Sally Beauty Holdings Inc. (SBH, Financial) has had some good years.
But for almost two years now, it has struggled to grow its share price, and in recent months its price has reflected churn in the executive offices, disappointing fundamentals and downgraded guidance. The decline has been enough to put Sally Beauty on the Undervalued Predictable list at GuruFocus, a list for companies with good earnings power but weak share prices.
The company is a retail and distribution giant; it has more than 5,000 stores, a growing web presence and a widening presence beyond American borders. Because of its relationships with hair dressers, beauticians and others in shops and salons, it has some protected pricing power and some protection from the immediate predations of online vendors.
Sally Beauty has strong selling points, but the market hasn’t been buying, or at least buying with any conviction, for a couple of years. What’s up?
History
The first Sally Beauty store opened its doors in New Orleans in 1964. Twenty-three years later, it entered the international market after buying a chain of 30 stores in the U.K.; in 1987, it marked the opening of its 500th store. It entered Canada in 1998 with more acquisitions; that same year it opened its 1,800th store and reached $1 billion in annual revenue.
It became a public company in November 2006 with a listing on the New York Stock Exchange. By 2010, the company had its 4,000th store, mainly because of the many acquisitions it had made. It opened its first store in Peru in 2014, and two years later opened it first store in Colombia. Also in 2016, it opened its 5,000th store. In its 10-K for 2016, the company notes it made 40 acquisitions in the past 10 fiscal years.
History based on information at the company’s web site.
Comments: Sally Beauty has grown rapidly, using acquisitions and internal growth, to cement a prominent place in the American market, and a growing presence internationally.
The business of Sally Beauty Holdings
According to its 10-K for 2016 (unless otherwise noted, information in this article comes from it), Sally Beauty is a retailer and distributor of professional beauty supplies.
It operates through two business units, Sally Beauty Supply, and Beauty Systems Group. At the end of fiscal 2016, it operated 4,937 of its own stores and supplied 182 franchised stores; based on the store count, the company considers itself the largest distributor of professional beauty supplies in the U.S. (“professional” refers to the fact it sells to, and through, professional hairdressers and others in the trade).
In an investor Overview from August 2015, it provided this structural look:
This excerpt from the Overview shows its product mix and the contributions of individual product groups:
The two business units sell both third-party branded and exclusive-label professional beauty supplies with third-party products responsible for 64% of sales and exclusive-label responsible for 46%.
For each of the last three fiscal years, more than 80% of consolidated net sales came from domestic customers.
Sally Beauty reports the industry is highly fragmented with 295,000 salons and barbershops in the U.S. alone. At the same time, there is increasing consolidation among distributors and manufacturers, which changes the dynamics of the marketplace.
It also notes there is a critical need to control costs, through right-sizing and maximizing the efficiency of the business because both labor and real estate costs are rising.
Comments: Sally Beauty Holdings is a giant in beauty products sector, selling to both hair care professionals and to retail customers (retail is often handled through professionals and salons). It has a wide-ranging product line, but limited penetration beyond the domestic market.
Revenue
Sally reports $3.953 billion revenue for fiscal 2016.
As this chart shows, revenue has grown steadily in all but one of the last 10 years:
As for the rate of revenue growth, GuruFocus provides these average annual growth rates:
- Three years: 8.9%.
- Five years: 9:0%.
- 10 years: 7.6%.
This excerpt from the 10-K shows the relative contributions of each of the major product lines:
Comments: Sally Beauty Supply has posted good revenue growth rates throughout most of the past decade, and its revenue is diversified among a number of product lines.
Competition
The company says, “The beauty products distribution industry is highly competitive and is consolidating.”
To some extent, it tries to sidestep price competition by positioning Sally Beauty Supply as a source of professional advice and salon-quality products rather than as a discount leader. For Beauty Systems Group, it tries to position the unit as the supplier of a comprehensive line of products for professionals, rather than as a price leader.
Hoover’s lists its main competitors as: CVS Health Corp. (CVS, Financial), Walmart Stores Inc. (WMT, Financial) and Walgreens Boots Alliance (WBA, Financial).
This list highlights one of the key changes taking place in the industry. Sally reports increasing competition from authorized and unauthorized retailers and internet sites that also offer salon-only products. When competing with grocery stores drug stores, and others, the company has less price-setting freedom.
Other stocks in the beauty space include Estée Lauder Companies Inc. (EL, Financial), L’Oreal SA (LRLCY, Financial) and Ulta Beauty Inc. (ULTA, Financial).
Comments: The company competes not only with other beauty product distributors, but also with the giants of retail, including Wal-Mart. It can shield itself, to some extent, with positioning but is increasingly exposed to price competition.
Moat
Morningstar argues that Sally Beauty Holdings has a narrow moat.
Vuru is more generous in its assessment of the moat:
Sally Beauty says, in its 10-K for 2016, that it has three important competitive strengths:
- It is the largest distributor of professional beauty products in the U.S. by store count, and it has multiple channels through which it can reach customers.
- A strong value proposition, which includes salon-quality products and solutions at prices that competitors cannot match; conveniently located stores; wide selection of products; knowledgeable staff; and ethnic products (which can be tailored to individual stores).
- Attractive store economics: It says its stores show positive contribution margins within a few months to a year of their opening and that cash payback on investment usually occurs within two to three years.
Comments: A medium moat seems an appropriate conclusion, particularly given how quickly it can recoup its investment in new stores. And, size does matter in retail, if for no other reason than being able to spread costs over a larger number of outlets.
Growth
Sally Beauty says it has a growth strategy:
- Increase overall traffic and sales productivity at existing stores – the company has an ongoing store makeover program for existing stores.
- Expand the store base – its organic store growth target is 2% to 3% of existing stores per year.
- Grow internationally – more stores and sales in Europe, Central America and South America.
- Increase operating efficiency and profitability – one of the tactics is growing online sales.
- Strategic acquisitions and new territories for organic growth.
The company also expects to benefit from continuing industry growth:
Comments: As noted in the Revenue section, Sally Beauty Holdings has a history of growth, both organically and through acquisitions. Its current growth strategy, as well as strong industry trends, should allow it to keep growing.
Other
Sally Beauty Holdings is headquartered in Denton, Texas.
Fiscal years end on Sept. 30.
At the end of September 2016, it had 29,665 employees (15,255 of whom were part time).
Chairman of the board: Robert McMaster, age 68, has held this position since 2016. He had been the lead independent director since 2012.
President, CEO, Director: Christian Brickman, age 51, has been CEO since 2015. He joined the company in 2014.
Chief Financial Officer, Chief Operating Officer, Senior Vice President: Donald Grimes, age 54, assumed the CFO position in December 2016. Officer information from Reuters.com.
Comments: There’s been turnover at the top, wholesale and recently. Whether by design or circumstance, the lack of company- and position-specific experience among the top three officers may be a concern.
Ownership
Mario Gabelli (Trades, Portfolio) is Sally Beauty's largest holder among the gurus followed by GuruFocus; he has 952,277 shares, which give him a 0.16% share in the company. The second- and third-largest holdings are those of Steven Cohen (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio).
An extremely high level of institutional investor ownership for this company:
Insiders hold a modest number of shares while the short sellers hold a relatively high number, more than 8%.
Comments: While the number of short sellers may be concerning, the company apparently has the confidence of institutional investors, and at least a few of the gurus.
By the numbers
Comments: At the close of trading on Feb. 9, the stock was trading close to its 52-week low; its price-earnings (P/E) ratio is in the mid-teens; it has a negative (or zero) ROE but double-digit ROA; it does not pay a dividend; and it bought back more than 4% of its own shares in fiscal 2016.
Financial strength
The GuruFocus system gives Sally Beauty a weak rating for financial strength and a strong rating for growth and profitability:
The level of long-term debt is one of the reasons for the poor showing on financial strength:
This GuruFocus table show the amount of total debt per share has grown and now amounts to more than half of the current share price:
This debt has helped the company grow its earnings; here’s the story on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization):
Recently, though, net income has slipped:
Similarly, free cash flow has slipped:
The operating margin has also been troubling. GuruFocus reports, “Sally Beauty Holdings' operating margin has been in five-year decline. The average rate of decline per year is -2.2%.”
The company’s WACC (Weighted Average Cost of Capital) is 5.48%, and its ROIC (Return on Invested Capital) is 21.75%.
In its First Quarter Fiscal 2017 report, the company conceded its underperformance and announced a restructuring plan and cost reduction initiatives. It says it expects to achieve “annualized pretax benefits in the range of $17 million to $19 million with pretax benefits in fiscal 2017 estimated in the range of $10 million to $12 million.” And the company said it expected for fiscal 2017 “full-year same-store sales in the range of flat to low-single-digit growth versus prior guidance of approximately 3%.”
Comments: All in all, investors will not find much to like in these results, or the 2017 forecast. Debt is high and growing, while another year of lacklustre results seems inevitable.
Valuations
Sally Beauty receives a 4-Star (out of 5) rating for earnings consistency or predictability. That’s well above average and, barring major new problems in the future, suggests good future earnings, which in turn should pull up the share price.
A mixed bag of valuations at GuruFocus: The DCF (Discounted Cash Flow) based on free cash flow comes in at $22.90, which is just below the current price while the DCF based on earnings values Sally at $39.61, well above the current price:
The analysts followed by Nasdaq.com have a 12-month consensus price target of $25.00, which is slightly above the current price. And they are split when it comes to buy/sell/hold recommendations:
Sally Beauty’s P/E ratio is near the bottom of the range it has established over the past 10 years.
Its PEG ratio (P/E divided by average annual earnings growth over five years) is 1.76, which puts it just into the upper quadrant of fair value range (a PEG between 1.0 and 1.9 is considered fair valued).
From a technical analysis perspective, the share price is well below the 200-day Simple Moving Average:
Comments: Overall, the various indicators suggest Sally Beauty is currently under-valued, perhaps modestly under-valued. On an earnings basis, and the power of its earnings is perhaps the company’s biggest asset, that bias to under-valuation is even stronger.
Conclusions
Despite its many operational and financial strengths, the market has not rewarded Sally Beauty Holdings. The reasons? No doubt those strengths are trumped by some critical liabilities: the high level of debt, the declining operating margin and lowered guidance to cite a few.
The restructuring plan, as well as the cost reduction initiatives, should help. Investors are likely to stay in a “show me” mood until they see management deliver on its promises.
Value investors may give Sally Beauty a look, based on its price and its earning power, but many will want stability in the executive offices, improved fundamentals and more optimistic guidance before taking a serious look.
Disclosure: I do not own shares in any of the companies listed in this article, and I do not expect to buy any in the next 72 hours.
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