As the economy reopens from the Covid-19 pandemic, I expect strong pent-up demand for many things, one of which is beauty products. I last wrote about Sally Beauty Holdings Inc. (SBH, Financial), a retailer and wholesaler of cosmetics, hair and beauty products, in my 2019 article, "No Need to Panic: Sally Beauty Can Coexist With Amazon."
Like many retailers that rely mainly on brick and mortar locations, revenue and net income have suffered since the beginning of 2020, though cash flow remains good for Sally, helped by inventory reduction. Same store sales have decreased 3.7%, primarily reflecting temporary store closures at the beginning of the pandemic.
The company is in recovery mode now. It has strengthened its e-commerce offering with e-commerce growing by 48%, and has launched an order online, pick-up in store option for customers who want to save on shipping costs. What is really encouraging to me is that the company's profit margins have now bounced back.
A snapshot of the company's balance sheet is given below. The company has maintained a strong liquidity position with cash of $538 million and zero balance outstanding on its $600 million asset-based line of credit at quarter's end.
Chart 2. (Click for larger image)
The company ended the most recent quarter with a leverage ratio of 2.78, taking into account cash. It had levered up deal with the Covid-19 crisis and is now beginning to lever down. After the recent quarter's end, the company utilized excess cash to repay the remaining $213 million on its 4.5% fixed-rate term loan.
Chart 3. (Click for larger image)
The following diagram breaks down the company's operating cash flow (by quarter). Earnings from contiuned operations (the green bar) and core free cash flow (the orange line) have bounced back to normalized levels already.
Chart 4 (Click for larger image)
I used Gurufocus' Discounted Cash Flow (DCF) calculator to estimate the value of the company's shares. I used $2 in earnings per share as normalized earnings (the company earned $2.27 in 2019 and $0.99 in 2020). With this and the other assumptions shown below, I came up with a value of ~$25.
However, Gurufocus rates the "business predictability" of the company as low at only 1 out of 5 stars. Thus, the Gurufocus "Projected FCF" method may be a better estimate. This calcualtion shows a value of $20.92. Between both methods, we have a decent undervaluation of 20% to 40%.
I believe Sally Beauty is a strong candidate for a bounce back as "Main Street" in North America re-opens. The CEO has recently bought shares. Currently almost 40% of the float has been sold short and there is potential for a short squeeze. There is huge pent up demand waiting, so I estimate the stock will bounce back at least into the low to mid-$20 within the next 6 to 12 months.
Disclosure: The author owns shares in Sally Beauty Holdings Inc.
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