Let’s be clear… going long SBH is not a typical Hedgeye Retail Long Idea. I like multi-year top line tailwinds, positive inflection points in market share, structural margin lifts, strong management and improving ROIC – all of which are underappreciated by the Old Wall. I like 2-3-year doubles (or more). We’ve got plenty of those on our Position Monitor. Sally Beauty Holdings – for the most part -- doesn’t fit the bill on any of those fronts – at least not on a multi-year basis. It’s got too many stores, is losing share on the margin in its core hair care/color business to ULTA, Target and Drug Stores, management is highly promotional (aka mediocre), and it’s got serious leverage (4.2x Debt/EBITDA). In no way, shape or form is this the kind of name you buy and stick it away for a couple of years. I can’t be more clear about that. This is actually the kind of name I’d ordinarily look to short. One day, I probably will.
But that day is not today. Not with a positive 30% earnings revision coming down the pike. Not with 17% of the float held short. Not with the stock trading at 6.2x earnings. And definitely not with the market sitting in Macro Quad 2 – where small cap, hated, levered, cheap, garbage names like SBH trade up violently with the slightest positive catalyst. And a 30% upward earnings revision is a heck of a lot more than a ‘slight’ catalyst. We’re looking at $2.43 in EPS for 2021 vs the Street at $1.85, and if we put a ‘structurally challenged retailer’ multiple on that of 10x, we’re getting to a mid-$20s stock – about 50-60% higher from where it sits today. That also would equate to 7x EBITDA and a 10% FCF Yield.
For those unfamiliar with Sally, it’s a retailer that sells beauty supplies under two banners:
- Sally Beauty Supply (SBS) with 3,644 retail locations in the US, Canada, Europe and Latin America. The stores serve a low-end to middle consumer (which will benefit from stimulus and a Democratic Administration in the same way Citi Trends should) and generates 50% of sales from hair color and hair care, with the remaining mix coming from styling tools, salon supplies, and skin/nail care. This business comped down 9% during the pandemic.
- Beauty Systems Group (BSG) which operates 1251 stores in the same geographies as SBS, but caters exclusively to the Salon Professional. The company has 715 dedicated Distributor Sales Consultants (DSCs) which sell directly to beauty salons. Hair Color and Hair Care represents 75% of BSG revenue. Out of the two divisions, this is the more defendable business, as each DSC generates approximately $375,000 in sales and has regular outreach to her Salon customers. Note that productivity per DSC was down 19% during the pandemic simply because so many salons were closed.
Key Modeling Assumptions.
- Revenue: We’re expecting a 10% comp rebound in these businesses combined in 2021 as we anniversary the pandemic. One key factor to keep in mind is that at the end of last FY, SBH rolled out a private label credit card – and in looking at other case studies such as ULTA, PLCE, and BURL we see on average a 10% lift in average basket size when consumers use the private label card. In our due diligence, we don’t think that the impact of the card is being modeled by the Street. Aside from seeing a comp lift, it also helps in customer retention. Surprising that SBH never offered this, but it’s a no-brainer. Given the low income levels for the SBS consumer, this might be among the only credit the consumer can get. The program is also available to the BSG consumer, which will make it easier to transact with Sally. The risk on the receivable is born by Comenity Capital Bank (owned by Alliance Data), unlike what we see with retailers like KSS that share in delinquencies with COF. SBH also receives incentive payments for card activations that are booked as an offset to SG&A. It’s worth noting that the company guided that 2021 sales will be higher than in 2019 – and yet the consensus is 2% below. We’re 1% above 2019, and have a bias to the upside.
- Gross Margin: Gross margins in this business are remarkably stable – running between 49-50% for the past seven years on an annual basis leading to the pandemic. Even during 2020 GM slipped to only to 48.8%. The last time we saw outsized comps in this business (like we should see in 2021) was in 2010 as we emerged from the Great Recession, where we saw a 160bp lift from 2009 levels. We’re modeling a 50% GM for the year – keeping in mind that the company hit 51.1% in 4Q20 and noted that the first three quarters of 2021 would show ‘continued strength’. All in, our assumptions are hardly aggressive.
- SG&A: Despite the incentive payments that should be booked as a contra-cost to SG&A, we have SG&A for the combined businesses coming in at 35.2% -- still above the 34.5% level we saw in 2019. Given that we’re likely to see higher e-comm sales in 2021, we think its prudent to be more conservative with higher fulfillment costs on this line item.
- Operating Margin: We’ve got margins going back up to 11.9% for the year, versus the consensus at 9%. During the thick of the pandemic, the company still clocked in an 8.4% margin – 9% in recovery seems too conservative from where we sit.
Where We Could Be Wrong Over the Immediate Term
The majority of the upside to earnings falls in 2Q-4Q. That’s the call. We’re making this call a week early. Until then, we have to get past this Thursday, when the company reports its 1Q21. We think that the US business is tracking well – which is about 80% of total sales. But Canada has been largely shut down, and that adds an element of volatility for ~10% of SBH’s sales. In the event of a Canada miss on Thursday, we think that the 6x p/e and 17% of the float being short will limit downside. We’d simply buy more on the event. But if you’re really risk-averse, you likely want to de-risk this print and buy on the day. You risk leaving money on the table if the earnings upside story plays out a quarter early – but should still see a solid return on a 2Q-4Q upward revision cycle.
