Are Beauty Salon Businesses Beautiful?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Since the beginning of the year, shares of Ulta Salon, Cosmetics & Fragrance (NASDAQ: ULTA) has experienced a significant decline of nearly 14%, from $101 per share to nearly $85 per share. According to Barron’s, Credit Suisse remained confident in Ulta’s business model, with its compelling valuation. It also liked Sally Beauty Holdings (NYSE: SBH) due to its niche retail positioning and its consistent growth. In contrast to Ulta’s share price performance in the past four months, Sally Beauty has rallied as much as 25%. Should investors accumulate shares in those two companies? Let’s find out.

Ulta Salon – a fast and consistent growing business

Ulta Salon, after more than 20 years of operations, has become a large beauty retailer with more than 20,000 salon service locations in the U.S. The company has kept expanding itself, opening more stores in the past five years. Since 2008, the total number of stores has increased significantly, from 311 in 2008 to 550 in 2012. The total square footage has also risen from 3.24 million to 5.85 million during the same period. What investors should take notice is its extremely high growth in comparable store sales. Its comparable store sales growth were 11%, 10.9% and 8.8% in 2010, 2011 and 2012, respectively.

Indeed, what leaves me impressed is its historical consistent high growth in both the top line and bottom line. Revenue grew from $1 billion in 2008 to $2.2 billion in 2012 while net income rose from $25 million, or $0.43 per share to $173 million, or $2.68 per share during the same period. Furthermore, Ulta Salon is also a cash cow. In the past five years, its operating cash flow has been growing consistently from $75 million to nearly $240 million. In 2012, its free cash flow stayed at $50 million.

Sally Beauty – also a consistent grower

Sally Beauty, an international specialty retailer and distributor of beauty supplies, has also experienced a consistent positive comparable store sales growth in the past three years. In 2012, its same store sales increased 6.4%. Sally Beauty has a wide distribution network, delivering more than 6,000 products through 4,500 stores including around 200 franchised units in different areas including North America, Europe and South America.

Sally Beauty is also a consistent grower. While its revenue grew from $2.65 billion in 2008 to $3.52 billion in 2012, its net income climbed from $78 million, or $0.42 EPS to $233 million, or $1.24 EPS in the same period. Trailing twelve months, Sally Beauty generated nearly $300 million in operating cash flow and $219 million in free cash flow.

Ulta Salon has a much stronger balance sheet

In a retail business, investors should take a very close look at the balance sheet. The strong balance sheet will give retailers a lot of financial flexibility. In this aspect, investors might feel safer with Ulta Salon with its much stronger balance sheet. As of Jan 2013, it had $787 million in total equity, $320 million in cash and no debt. In contrast, Sally Beauty has a quite weak balance sheet with lots of leverage. As of December 2012, it booked a negative equity of $157 million, $148 million in cash and as much as $1.6 billion in long-term debt.

A much smaller peer of those two companies, Regis Corp (NYSE: RGS) also has a very strong balance sheet with conservative capital structure. At the end of 2012, Regis had $867 million in total stockholders’ equity, $218 million in cash and only $29 million in short-term debt. However, because its business has grown a lot via acquisitions, Regis’ had as much as $486 million in goodwill and intangible assets.

Regis might be the best pick among the three?

Regis, the beauty salon with 10,000 locations globally, has completely exited the sale of Hair Club for Men and Women for $163.5 million in cash. It could be considered a good move for Regis as the company could be more financially flexible while divesting its non-core business to focus on its core North American salon business.

Interestingly, Regis has the cheapest valuation among the three. At $18 per share, Regis is worth around $1 billion on the market. The market values Regis at only 6 times EV/EBITDA. Ulta Salon is trading around $85 per share, with a total market cap of $5.4 billion. Ulta Salon is the most expensively valued at 13.6 times EV/EBITDA. Sally Beauty, at $29.50 per share, is worth around $5.20 billion on the market. The market values Sally Beauty at 11.6 times EV/EBITDA.

My Foolish take

Personally, I do not like Ulta Salon and Sally Beauty at their current valuations. Even with the fast growth, Ulta Salon is valued at 1.11 times PEG, meaning that the market values the company higher than its potential growth. Sally Beauty is not my favorite either due to its substantial leverage. Among the three, I like Regis the most with the cheap valuation and the conservative capital structure. In addition, it is the only company of the trio paying dividends with a yield of 1.4%.

Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Ulta Salon, Cosmetics & Fragrance. The Motley Fool owns shares of Regis and Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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