Trading Sally Beauty Holdings (NYSE:SBH)

Sally Beauty Holdings, Inc. (NYSE:SBH) shares are at an interesting point here. Shares have been crushed this year along with many other retailers. Inflation is a real problem and it is hurting consumers’ wallets. Their dollar is just not going as far. At the same time inflation in costs of supplies and in labor is also weighing.

We actually think the stock is setting up for a nice trade, and think you can scale in on the next market hiccup. After a session like today, with some of the best gains in years, we think you will get that shot. The stock is not without risk, and recession is certainly a risk we are watching, as is the debt load of the company, but the just reported quarter certainly was better than expected. The outlook, while uncertain with how the economy might look month to month, shows profit remains strong, especially when factoring in the big declines. Here is how we would play this. This is the type of trade we outline for members at our investing service.

The play

Target entry 1: $12.50-$12.60 (25% of position)

Target entry 2: $12.10-$12.20 (30% of position)

Target entry 3: $11.40-$11.50 (45% of position)

Stop loss: $9.75

Target exit: $15+

Options are not recommended due to wide bid/asks

Discussion

The market had a huge run and may pull back and give us better chances to enter than the current $12.60. That said, the top line was better than expected versus consensus in the Q4 report. We think sales will remain pressure until H2 2023 when we emerge from what we think will be a mild recession based on the rate hike cycle from the Fed. We think based on the trends we are seeing, the company will still perform well in the holiday first quarter. Still there is likely to be significant pressure on retailers as inflation is still hot, while consumer dollars just do not go as far. Next year, when there is more clarity, this stock could catch a bid along with other retailers. We saw some real improvement in key lines in the report.

The company is bringing in solid revenues, demonstrating demand for the products it carries. We saw some declining performance from last year, as there has been real shifts in consumer spending habits. Expectations have cautiously come down as evidenced by the market revaluing similar companies lower in recent months. A lot of specialty retailer stocks have been crushed. The competition and pressure in the space, coupled with a changing consumer, had made retail a tough place to invest.

Sales were a bit better than expected even with a tough quarter to handicap. The sales came in at $962 million and beat estimates by $15.6 million. That was surprising as we were expecting sales down at least 5%. Instead sales were down just 2.9% from year ago, which isn’t terrible all things considered the way this market has gone. We think the sales figure was positive.

The one critical metric we really focus on with retailers is comparable sales. Well, comparable sales were flat to the prior year, and were hit by inflationary pressures that continued to impact consumer behavior and supply chain challenges at the Beauty Systems Group. It is also worth noting that the company was operating 117 fewer stores at the end of the quarter compared to the prior year and that hits overall sales. One big win was in e-commerce, as sales increased 30% compared to the prior year to $90 million or 9.3% of total sales. Margins were pressured somewhat due to the product mix and pricing, as well as high freight costs.

Consolidated gross profit for Q4 was $463.5 million, a decrease of $28 million from the prior year. Margins weakened some. Consolidated gross margin was 48.2%, a decrease of 240 basis points compared to the prior year. Adjusted margin was 50.1% down from 50.7%. Selling and administrative expenses rose though. As a percentage of sales, selling, general and administrative expenses were 41.3% compared to 39.0% in the prior year, driven primarily by higher labor costs. Adjusted operating earnings and operating margin were $83.9 million and 8.7%, respectively, compared to $115.8 million and 11.7%, respectively, in the prior year. This was due to lower sales and slightly worse margins. Finally, net income was $54.4 million, a decrease of $19 million from last year. On a per share basis we saw $0.50 of earnings, which beat consensus by $0.02.

Looking ahead

As we look ahead we do see the market’s overall earnings coming down. Retailers are in a tough spot, and this is why their stocks are down so much. We are seeing wage inflation and inflation on goods and supplies. Utilities are higher costs, too. These things add up. Ok, great. The stock is down heavily, from over $20 a year ago. So, we are down a good 40% here.

It will take time for the economy to really get going. The market will have another pullback, and you can scale in here. We think the cash position is strong.

Sally ended the year with $71 million of cash and cash equivalents and $69 million outstanding under its asset-based revolving line of credit. The net debt leverage ratio stood at 2.2 times. Two years ago, leverage was nearly 3X. So progress has been made here. Sally strengthened the balance sheet in fiscal 2022 with a complete repayment of $300 million outstanding senior secured notes, while returning $130 million to shareholders through the repurchase of almost 7 million shares this year. Solid.

There is an optimization plan underway as well. Sally Beauty Holdings generated free cash flow of $75 million in the fourth quarter and $57 million for the full year, and the company is projecting it will see free cash flow of nearly $200 million in 2023. That is a huge improvement. The stock is a buy based on this outlook in our opinion. Net sales are expected to decline by low single digits compared to the prior year mostly due to more stores closed. The company continues to plan to lean out the stores. Gross margin is expected to remain above 50% and adjusted operating margin is expected to be 9%. This is lower than we would like, but stems from the revamping of the company.

Finally, valuation wise, shares are very cheap. We see EPS coming in at $1.95-$2.15 in 2023. That puts shares at just over 6X FWD EPS at the high end of this range. That is dirt cheap for a company that is on the mend. We think you let the market take this down some and scale in for a trade. We suspect Sally Beauty Holdings, Inc. shares offer substantial upside in H2 2023, and our trade should net gains of about 25%-35% depending on where you enter and if the stock fills the complete position.