Description

1-800-FLOWERS.COM FLWS

Note: FLWS uses a June-end fiscal calendar (i.e., FY22 ended 6/30/22, FY23 ends 6/30/23)

Description

The timeliness of this one is obvious enough that I want to get to the point punchily – it is particularly top-of-mind since we had the opportunity to meet with management at a conference just yesterday. And then to quell those who customarily throw stones at brevity, you can have your wordiness in the detail to follow. We love these ones where we have reasons to get paid over short, medium, and long-term, so the write up will start with the immediate catalyst, then the temporal headwinds that are now reversing to multi-quarter tailwinds, and end with the substantially improved structural position the business in part finds itself in fortunately and in part has put itself in smartly.

But just to hammer home the why-now: it seems, based on the various brokers hitting me with constant short sell interest in FLWS over the past couple weeks, that everybody and their mother wants to bet against FLWS for the wrong reasons right now. So much so that after crushing earnings just before Valentine’s Day, the stock not only retraced its 35% move higher but has now fallen below the pre-positive inflection stock price. Most of this, we more than strongly suspect, is simply due to a couple alternative data sources pointing to seasonally-significant Valentine’s Day looking weak. Not only are these assessments ill-founded (the data sources failing to account for a 52 to 53 week shift and experiencing tagging issues at the Gourmet Foods segment) in terms of their magnitude, but they’re pointing precisely in the opposite direction of the business fundamentals — which suggests to us that all-else-equal, over the course of the remainder of the quarter and especially as it gets reported, a bunch of wrong-way, largely programmatic and quant-driven shorts are absolutely going to get their faces ripped off.

To explain: Having now done the work to understand why the often trusty but even more often over-trusted credit card panels are wrong in their projections, we looked at historically more directionally consistent and higher correlation web scraping and order receipt panels, which paint a very positive picture for the company’s QTD transactions and AOVs. Manual and automated promotional tracking further suggests less discounting across core divisions (we’ll come back to this), a meaningful gross margin driver. Notwithstanding the mid-90s correlation and spot-on historical directional consistency of these data tools, we’d not fully trust them if it wasn’t for the primary research work supporting them. The former SVP of the floral side of the business conducted supplier and competitor channel checks for us over the time period, as he has each quarter for us over the last several years; as did a former senior manager from the Harry & David (Gourmet Foods) side of the business, among others. While qualitative detective work is by nature imprecise, the feedback has been particularly positive, as is the credibility and signal of these research advisors.

All the better when the bar is especially low. Stock price action and some sell-side calls re: sentiment suggest to us that buyside investors are positioned for the company’s revenue this quarter to decline by ~15%, versus published consensus of about a 10% decline. Suffice it to say that all signs from our work point to an outcome that is far better, the flow through to the bottom line from which (as we’ll get to in a minute) may lead to an explosive stock price reaction. It’s not often you get the first 50% for free, but that’s very reasonably the case here.

And as what follows will outline, there is probably a heck of a lot behind the first move higher. In the sequential quarters we’ll see normalization of capex and gross margin headwinds snap-shifting into meaningful tailwinds = step function upside in FCF and EBITDA. As margins revert toward pre-covid levels (and quite possibly higher in time) on roughly 2x the customer file and revenue base, we see EBITDA rebasing to $170M, more than twice consensus estimates, on even a modest 2% revenue growth estimate. Capitalized at their long-term 8.5x multiple, implies $24 / share or +130% upside (implies 12.2x FCF / share). In an upside case, where they return to the low-end of MGMT’s long-term growth range of 10-12%, and margins still below pre-Covid levels, they make $191M of EBITDA and shares worth $27 / share (+160% upside). All this is while being punitive to the multiple we’re assigning a leading market share ecommerce business in a structurally better industry backdrop (assign just 11x EBITDA for instance, a discount to its peer group, and you’re comfortably at $35, or more than a triple in stock price). Oh and one more thing: our recent diligence suggests there are private equity and strategic buyers at massively higher prices at the drop of a hat, if ever ownership/management would be willing to sell.

Business Description / Background

1-800-Flowers.com is a provider of gifts designed to help customers express, connect, and celebrate. The company's e-commerce business platform features all brands, including 1-800-Flowers.com, 1-800-Baskets.com, Cheryl's Cookies, Harry & David, PersonalizationMall.com, Shari's Berries, FruitBouquets.com, Moose Munch, The Popcorn Factory, Wolferman's Bakery, Stock Yards, and Simply Chocolate. The company has three reportable segments: Consumer Floral, BloomNet Wire Service and Gourmet Food & Gift Baskets.

Near Term

Demand trends are significantly better than buyside expectations, which runs counter to many alternative data sources. If you were to take most credit card panel projections right now, they would estimate QTD FQ3 (ending March 31^st) revenue down a least -10-15% year-over-year vs. street expectations of -9% (and we believe buyside closer to -15%). However, this fails to account for an easier compare in the remainder of the quarter and a calendar shift as we lapped the extra week (53^rd week) in FY22. (See chart below for weekly evolution of the QTD impact).

As you can see, simply looking at number from the data provider would lead one to believe there was a large deceleration into the Valentine’s Day period whereas correcting for this lap suggest the opposite. Furthermore, it should also be noted that the current weakness in the business is coming from the less seasonally significant Gourmet Foods & Gift Baskets segment which will experience a drastic easing in YoY comparisons through the rest of the quarter. Thus, if the 2-year stack holds, using solely the NRF calendar-adjusted credit card data, that would imply a better than consensus e-commerce revenue growth in the 3^rd quarter as illustrated below.

However, beyond the year-ago comparisons easing, we also believe the credit card data are simply underestimating the true performance of the current business. We also track website data on all of FLWS’s brands, which is of similar, if not higher, correlation to e-commerce sales for the company compared to the credit card data. Since being finalized in early March, we noted a significant acceleration in web traffic, unique visitor, and duration of visit metrics into the important month of February (Valentine’s Day). We should further emphasize that this was across both gourmet food and floral websites and the magnitude of change was higher than the credit card panels.

Lastly, in addition to our analysis of the quantitative data sources, we employed numerous industry formers, competitors, and suppliers to conduct primary research. We’ve worked with several of these contacts for years and they span both the floral and the gourmet food sides of the business. In short, their feedback while imprecise numerically has been particularly positive for both Valentine’s Day and the quarter vs. both guidance and buyside expectations. We’ve put some of the key highlights below and would also note that these same contacts were relatively conservative for the FQ2 (holiday season) period, a period during which FLWS strongly outperformed consensus expectations.

Selection of quotes from our primary work:

Former FLWS SVP, currently working in industry for a competitor:

• “The basic gist is that I think they had a good Valentine’s Day vs. plan if I had to estimate, and a direct quote I heard from suppliers was that it was a ‘record’ in reference to the floral side. I would guess that means the holiday period was at least up YoY on a dollar basis, I would guess 10% if I had to put a number on it. Remember too that one third of the Floral revenue for the quarter comes in the 3 days leading up to Valentine’s Day and that Floral is over half the revenue of the quarter, so it’s roughly 20% of the quarter’s sales.”
• “I didn’t get the sense they had to discount heavily either or give it away. FTD seemed more promotional while FLWS was holding the line so that’s a good indicator for the quarter, to get sales without promoting a ton.”
• “Historically when I was at the company, internal plan was usually around 10pp higher than public guidance. I would think their plan is to have revenue flat to LY right now and that they are hitting that so far with V Day. If I had to guess, they at worst missed that internal plan by MSD% from weaker everyday gifting so they would finish around -MSD% to LY.”
• Note: Advisor predicted -MSD% (but a miss to internal plan) for the December-end 2FQ23, which ultimately finished with revenue -4.8%.

Former operations executive on food side, maintains competitor and supplier contacts across the space both in the floral and food segments:

• “Based on competitor and supplier commentary, I believe that both Harry & David/1-800-Flowers had a very strong Valentine’s Day.”
• “Actually, Shari’s Berries boosted sales with big growth YoY is what vendors observed.”
• “The good news is there will likely be little inventory left over to sell through and there were no major delivery issues that I heard about publicly.”
• Note: Advisor has generally been conservative estimating 2FQ23 -HSD% and a miss to internal plan (vs. -4.8% actual)

Former FLWS executive covering B2B accounts:

• “I maintain vendor relationships since leaving the company and at least on the gourmet food and gift baskets side of the business, I would estimate they are trending slightly up YoY based on the commentary from vendors.”

In tandem, the easier compares in the credit card data, the website data inflection, and our positive primary research lead us to project FY23 revenue of -3.8% YoY vs. consensus of -6.4%. We should note that we are taking a conservative approach and assuming continued weakness in everyday gifting for the remainder of the year.

Beyond the revenue side, we also believe there are significant near-term headwinds alleviating on the margin side that also lead to significant upside vs. street numbers and guidance.

Broadly speaking, management specifically called out 3 major headwinds to gross margin this last fiscal year that led gross margins to sink to 37%, well below their historical margins which centered tightly around 42%. These included:

• 250 bp of freight (in-bound, outbound, and labor) ($55M)
• 100 bp of commodity inflation ($22M)
• 75 bp of inventory write-offs ($17M)

Without these impacts, gross margins would have been ~41.5% in FY22. Because FLWS’s fiscal year ends on June 30^th, they carried these mostly in the back half of FY22 and into the first half of FY23, with FQ2 (ended December 31^st) recovering substantially faster than management and the street anticipated (GM of 41% vs. street of 36%). For the next 2 quarters, we believe that all 3 of the major headwinds will either substantially subside or in some cases become tailwinds to GM.

From most to least impactful, ocean freight has now fallen below 2019 levels with container rates 30% below 2019 at $1,250 and vs. highs of $15,000-18,000 in mid-2021 and into 2022. They will still have to work through some higher priced inventory going forward but given they already decreased inventories 40% QoQ in FQ2, the bulk is now behind them. Under conservative assumptions, we estimate a 100 bp tailwind from freight in the 2H of this year. In conversation with management, the CFO explicitly confirmed to us that barring some major demand change, freight will be a “tailwind for sure” in the back half of this fiscal year. In addition, agricultural commodities are normalizing. While management stopped disclosing this impact beginning in FY23, we believe that this headwind has started to abate given prices in wheat, fruit and wholesale flowers. Prices in these commodities could revert back to pre-Covid levels, but we continue to model it as a headwind for the rest of this year. Finally, their inventory position is much healthier now and the percentage of perishable has been drastically cut following the FQ2 holiday season. Management has also expressed to us that they expect inventory write-offs are now behind them.

Lastly, the e-commerce floral industry largely consists of 3 major players: FLWS, FTD and Teleflora. We scraped emails and the websites to do our promotional analysis and found that so far in FQ3, FLWS had netted 3 less promotional days vs. last year while FTD netted 9 more promotional days. When we ran our analysis by FLWS management, they confirmed that the promotional environment in this recent time period has been subdued. Importantly, it appears both FLWS and FTD were less promotional during the crucial Valentine’s Day period, a fact we were able to confirm in discussions with FTD’s current private equity owners. Clearly, this is also a significant benefit to margin.

Putting it all together, this analysis leads us to model slight gross margin improvement vs. 2019 (i.e., less bad) in the back half of this fiscal year vs. street expectations for worsening margin deterioration. Thus, coupled with our above-consensus revenue, we estimate 38.2% in GM for FY23 vs. street of 37.5% and at least $100M in EBITDA vs. street consensus of $81M.

Our read from running our work by management in recent conversations suggests to us that we are right in suspecting that everyday gifting is now lapping easier comparisons as they get past the Omicron period LY, and that industry promotions were shallower this Valentine’s Day than in the past.

Medium Term

Post-Covid, FLWS is a bigger business with a larger customer file and a weaker competitive set. Our work suggests they can realistically recapture their historical GMs, which at higher scale will translate in our estimation to LDD% EBITDA margins, making this a structurally more profitable and more valuable business. Relative to an EV that is flat to down vs. pre-Covid we think this is attractive. This is in tandem with continued smart acquisitions such as Shari’s Berries for $20M (a former FTD executive we spoke with expressed he was impressed with what FLWS has done with it), Pmall for $250M in early 2020, Vital Choice for $20M in late 2021, and most recently ThingsRemembered for $5m.

During the pandemic, people sent flowers and gift baskets in lieu of attendance of events and they were no doubt a Covid beneficiary as the company stated they doubled their existing customers vs. 2019. The major concern now is that revenues will substantially revert as all of their one-time Covid customers churn off as we return to more in-person celebrations. Existing customers compose approximately 70% of sales. However, we believe that not only is FLWS maintaining a good chunk of these customers, but that they are also monetizing them better.

The company does not provide many customer metrics in their filings or calls but by piecing together the tidbits they do provide in addition to our own calls with management, we have been able to construct several figures that give us confidence in their ability to maintain their file and sales. Firstly, in FY22 , they were able to grow existing customers again by 5% to over 7.4M despite the inflationary environment and getting past initial reopening. Furthermore, they also have started to disclose metrics on their Passport loyalty program for the first time that gives us confidence that this is not just throwaway speech for the prepared remarks. Specifically, Passport members surpassed 1 million in FY21 and grew again 40% to 1.4 million by the end of FY22 and now represent 20% of customers vs. 15% in the prior year. This suggests to us that if anything, their customer file is not only still growing, but also becoming more passionate about the family of brands (Passport members purchase 2-3x the normal amount vs non-members). This is reflected in the increase in AOV every quarter including the last 2.

In addition to the company-provided information, we also conducted our own cohort analysis of their customers using the customer data provided by our credit card data provider. Amalgamating all the FLWS brands, we clearly see that in both CY 2021 and 2022 a shockingly similar percentage of the new customers from February and March of 2020 returned to shop again at FLWS for the holiday periods. This gives us further confidence that a solid number of these new additions are not one-time customers and they will have a solid revenue base to work with in the medium term.

On the cost side, they are now suffering a Covid hangover in the form of elevated labor expenses and commodity costs which are still flowing through the P&L due to their heavy investment in inventory during the height of the pandemic and the company’s FIFO accounting treatment. While the consumer floral business has managed to maintain closer to historical margins, the brunt of the cost pressures has been felt on the Gourmet Food & Gift Baskets segment. Our work points to this being primarily due to continuing to work through slow-turning elevated cost goods and higher labor costs as opposed to any change in competitive intensity. This margin pressure and inventory buildup put immense pressure on FCF as the company simultaneously spent $50-$60M on CAPEX the last 2 years (vs. normalized levels of $30-$35M) as they invested in automation in their distribution facilities.  This led to FY22 FCF of -$60M after generating at least $25M in each of the past 7 years.

As stated previously, almost all of the relevant drags are in the process of normalizing, with labor being the one component likely structurally higher vs. pre-Covid. Because FLWS’s current fiscal year ends in June, we believe that they will experience the full benefit of these changes mostly in FY24, particularly in FQ2 of that year. Specifically, they’ll get a full year of normalized freight rates 30% below 2019 level (which are still declining but we do not assume will decline further) and stabilization of commodities. Our primary research contacts in both the floral and food sides of the business have told us that wholesale floral, wheat and fruit prices have stopped rising but have not yet started to revert but they expect this to start to decline mostly in FY24. Lastly, they will no longer have to write off inventory. The net impact of these components is outlined in the chart below.

Freight Rates

Gross Margin

Long Term

Our medium-term base case assumes minimal revenue growth and only a return to close to pre-Covid margins. Longer-term, there is ample opportunity on the revenue side for FLWS to increase monetization of existing customers by converting them into multi-brand spenders in their loyalty program in addition to taking market share as they consolidate the market.  Furthermore, our medium-term profit numbers include minimal benefit from the recently completed automation, which could lead to margin expansion beyond pre-pandemic levels.

We’ve put some of the key points on the customer side as food for thought that could lead to a substantially higher revenue per customer scenario in the longer-term:

• The Passport loyalty program hit over 1M members (and 14% of total existing customers) in FY21 and over 1.4M (20% of total existing customers) in FY22. FLWS could expand the penetration of Passport members, which becomes an even more attractive offering considering all of the acquisitions they’ve made.
• Passport members spend 2x to 3x the amount annually than non-members and are less sensitive to pricing
• Multi-brand customers still present just under 10% of the total customer base, giving plenty of opportunity to ramp up growth particularly now that all the brands are consolidated on the one website.
• FLWS has continued to smartly acquire other brands and their loyal customer files (Shari’s Berries from FTD is a recent example of this)

On the market share side:

• The e-commerce floral side has 3 major players: FLWS, FTD and Teleflora (owned by the Resnick family of California)
• FTD filed for bankruptcy in 2019 and has continued to struggle since then while ceding share to FLWS. This has been stated by the company but also reaffirmed in our checks with current and former FTD executives. In our conversations with the control group behind FTD, they confirmed that they believe industry structure has improved since Covid and they are expecting to be less promotional going forward.
• Smaller VC-backed competitors such as Bouqs and Urbanstems which had been buying share pre-Covid are likely to be forced to retrench in a more rational funding environment
• On the food side, FLWS again has maintained share after buying Harry & David in 2014
• They also continue to have ample liquidity (net cash as of last quarter) to continue to buy their competitors, which they have done with Vital Choice most recently among others such as Popcorn Factory and Cheryl’s Cookies

Lastly, we should outline some of the information on automation, which is just starting to have an impact on margins and could lead to expansion longer-term:

• They installed automation in their Medford plant 2 years ago, 1 year ago in their Hebron plant, and are nearly complete in their Atlanta plant.
• Management has been rather unspecific and terse with information on impact, but they did share with us that the Medford plan (at 80% automated) was able to do over 100k packages during peak period with 400 employees in 2021 vs. 80k packages with 750 employees in 2019, a 150% improvement in per-employee productivity. The CFO has also confirmed to us without numbers that what they have automated already is “absolutely having an impact on margins” albeit less noticeable given the higher wage rates offsetting it at the moment
• Our primary research contacts tell us that the newer facilities are still in the process of ramping and then reducing the workforce, with most of the benefit coming in the tail end of FY24.
• Management confirmed we were roughly accurate to assume labor is 25% of COGS right now, so as you can see there could be major margin benefit in the future while still maintaining throughput.
• Taking all the changes to the model into account, it wouldn’t surprise us to see this business in FY26-27 do $2.5b in sales and earn $250M in EBITDA (10% EBITDA margin on 44% GM)

Valuation

As summarized above, we believe FLWS can earn $170M of EBITDA in FY24 on GM of 41.2% (still below historical norms of 42%). This translates to $125M in FCF or $1.99 per share due to reduced CAPEX and the improving inventory situation. Management has already called out “at least” $100M YoY in benefit from reduced capex and working capital benefit alone in FY23 vs. FY22. We estimate that the $60M in annual CAPEX over the last two years was inflated by $20M in automation investments and going forward will be normalized to $40M/year (still above $30-35M pre-Covid levels). Furthermore, given the composition of inventory is now close to 90% non-perishable (per management) they will continue to work this down this year and into next, providing a working capital benefit.

Our $170M in EBITDA capitalized at their long-term average 8.5x EBITDA multiple implies $24/share or +130% upside (or 12.2x FCF/share). In an upside case, where they return to the low-end of management’s long-term growth range of 10-12%, and with margins still below pre-Covid levels, they make $191M of EBITDA and shares are worth at least $27/share (+160% upside). Baking in even modest multiple expansion to account for the improved industry structure, we think $35/share (11x EBITDA / 17x FCF / +230% upside) is not out of the question. Note: in the upside scenario, we model working capital as less of a tailwind as inventory purchases increase to support higher demand; this explains the similar FCF/share results in both scenarios.

Risks

• Recession reduces consumer spending during major gifting occasions.
• Commodities re-inflate in the wholesale food and floral markets
• Newer customers gained during Covid churn off

Catalyst

• FQ3 sales & profit results ahead of street and buyside expectations (likely reporting late April)
• Stabilization of profit headwinds leading to upside on EBITDA and FCF in near and medium term on a customer and revenue base twice the size of pre-Covid levels