EWCZ - European Wax Center Grows Quickly Amid Signs Of Client Fatigue

2023-07-27 15:16:22 ET

Summary

• European Wax Center, Inc. is a primarily franchised network of nearly 1,000 personal beauty care centers in the United States.
• The company's franchise base is expanding and has access to plenty of investment capital.
• However, "episodic" visitors are starting to show demand reduction, perhaps as a harbinger of the potential for wider demand softness ahead.
• I'm Neutral [Hold] on European Wax Center in the near term.

A Quick Take On European Wax Center

European Wax Center, Inc. ( EWCZ ) operates a primarily franchised network of waxing service providers across the United States.

I previously wrote about the firm with a Neutral [Hold] outlook.

European Wax Center, Inc. is seeing reduced visits from "episodic" customers, so perhaps this is an early warning sign for further demand softness ahead.

I remain Neutral [Hold] on EWCZ for the near term.

European Wax Center Overview

Plano, Texas-based EWCZ was founded to develop a franchised and corporate-owned network of waxing services by licensed estheticians in the U.S.

Management is headed by Chief Executive Officer David Berg, who has been with the firm since October 2018 and was previously CEO of the Carlson Hospitality Group (global hotel business).

The firm seeks business relationships with franchise owners and assists them in various aspects of site selection, financing and store construction.

Management says the company is the largest franchisor of out-of-the-home waxing service locations in the U.S.

European Wax Center’s Market & Competition

According to a 2020 market research report by IBISWorld, the U.S. personal waxing and nail salon market is an estimated $18.7 billion market.

The estimated average annual growth rate of the market from 2016 to 2021 was 6.4%.

The market is expected to grow by 5.8% in 2021.

The main drivers for this expected growth are available consumer discretionary spending on personal care services and products after a market slowdown in 2020 due to the COVID-19 pandemic.

The waxing services market is highly fragmented, with at least 10,000 independent waxing operators and nearly 100,000 beauty salons that include waxing services in their offerings.

EWCZ’s Recent Financial Trends

• Total revenue by quarter has grown per the following chart; Operating income by quarter has begun to roll over in the most recent quarter.

• Gross profit margin by quarter has trended lower in recent quarters; Selling, G&A expenses as a percentage of total revenue by quarter rose sharply in Q1 2023.

• Earnings per share (Diluted) have trended lower in recent quarters.

(All data in the above charts is GAAP.)

In the past 12 months, EWCZ’s stock price has fallen 1.11%, as the chart indicates below.

For the balance sheet , the firm ended the quarter with $45.9 million in cash and equivalents and $375.2 million in total debt, of which only $4.0 million was categorized as the current portion due within 12 months.

Over the trailing twelve months, free cash flow was an impressive $42.8 million, during which capital expenditures were $0.3 million. The company paid $11.6 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For EWCZ

Below is a table of relevant capitalization and valuation figures for the company.

(Source - Seeking Alpha.)

Commentary On European Wax Center

In its last earnings call (Source - Seeking Alpha ), covering Q1 2023’s results , management highlighted the opening of 34 new locations, the highest figure since the company's inception in 2004, reaching nearly 1,000 locations across the U.S.

40% of the company's customers are buyers of its Wax Pass program, a discount loyalty program and they represent over 66% of customer visits and network sales.

As for location ownership mix, within the next few years, management expects its franchised centers to be equally owned by three different categories of franchisees:

• Independently owned

• Small self-funded multi-location

• Private equity-owned.

Total revenue for Q1 2023 rose by 9.9% YoY, while gross profit margin fell by 2.6%.

Selling, G&A expenses as a percentage of revenue increased 1.8% year-over-year and operating income dropped 15.9%.

The company's financial position is moderate, with some liquidity against meaningful long-term debt and reasonably strong free cash flow.

Looking ahead, management guided 2023 year-over-year revenue growth of approximately 9.2% at the midpoint of the range.

If achieved, this would represent a substantial decline in revenue growth versus 2022’s growth rate of 16% over 2021, indicating a slowing growth trajectory.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below.

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited "Uncertain" once, "Challeng[es][ing]" once, "Macro" three times and "Drop" once.

Analysts questioned company leadership about a reduction in demand from "episodic" customer types, and management said it has ‘deployed some additional levers to drive transactions and ticket size.’

Management is also seeing strong capital sources seeking to support franchisor expansion, highlighting the Southeast U.S. as an example of an area with expected growth in franchise coverage.

Regarding valuation, in the past twelve months, the firm's EV/EBITDA valuation multiple has dropped by 26% from its high of 30.6x down to its current 22.6, as the chart from Seeking Alpha shows below.

The primary business risk to the company’s outlook is that consumers become "tapped out" of their excess savings and ability to access consumer debt and reduce their discretionary spending habits.

An early indicator of this dynamic is the demand softness management is seeing from ‘episodic’ visitors.

As a result, the company and franchisors may have to spend more to keep these episodic visitors coming back in a meaningful way.

A potential upside catalyst to the stock could include a stronger-than-expected macroeconomic environment due to continued elevated spending by U.S. consumers despite higher interest rates.

EWCZ is a difficult call at this time in the economic cycle, but I’m on the side of caution.

I’m Neutral [Hold] on European Wax Center, Inc. for the near term.

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