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Sally Beauty Holdings: A Good Risk/Reward Prospect (NYSE:SBH)

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Modern hairstyles and other cosmetics are important. People like to look certain ways because it affects how they feel and how others perceive it.At first glance, they may not be obvious. Some companies do a great job serving these customers, while others have a difficult time. Over the past few years, one business has fallen into the latter category. Sally Beauty Holdings (NYSE:SBH). The business has experienced a decline in revenue and some indicators of profitability over the past five years. However, the tide may be turning. This is because shares are at an attractive price and the business is rebounding after the COVID-19 epidemic. Shares could be attractive for investors if this is a true turnaround. If the business continues its struggles, shares are not too expensive to be considered a risky investment. This makes it a good investment opportunity for value investors.

Understanding Sally Beauty’s business model

Sally Beauty’s business model is quite simple. As of today, the company owns 3,611 Sally Beauty locations around the world. 2,728 of these stores are located in the US while 883 are worldwide. Beauty Systems Group also services 1,367 stores and employs 724 consultants who cater to two salons and licensed beauticians. This allows the company to offer professional color services for home use. It is actually responsible for 44% of brands it sells.

According to ManagementHair color products account for 33% of Sally Beauty’s sales. This makes her hair color the most popular category. Hair care products account for 19% of the company’s sales. 14% of sales can be attributed to skin and nail health. The rest of the revenue is split among styling tools, salon supplies, accessories, and textured hair products. Beauty Systems Group receives 41% of its revenue from hair color products, while 35% comes directly from hair care.

Sally Beauty has had some difficulties over the years. In 2016, Sally Beauty’s revenue was $3.95 billion. This number has dropped every year since 2016, falling to $3.51billion in 2020. To be fair though, 82.5% of the decline in sales occurred between 2019-2020. The pandemic, however, only made matters worse. After seeing its store count reach 5,156 locations in 2018, it began to decline each year, reaching 5,038 by 2020. As of this writing, that number is now 4,978. The company’s number of consultants has also been declining. In 2016, it was 914. It was 715 at the end of 2020. This number has risen to 724 since then.

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Volatility from a profitability perspective was also a result of the decline in revenue. As shown in the graph, this can be seen in the company’s net profit. EBITDA has been more consistent from a pain perspective. Since at least 2016, the EBITDA metric has been declining, falling from $627.7 million down to $438.5 millions. Surprisingly however, the trend for operating liquidity has been the opposite. It has risen in most years, rising from $351 million up to $426.9 millions.

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For the Current fiscal yearThings are starting to look up. Revenues of $2.89Billion in the first nine months are 12.8% more than the $2.56B that the company generated the previous year. The third quarter saw revenue surpass $1.02 trillion, the strongest quarter. This is 44.9% greater than the $705.29m achieved the previous year. Profitability increased as revenue increased. Net income jumped from $43.06million in the first three months of 2020 to $171.71million during the same period this past year. While operating cash flow fell, dropping from $274.38 to $217.73 millions, EBITDA rose from $243.51 to $398.15million. The difference between operating cash flow versus EBITDA seems to be due in large part to higher taxes in the past. This is added back into the calculation of EBITDA. Therefore, I believe that operating cash flow is a better indicator for the company’s financial condition.

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If these trends continue, it wouldn’t be unreasonable to expect operating liquidity of just $339million and EBITDA of up to $717million. Based on these numbers, the company would trade at a price/operating cash flow multiple of 6.8 and an EV/EBITDA multiple of 4. If we assume that the 2020 fiscal year will be more similar, these multiples would still be attractive at 4.5 & 6.9, respectively. Additionally, the company has a net leverage of just 1.6 using the 2021 figures. This figure rises to 2.5 when using the 2020 numbers. I compared Sally Beauty with one of its competitors as part of this analysis. I found that the only one that made sense was Ulta Beauty (ULTA). Ulta trades at a price-to-operating cash flow multiple (17.6) and a EV to EBITDA multiple (15.4). This is quite a big difference.

Takeaway

Based on the provided data, shares in Sally Beauty appear to be very cheap. There is a reason they are so cheap. The past few decades have not been very kind to shareholders and that shows in the company’s prospects or in the eyes the investors who bought into it. It is showing some signs of improvement this year. If the turnaround is genuine, it could provide significant upside for shareholders as they move forward. Even if this turnaround is not legitimate, it is difficult to imagine shares falling further at this point.

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