3 Reasons to Buy Sally Beauty Holdings

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

Consistent. Boring. Stodgy. While most of the investment chatter concerns smartphones and clouds, sometimes the best growth stories look dull by comparison -- which brings me to Sally Beauty Holdings (NYSE: SBH).

The company operates a chain of cosmetics retailers catering to women, stylists, and salons. Sally Beauty has been in business for over 50 years with 4,500 locations in over 11 different countries. In my opinion, the stock is a great buy because of the company’s growth story, expanding margins and reasonable valuation.

Growth story
Over the past five years, management has delivered excellent top- and bottom-line growth. Last year, Sally Beauty grew its sales and EPS by 8% and 33% respectively. 

<img src="/media/images/user_14324/sbh1_large.png" />

Going forward, analysts expect EPS to grow at a 15% clip over the next five years, driven by three key factors:

  1. Domestic Expansion: Sally Beauty plans to grow its domestic store count by 4%-5% annually. Management believes there’s room for 3,000 locations versus 2,650 in the U.S. today. In addition, the company is also expanding its Beauty Systems Group division and taking advantage of the fragmented nature of the industry by acquiring independent businesses.
  2. Same Store Sales Growth: The company is projected to deliver 4%-6% same store sales growth through new customer loyalty programs and implementing new CRM tools.
  3. International Expansion: Sally Beauty is also leveraged to growth internationally. The company has 671 locations internationally in Canada, Mexico, Europe and Chile with room to open 1,500 new locations over the next five years.

Margin expansion

Sally Beauty Holdings aims to improve profitability through a variety of initiatives. The company is changing its sales mix to emphasize higher-margin products. Management is also focusing on higher-margin retail customers and professional stylists, rather than bulk sales to salon operators.

These efforts have proved effective: Gross margins increased from 47.1% in 2009 to 49.5% in 2012.

<img src="/media/images/user_14324/sbh2_1_large.png" />

Cheap Valuation

Sally Beauty Holdings trades at 13.5 times forward earnings, making it the cheapest stock in the mid-cap cosmetics space.

<img src="/media/images/user_14324/sbh3_large.png" />

Ultra Salon, Cosmetics & Fragrance (NASDAQ: ULTA) takes most of the limelight in the industry, thanks to its spectacular 20% growth rate. However, investors are paying a big premium for growth.  The stock is priced for perfection at 28.5 times forward earnings.

Sally Beauty is also attractive compared to salon operator Regis (NYSE: RGS). Regis has struggled in recent years with declining revenues and profitability. Yet despite poor operating performance, the stock commands a premium 18 times forward earnings multiple.  

Sally Beauty Holdings looks even better when measured against its peers on a PEG basis. The stock trades a significant discount to comparables, with a 0.9 PEG ratio. 

<img src="/media/images/user_14324/sbh4_large.png" />

Foolish Bottom Line

The biggest concern with Sally Beauty is the stock’s financial leverage. The company recently re-levered its balance sheet by announcing a $300 million stock buyback, funded in part by a $180 million debt issue. I prefer businesses with pristine balance sheets, and I've publicly called for companies to ignore these types of shenanigans.

However, this is less of a concern for Sally Beauty. The company generates ample profits to fund its liabilities, with an interest coverage ratio north of 4.5. Unlike the technology industry, the cosmetics business is sufficiently stable to cover this debt.

Yet despite this debt issue, Sally Beauty Holdings is a great buy due to the company’s impressive growth story, margin expansion potential, and relatively cheap valuation. 

RobertBaillieul 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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