year net revenue, respectively.
•  Competitively advantaged as low-price provider enabled by operational efficiency and investment in equipment -> results in a recession resilient model.
  • 2008 and 2009 SSS at ~+4%.
  • Note: Lower price value proposition results in higher skew to lower income consumer. EYE customers are 2/3 non-insured vs 1/3 insured, which is the inverse for the overall industry.

• Unit growth opportunity: open 80 new stores per year = ~6% unit growth annually -> scarcity of retail growth concepts results in high multiple (e.g., OLLI, FIVE, BURL).

Thesis:

• EYE stock cut in half on Q4 print, due to weak guide: guided 2023 SSS at 0-3% and EPS 50% below Street expectations (2.7% operating margins vs Street at 5.4%). Importantly, there has been no structural impairment to the business model (business with 72 consecutive quarters of positive SSS pre-Pandemic, no change in competitive dynamics/intensity, no structural change in consumer demand / habits). So why was guide so bad?
  • (1) Inflation has disproportionately impacted lower income consumer. As we know from off-pricers, all of them missed / cut guides through 2022. Similarly, EYE is disproportionately exposed to lower-income consumers given 2/3 of its customer base pay out-of-pocket (vs overall industry at 1/3), given its value offering, well below the price point of any competitor. This is a temporary impact given eyecare can only be deferred for so long. In fact, you could make the case there could be a wave of consumers that have deferred eyecare purchases last year, that need to come to market this year. Additionally, you should start to see consumers trade-down into EYE as middle-income consumers look to stretch their wallets.
  • (2) Optometrist labor shortages have adversely impacted EYE. It is well documented that the Pandemic has caused material labor shortages, particularly within the healthcare industry. This has been caused by early retirements, increased burnout rate, wage inflation incentivizing job switching, pushback on working weekends / extended hours = “The Great Resignation”. Given EYE’s optometrists are >3x more productive than the overall industry, they are pumping out eye exams like machines, with little/no flexibility in their schedules (e.g., forced to work Saturdays). Reddit forums confirm: “They will pay you well but will work you like a dog.” Therefore, given the demanding requirements for an EYE optometrist (~3 exams/hr), inflexibility in the work schedule, increased female mix of optometrist that value flexibility and EYE’s scale (employs ~5% of all U.S. optometrists), it is logical that optometrist shortages disproportionately hurt EYE.
    • Optometrist labor constraints hurt revenue growth, given 80% of EYE’s eyeglass/contact sales are tied to an eye exam.
    • Optometrist labor constraints hurt margins given wage inflation and deleverage on negative comps (high fixed-cost model).
    • According to The 2021 Optometry Healthcare Business Insights Report, nearly 60% of optometry offices do not have enough staff to operate to their full potential.
    • In 2014, 40% of Optometrists were female (per Eye Care Workforce Study) vs today that stands at 74% (per Zippia) -> females place higher value on work flexibility then men.
    • EYE employs ~5% of all U.S. optometrists.
  • Top line-pressure from core lower-income consumer challenged, and revenue/cost pressures from optometrist shortages / pushback on schedules, have caused margins to contract temporarily, not structurally.
    • Eye glass / contact lens purchases can only be deferred so much.
    • Middle-income trade down to come (note: EYE mgmt. says they were already seeing some trade down in 2022, but from off-pricers commentary, trade down has not occurred in any meaningful way, YET).
    • Employment market should loosen from here, shifting bargaining away from employee and back towards employer.
    • EYE addressing Optometrist shortage via (1) more flexible work schedule options (e.g., can take some weekends off, can take 2 consecutive days off, etc), (2) remote optometrist roll out (rolled out to 300 in 2022 and guiding to 200 incremental in 2023).
      • Remote optometrists could be a game changer for EYE.
        • (+) Increases optometrists productivity as empty appointment slots are reduced/eliminated. Instead of a doctor limited to people physically walking into a store, a remote optometrist can jump from store-to-store, depending on where demand is -> should help remedy optometrist capacity constraint.
        • (+) Increases optometrist recruitment and retention, as WFH can be attractive to a segment of optometrists, particularly women. 74% of optometrists are female.
        • (+) Increases store growth opportunity as it opens the possibility to open stores in less populated towns, where an optometrist may be hard to procure.
        • EYE taking some pricing, to offset inflation pressures (historically SSS almost entirely traffic driven).
  • Perhaps the biggest driver of the stock reaction, was the botched communication from management, in the face of a buy-and-hold investor base, under the impression that this is a rock-solid defensive business. EYE had first mentioned issues with eye exam capacity (i.e., optometrist labor availability) in late 2021, but by Q2’22 noted that it was feeling “incrementally better” about exam capacity, given initiatives around retention and hiring. In Q3’23, exam capacity was still out of sync with demand, but expected to get better in 2023, while retention levels were starting to improve. Thus, EYE caught many investors off guard in Q4’23, when management included prolonged capacity constraints requiring investment in ongoing optometrist recruiting and retention efforts and continued remote optometrist rollout, as drivers for a weak guide. Guided full year 2023 SSS at 0-3% (below historical algo, and on an easy 2022 SSS compare of -8%), with operating margins at 2.7% (Street at 5.4%, and 2017 and 2018 at 6.8% and 6.6% respectively). This caused many investors to doubt the credibility of management and/or question whether management has a good grasp on their business.
    • Q3’23 earnings call: “In terms of constraints to our exam capacity, we're making sequential progress through improved retention, strong hiring and remote medicine. While our exam capacity remains out of sync with our needs in certain markets, which, of course, affects patient traffic, we expect exam capacity to gradually improve into 2023 and throughout next year.”
    • Q4’23 earnings call: “Given the current uncertainty around the consumer and the macro environment for this year, our outlook reflects a wider degree of potential results… The low end assumes prolonged and increased pressure on our budget-conscious consumer and less success in addressing exam capacity constraints… Aggressive actions are being taken to address the new reality of the optometry labor market, with more scheduling options, variable compensation program updates and continued investment in remote medicine initiative.”

• After 2023 earnings expectations were reset (low bar), Street has incorrectly extrapolated depressed margins into perpetuity. While operating margins were ~6.7% pre-Pandemic, Street is modeling 3.4% and 4.6% operating margins in 2024 and 2025.

• Valuation: On normalized earnings power (margin mean reverts to 2018-2019 level) = $1.50 Adj. EPS on 30x PE (pre-Pandemic NTM PE averaged 43x) = $45 stock (was $40 stock prior to Q4 earnings print / guide down) = 100% upside over 12-24 months. Said differently, EYE is trading at 15x normalized EPS vs historical multiple at 43x
  • This does not include potential margin uplift from remote optometrist roll-out, or revenue upside from consumer trade-down.
  • Defensive, recession-resilient business likely to get a bid as start to beat and raise (off sand-bagged guide).

Catalyst

• Earnings beats
• Remote optometry rollout benefits
• Trade down benefit accelerates
• Lower income consumer stronger after lapping tax refunds and SNAP headwinds