Sally Beauty ($SBH) — Initiation (1/24/21)

Sally Beauty was once a high-flying compounder trading at a premium multiple… With larger brands like Ulta and Sephora getting attention and market share, this stock has been left for dead (even though they compete in totally different markets)…

Sally came public after Regis Corp failed to buy the company in 2006 causing then-owner Alberto-Culver to spin-off the business in tandem with an investment from PE firm Clayton Dubilier

Fundamentals had been solid coming out of the 2008-2009 crisis… Sales growing ~4% and EPS growing ~16% per year since 2009.

image

Salon industry…

This is a pretty fascinating industry given how fragmented hair care still is.

It’s a roughly $20bn industry with 2 of the major / well-known players Regis (SuperCuts) and Great Clips (private) making up only 15% or so of revenue.

Sally Beauty is a distributor of beauty products with both a direct-to-consumer and wholesale division. The primary customer is an independent salon operator or booth renter. Larger salons typically purchase supplies and product direct from manufacturers.

image

The small-time operator, or “booth renter,” as they are known are a large portion of the industry. These are folks who rent space from a salon owner and have their own book of business. A salon may have 15-20 chairs with 10-15 of them operated by W-2 employees and the rest being rented out to independent contractors (booth renters).

image

COVID might be amplifying a pre-existing trend toward booth renting… From SBH Q4 earnings call:

image

Not to get too excited too quickly but the implications for growth are significant. COVID related shutdowns of hair salons may lead to some permanent closures of smaller or poorly run salons — just as happened during the 2008-2009 crisis. Looking back at post-crisis performance of Sally, it may be situated for a good run if that’s the case.

image

Here are some employment stats from the US Labor Bureau:

image

Same-store sales…

Were growing at a healthy clip from 2009-2016 before turning negative in 2017 and 2018… Then bounced back slightly in 2019 only to turn negative again in 2020 (which seems excusable with COVID).

SSS by segment

image

Fortunately, same store sales have started to rebound from the COVID lows… Q4 (ending 9/30/20) saw a 1.3% increase in consolidate same store sales — this is the highest growth registered in years…

image

Sales are split about 60% to SBS (retail stores) and 40% BSG (distribution). Ecommerce has been a positive recently but remains small at < 10% of sales.

image

Financials…

As you probably already know, I love a consistently cash generative business… If I can be sure those cash flows are stable and/or increasing, I love it even more.

Sally Beauty has historically been a very stable cash generator.

image

Sally does not disappoint here… This $1.6bn company generated ~$1.47bn in free cash flow from 2015-2020 — most of which went to share buybacks.

image

At $14, SBH is a $1.6bn market cap. Like many other businesses, fiscal 2020 looks like a write-off thanks to COVID.

image

So what’s this worth and what happens next year?

Historically, SBH has produced excellent returns on capital while exhibiting stable revenue and cash flow — sure, comparable sales have been a problem though. Share count has plummeted and leverage has declined.

image

If you believe that salon closures and the tailwind toward booth renting / individual operators will lead to future growth (as I do); then peeking back 5 years to use a historic multiple seems reasonable.

image

I consider fiscal 2019 to be the baseline from which they should grow in the future — management guided 2021 revenues to grow from 2019 levels which is a good start.

$23/share would equate to 1x sales of $3.9bn and ~8x operating cash flow at $320m (both figures close to 2019 levels). This is ~60% upside alone.

This doesn’t tell the whole story…

If the current environment creates a 2009 redux for the salon industry, then growth could take hold for years to come. Beyond that, this isn’t a low-multiple business due to excessive debt — with $1.3bn in net debt and estimated ~$500m in EBITDA, SBH has already hit their targeted leverage ratio.

My position is still somewhat small at ~2% of my portfolio. I’m inclined to continue adding below $15/share under the current circumstances but could build a larger stake if they get some momentum in top-line growth.