Investor Essentials Daily

Zoom caused people to put less time into their looks, and beauty companies are scrambling to adjust

Sally Beauty Holdings, Inc. (SBH)
April 7, 2021

With a market value of about $100 billion, the entire beauty and cosmetic industry has undergone severe macroeconomic related pressures as a result of the pandemic.

While the industry has not fully recovered from its lows during the height of the pandemic, rating agencies are rating many names for a high risk of bankruptcy, which may be excessive for today’s name.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

Investor Essentials Daily:
Wednesday Credit Insights
Powered by Valens Research

With so many individuals stuck at home quarantining since the onset of the pandemic, large consumer spending trends have shifted.

It is easy to see the hurt for some industries such as leisure and travel, hit hard by the halted demand. Many market segments have also undergone significant pandemic-related pressures.

One industry that has faced significant headwinds throughout the lockdowns is the beauty and personal care space.

As more people have been at home over the last year rather than in offices, the beauty industry has needed to navigate difficult obstacles.

With nowhere to go as individuals have been stuck at home, people have seen less and less reason to dress up and use beauty products.

In 2020, the beauty and personal care space was estimated to be worth approximately $100 billion. Additionally, women in the U.S. tend to spend roughly $3,000 annually on cosmetic products.

Being such an established industry in the U.S., these challenges have not come easy.

Specifically, as a McKinsey study suggests, revenues in the space collapsed more than 50% in the months of April through June of 2020.

Moreover, these declines in revenues have not yet rebounded to pre-pandemic levels, as many other industries have done throughout the past few months.

With these ongoing challenges in the space, many companies such as Sally Beauty (SBH) have been under the spotlight.

With cash flows under pressure as well, rating agencies highlight concern for Sally Beauty, as they are skittish around the company’s debt. Specifically, S&P gives Sally Beauty a non-investment grade speculative BB- rating, with the implied assumption of a 10%+ risk of default over the next five years.

Additionally, many of the company’s bonds hold highly speculative B ratings from S&P as well.

However, our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of the firm’s true credit risk.

In the below chart, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

As depicted, Sally Beauty has massive cash liquidity and therefore should have no issues handling its obligations going forward. Cash flows generated by the firm should cover operating obligations through 2023. Additionally, the firm’s cash on hand and cash available to withdraw are good to cover all obligations through 2026.

Rather than a name under pressure, Sally Beauty has its debt under control. This is why S&P’s non-investment grade speculative BB- rating, with a 10%+ risk of default expectation does not make sense.

Using the CCFP analysis, Valens rates Sally Beauty as an investment grade IG4 rating. This rating corresponds with a default rate below 2% within the next five years, a more realistic projection once a holistic understanding of the company’s risk is taken into account.

Although the beauty and personal care industry has taken a massive hit throughout the pandemic and has yet to recover back to normal levels, rating agencies are overly pessimistic when rating Sally Beauty’s credit risk.

SUMMARY and Sally Beauty Holdings, Inc. Tearsheet

As the Uniform Accounting tearsheet for Sally Beauty Holdings, Inc. (SBH:USA) highlights, the Uniform P/E trades at 17.0x, which is below global corporate average valuation levels of 25.2x and its historical average valuations of 16.1x.

Low P/Es require low EPS growth to sustain them. In the case of Sally, the company has recently shown a 46% Uniform EPS decline.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Sally’s Wall Street analyst-driven forecast is a 46% and 10% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Sally’s $11.69 stock price. These are often referred to as market embedded expectations.

Sally is being valued as if Uniform earnings were to grow immaterially over the next three years. What Wall Street analysts expect for Sally’s earnings growth is above what the current stock market valuation requires in 2020 and 2021.

Furthermore, the company’s earning power is 1x the corporate average and cash flows and cash on hand are slightly above its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals moderate credit risk.

To conclude, Sally’s Uniform earnings growth is near peer averages, and is trading below peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research