Sally Beauty Is Looking Pretty Attractive
Some business models are more recession-proof than others. One business that may fall into that category is womens beauty or hair styling. The leading retailer in that field is Sally Beauty Holdings Inc. (NYSE:SBH). The company operates in two different segments, Sally Beauty Supply and Beauty Systems Group.
The Sally Beauty Supply is a retailer that sells beauty products, including hair color and care products, skin and nail care products, styling tools and other beauty products for retail customers, salons and salon professionals. The Beauty Systems Group segment offers professional beauty products, such as hair color and care products, skin and nail care products and styling tools to salons and salon professionals through its professional-only stores, e-commerce platforms and sales force.
It operates primarily in the U.S., but also has stores in Puerto Rico, Canada, Mexico, Chile, Peru, the United Kingdom, Ireland, Belgium, France, Netherlands, Spain and Germany. Founded in 1964, the company is headquartered in Denton, Texas and currently has a market capitalization of $1.1 billion.
Units of operation
Sally Beauty Supply has 3,141 stores as of the end of its third firscal quarter that offer more than 8,000 products for hair color, hair care, skin and nails. Of these stores, 2,322 are located in the U.S. and 819 locations are international. The company also has a popular e-commerce business at sallybeauty.com.
The Beauty Systems Group business has 1,366 stores. It also has one of the largest networks of professional distributor sales consultants in the country with approximately 650 consultants. The stores and sales consultants sell over 10,500 professionally branded hair, skin and nail beauty products that are sold exclusively to professional stylists and salons.
Financial results
The company reported fiscal third-quarter results on Aug. 3. For the period ended June 30, sales decreased 3% due to foreign currency effects and fewer stores in operation. Same-store sales increased 0.6%. The Sally Beauty consumer retail segment saw sales decrease 3%, but same-store sales increased 3% due to the companys recent store optimization efforts.
In the professional Beauty Systems Group segment, sales decreased 3.3% and same-store sales decreased 2.4%. These declines primarily reflect the continuation of stylist demand trends seen over the last several quarters where salon operators are not buying as much product as they used to.
Adjusted Ebitda declined 7.5% to $118.8 million and operating income declined 9.2% to $90.1 million. Operating cash flow remained strong and increased 2.2% to $53.1 million. Capital expenditures in the quarter were $21.6 million and free cash flow was $31.5 million.
As of the end of the fiscal third quarter, the company had cash and cash equivalents of $74 million and total debt of $1.1 billion. The net debt leverage ratio was 2.20. Inventory decreased 2% to $996 million. The company has no debt maturities until 2026.
In a statement, President and CEO Denise Paulonis said,We are pleased to report another solid quarter with net sales of $931 million, Adjusted Gross Margin of 51%, Adjusted Ebitda of $119 million and free cash flow of $32 million. Three quarters into our fiscal year, we are on track with our operating initiatives and the financial guidance we originally laid out for fiscal 2023. Our teams remain focused on fueling growth through our core strategic initiatives enhancing customer centricity, driving innovation and increasing operating efficiency.
Valuation
Sally Beauty provided a 2023 outlook in its recent earnings release. Comparable sales are expected to increase in the low single digits and consolidated net sales are expected to decline by low single digits compared to the prior-year period. Gross margins are expected to remain above 50% and the operating margin is expected to be in the range of 9% to 9.4%.
Consensus analyst earnings per share estimates for the fiscal year ending September are $1.87 and $2.10 for the 2024 fiscal year. That puts the stock selling at only 5 times this year's earnings and 4 times next year's earnings. However, because of the high debt load, price-earnings ratios can often be misleading. The enterprise value/Ebitda ratio takes net debt into consideration. On that basis, the stock is selling at 5.7 times Ebitda, which is still below the sector average.
The GuruFocus discounted cash flow calculator creates a value of $23 when using $1.87 as the earnings per share starting point and a long-term growth rate of only 5%.
There are three Wall Street analysts that cover the company with an average price target of $13.67, including a high target of $19 and a low target of $10. Sally Beauty does not currently pay dividends.
Guru trades
Gurus who have purchased the stock recently include John Hussman (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio). Investors who have reduced or sold out of their positions include Ken Fisher (Trades, Portfolio) and Ray Dalio (Trades, Portfolio).
Summary
Sally Beauty appears to be substantially undervalued at this time. There are some tailwinds, including store optimization initiatives, additional cost-saving and cost-cutting measures and a defensive business model as hair styling and hair coloring may be somewhat recession-proof. However, store traffic may not accelerate if customers do not react favorably to new initiatives. In addition, even though the companys leverage ratio is reasonable at 2.2, the debt load is still above $1 billion and may limit initiatives or share buybacks.
The stock still represents a solid small-cap opportunity for long-term investors and there appears to be a margin of safety.
This article first appeared on GuruFocus.
