HELE - Helen of Troy: Low Valuation But Near-Term Uncertainties

2023-03-22 10:55:08 ET

Summary

• Near-term headwinds from lower consumer demand, inventory destocking, inflationary costs, and volume deleverage are a concern for sales and margins.
• In the medium to longer term, cost-saving initiatives should help margin recovery but the recent CFO's departure has added some uncertainties.
• Valuation is significantly lower than the historical average.

Investment Thesis

Helen of Troy Limited (HELE) is expected to face revenue growth challenges due to near-term headwinds such as tight consumer spending and continued retail inventory destocking. In terms of margins, inflationary costs and operating deleveraging continue to pose challenges in the near term, but HELE's restructuring and cost-saving initiatives should support margin recovery in the medium to longer term. However, the recent departure of the company's CFO amidst the company's restructuring plan has added to the uncertainty.

While the stock is trading at a significant discount to its historical valuations, the current near-term headwinds and added uncertainty keep me on the sidelines and I prefer to wait until the company's fundamentals bottom and long-term growth prospects gain traction. Hence, I have a neutral rating on the stock.

Revenue Analysis and Outlook

In December, I covered HELE and recommended waiting on the sidelines due to headwinds from tight consumer spending and retail inventory destocking, which were expected to continue affecting revenue growth. Since then, the company has reported its Q3FY23 earnings, which showed similar dynamics. The company's sales declined by 10.6% Y/Y to $558.6 million in the third quarter due to lower consumer confidence and retail inventory destocking. Excluding a 9% benefit from the acquisition and a 1.1% FX headwind, organic sales declined 18.5% Y/Y.

Looking ahead, I anticipate that headwinds from lower demand and retail inventory adjustments will continue to negatively impact HELE's sales growth in the near term. The company's end-market is expected to remain soft due to consumers tightening their spending on discretionary products and trading down to lower-priced products in the case of non-discretionary products. This softening of demand in the end market should continue to be a major headwind for HELE's sales growth in the near term.

In addition, the company is lapping retail inventory build in Q4 of fiscal 2022 as customers stocked up ahead of price increases last year, which should also pressure sales in Q4 due to difficult comps. In Q4 FY2022, sales were up 14.3% Y/Y versus down 2% in Q3 FY2022. So, Y/Y sales comparisons are significantly difficult for Q4 FY2023.

Furthermore, retail inventory destocking is expected to continue over the next couple of quarters due to lower sell-through, which should pressure sales growth. So, the near-term revenue growth outlook does not look encouraging at least for the next couple of quarters. In the medium to long term, however, once the inventory destocking ends and consumer spending starts recovering, the company should return to growth but it might take some time.

Margin Analysis and Outlook

In the third quarter of fiscal 2023, HELE was negatively impacted by inflationary costs and operating deleveraging due to lower sales and higher SG&A as a percentage of sales. However, the decline was partially offset by an increase in adjusted gross margin due to a favorable product mix and price increases, as well as lower incentive compensation expenses. As a result, the adjusted operating margin declined by 40 bps Y/Y to 16.6%.

Looking ahead, I expect that margins should remain under pressure in the near term due to higher costs and continued operating deleveraging. However, HELE is taking steps to restructure its costs to recover margins in the medium to longer term. Project Pegasus, which launched in Q2FY23, is expected to achieve annualized pre-tax operating profit improvements of $75 million to $85 million by the end of fiscal 2026. The company estimates that 25% of the savings from this project will be recognized in fiscal 2024, another 50% in fiscal 2025, and the final 25% in fiscal 2026.

Since my previous coverage, HELE has taken various measures to achieve these cost savings targets. The company plans to reduce headcounts by 10% by the end of fiscal 2023, which should support COGS savings to be recognized in FY24. It has also opened a Regional Market Organization (RMO) for North America to centralize operational processes, which should further help improve productivity and achieve savings from increased speed, eliminating duplication, and standardizing processes.

Additionally, the company has combined its Beauty and Health & Wellness segments into the 'Beauty and Wellness' segment to achieve cost synergies in operations, such as reduced COGS through shared raw materials. Moreover, HELE is focused on reducing its inventory levels, which should help increase its inventory turnover ratio and generate profitability in the medium term.

Overall, I expect these initiatives to support HELE's margin expansion beyond FY24. However, one thing that worries me is the recent departure of CFO Matt Osberg in the middle of this restructuring and transformation plan. Osberg left the company to pursue another opportunity early in March. The departure of such a high-level executive when the company is undergoing this crucial transformation project does add some uncertainties to the further execution of the plan. While I am optimistic about the company's long-term margin improvement prospects, I will be carefully watching out for their execution in this regard and the CFO transition plan.

Valuation and Conclusion

HELE's current trading multiple of ~10.01x FY23 consensus EPS estimate of $9.22 and ~10.43x FY24 consensus EPS estimate of $8.85 is at a discount to its historical 5-year average forward P/E of 16.81x. However, while the valuation is much lower than the historical average, the company still faces near-term headwinds, and its fundamentals have yet to bottom out. While the company's longer-term margin improvement plans are encouraging, the recent CFO departure has added additional uncertainty and one has to closely follow the company's execution in this regard. Therefore, it may be prudent to wait on the sidelines until the cost-restructuring initiatives start generating savings and the near-term headwinds subside before turning positive on the stock. As a result, I have a neutral rating on the stock, despite its low valuation.

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