HELE - Helen of Troy: Heavily Shorted But Delivering

2023-07-10 12:26:25 ET

Summary

• Short interest in Helen of Troy Limited stock is around 25%.
• We have traded the stock a number of times long and short.
• Our last buy call was earlier in the year, where we rated shares a buy the further they fell under $100.
• Shares are up about 25% in a few months, and fiscal Q1 results were strong, adding fuel to the rally.

It is a big week for markets, with inflation data ahead, as well as earnings season. As many of you know, there are key levels and results we are watching which will dictate the direction of the markets, sentiment, and how we position ourselves for the next quarter or two of trading. Earnings season kicks off this week, most notably with banks on Friday, but there are a few other reports still trickling in ahead of the "official" kickoff to earnings season.

One name that we have traded long and short, and most recently got behind for a trade when shares dipped well under $100, was Helen of Troy Limited ( HELE ). We believed coming into 2023, despite the massive macro headwinds, that the company was righting the ship. A lot of retailers have been crushed by inflation in the price of nearly everything over the last year and a half, and the Fed's actions to fight the inflation through rate hikes are only just starting to weigh on the consumer. It is our opinion that earnings estimates will be coming down from many companies this earnings season due to the pressure on businesses. While we do not know how far the Fed will go, or how far they will actually raise rates, we do believe the end is in sight.

However, the economy remains strong, and retailers that have worked to adapt, like Helen of Troy, are seeing strong results. This stock is heavily shorted , so expect waves of covering as momentum continues to the upside. The company just reported earnings , and those results were strong with a positive outlook. We see the stock heading to $140 in the near term given the momentum and valuation . It sets up a nice trade.

Q1 headline results strong

Fiscal Q1 results were well ahead of consensus expectations . Here in Q1, shifts in consumer preferences and the fact that COVID-19 is quickly becoming a distant memory led to further changes in sales trends for the company. Flu season was a bit heavier in late winter and early spring, so that may have helped some in the quarter as well for health-care related products. The company reported sales figures that were down from last year. While the operating environment remained difficult for many retailers once again, we were impressed to see the company improve gross margin, and cash flow improved significantly during the quarter. On top of that, the restructuring efforts are paying off, and they have been able to reduce inventory, while setting targets for leverage significantly lower over the next year.

We were expecting sales to be down about 10% overall, but sales came in down 6.6% to $474.7 million, and this was a $9.3 million beat versus estimates. While higher revenues than expected were great, we really liked that margins improved, which also helped deliver an EPS beat.

Gross profit margin increased 380 basis points to 45.4%, compared to 41.6% a year ago. This is outstanding and was a big reason, combined with higher sales, that EPS beat. The increase in gross profit margin was due to a lower comparative impact of EPA compliance costs, and a more favorable product mix within the Beauty segment, primarily due to the recent acquisition of Curlsmith.

Net income was $22.6 million, compared to $24.6 million a year ago, while EPS was $0.94, compared to $1.02. The lower diluted earnings were a result of higher interest expenses associated with debt from recent acquisitions to fuel growth. Adjusted EPS came in at $1.94, and crushed estimates by $0.26, though was still down from a year ago. In short, the COVID benefits are gone, and management also has divested a lot of business lines.

Fiscal 2024 outlook

The fiscal Q1 results were strong overall on the headline numbers, and the work put in by management to right the ship has clearly paid off. Many were betting against this company succeeding, but they put out a strong guide. Julien Mininberg, CEO, summed things nicely in the release:

We significantly improved our gross profit margin and expanded adjusted operating margin during the quarter. We also delivered outstanding free cash flow as we further reduced inventory and improved working capital. In line with our stated objective, we used our strong cash flow to reduce our debt, putting us in a better position to deploy additional capital sooner... We continue to expect adjusted EPS growth in the second half of fiscal 2024. Our outlook continues to include continued pressure on several of our categories as consumers continue to adjust their spending in an environment of inflation and interest rates that are expected to remain higher... we are reiterating our outlook for the full fiscal year on sales, adjusted EPS, margin expansion, free cash flow, Pegasus savings, and year end net leverage ratio.

We like the management team here, and we expect the company continues to work through this transition. We love the margin expansion and expense controls, as well as working to reduce leverage to under 2.0X by the end of the fiscal year. Still, although the company seeks to cut expenses, EPS is going to is going to fall from last year as the business has leaned out, but has taken on new lines to fuel future growth.

In Q3 of fiscal 2023 we thought fiscal 2024 could see around $9.50 in earnings, but adjusted EPS was guided in the range of $8.50 to $9.00, which implies an adjusted diluted EPS decline of 10.1% to 4.8% from fiscal 2023. However, these earnings are likely to improve going forward beyond fiscal 2024. At the current price of $120 a share, we are trading at about 13-14X FWD EPS, which is still below the historical multiple. W We see upside from here.

Looking ahead

Helen of Troy Limited stock is still cheap, even if the growth path is on hold during this transition period. The business is leaning out, and cash flow is ramping back up. Debt will be tackled. This was a great buy under $100. We think it is moving higher, and you can shave some profit on the winnings, but we still like being exposed to Helen of Troy Limited stock here until/unless the economy really rolls over.

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