HELE - Helen of Troy: Moving To Buy Given Improving Growth Prospects (Rating Upgrade)

2023-07-11 12:41:11 ET

Summary

• Helen of Troy Limited's revenue growth is expected to benefit from the completion of retail inventory adjustments, with revenue recovery predicted for the second half of the fiscal year.
• The company is expected to continue its margin expansion due to cost-saving initiatives, lower freight costs, and an improved business portfolio mix.
• Valuation is attractive.

Investment Thesis

Helen Of Troy Limited's ( HELE ) revenue growth is expected to benefit from the normalization of retail inventory adjustments and an increase in replenishment orders due to better alignment of sell-in with sell-through. This should help the company in the sequential recovery of revenue. Moreover, the company is also focused on increasing market share through new product launches that are developed to meet the changing consumer preferences and demand trends. This should help the company partially offset lower demand for discretionary products in an inflationary environment. Hence, the revenue decline should bottom soon and the company should see revenue recovery moving forward in the second half of the fiscal year.

On the margin front, the company is expected to improve margins with the help of cost savings initiatives, supply chain efficiencies, improving product mix, and a favorable cost environment. Moreover, the new management is also progressing well in executing the cost-saving initiatives and improving the margin profile for the company. So, the normalization of retail inventory levels and the success of new management's execution around the cost-saving measures has given me some confidence about the growth prospects ahead. I believe it is fair to upgrade the rating to buy given the lower-than-historical valuation and improving growth prospects.

Q1 FY2024 Earnings

Helen of Troy reported better-than-expected results for the first quarter of fiscal 2024 yesterday. The company's revenue decreased by 7.7% organically or by 6.6% YoY on a reported basis to $474.5 million, exceeding the consensus estimate of $465.3 million. Adjusted EPS declined by 19.5% YoY to $1.94, however, surpassing the consensus EPS estimate of $1.59. The adjusted operating margin grew 30 bps YoY to 13.9%. The revenue decline was driven by lower demand for discretionary products, partially offset by the normalization of retail inventory adjustments. Margins increased due to favorable inbound freight costs and an improved product portfolio. Adjusted EPS declined as a result of lower adjusted operating income and higher interest expense.

Revenue Analysis and Outlook

In my previous article , I was concerned about HELE's revenue growth prospects in the near term due to lower consumer demand for discretionary items in an inflationary environment. The company reported its first quarter of fiscal 2024 earnings yesterday, and similar dynamics were seen there. However, the company was able to post better-than-expected revenue growth with the help of a surge in demand for travel-related products ahead of the summer season and near completion of retail inventory destocking.

In the first quarter, lower consumer demand for general merchandise in an inflationary environment continued to impact sales negatively. The sales decline also reflects the impact of SKU reductions within the Beauty and Wellness segment over the last year in order to improve the product mix. This was partially offset by good demand for the prestige beauty category and travel-related products like backpacks. This resulted in a 6.6% YoY decline in revenue to $474.7 million. Excluding a 1.2 percentage point benefit from acquisition synergies and a 0.1 percentage point FX headwind, sales declined by 7.7% YoY on an organic basis. On a segment basis, the home and Outdoor segment saw a decline of 7.2% YoY on an organic basis and the Beauty and wellness segment declined by 8.1% YoY organically.

Looking forward, while the near-term concerns around consumer demand in an inflationary environment should continue to impact the sales growth for the coming quarter, the company should be able to resume revenue recovery in the back half of the fiscal year with the help of the normalization of the retail inventory adjustment. The company should also benefit from easing comparisons, improving demand in the prestige beauty category and outdoor travel category, and increasing investments in marketing and new product development.

Over the last year, the biggest pain point for the company's sales growth was the continuous retail inventory adjustments. In the first half of the calendar year 2022, retailers stocked surplus inventory in advance, ahead of price increases and supply challenges. However, in the back half of the year, consumer demand started to soften as a result of the inflationary environment. This led to major inventory destocking both domestically and internationally, which affected HELE's sales. Now, the company is seeing a normalization of retail inventory as destocking has been completed at major retailers and HELE's sell-through better aligns with end-consumer demand. As a result, HELE saw an increase in replenishment orders in the first quarter due to the normalization of retail inventory levels.

This increase in replenishment orders was not only experienced in the U.S. but internationally as well. The company has also increased its international exposure from ~22% of total sales in fiscal 2022 to ~26% of total sales in fiscal 2023. The major contributor to this international expansion was the EMEA region (now totaling 13% of total sales) where the company is seeing good strength in demand and an increase in replenishment orders. The company expects replenishment orders to further increase due to a more in-line sell-in and sell-through as compared to fiscal 2023. This increase in replenishment orders globally should help in the sequential recovery of sales in the coming quarters.

While in the near term consumer demand is still tough, I believe this normalization of retail inventory and easing comparisons in the back half of this year should benefit HELE's sales. Moreover, last quarter, the company also saw sequential improvements in market share in some of its categories which helped it partially offset the softness in weaker demand categories. These include outdoor travel and prestige beauty categories.

Post-Covid, the travel market is experiencing positive trends in demand as people across the globe continue to indulge more in outdoor activities. This demand is usually high ahead of the summer season and this year witnessed a strong surge in demand for the outdoor category products. HELE expects this demand trend to keep moving in a positive direction for the coming quarter as well. In addition to travel-related products, the prestige beauty category is also helping the company's sales. This is due to the good strength of the Curlsmith brand, which the company acquired in April 2022.

To further offset the lower demand in the discretionary categories, the company is also increasing its investments in promotions and new product innovations. The company is planning to increase promotional activity in the prestige beauty category during the upcoming holiday season in order to further increase its market share and support sales recovery. Moreover, the company saw softness in its Hydro Flask bottle category in the previous few quarters due to shifting consumer preference to tumblers from bottles. In response, in the month of June, the company improvised and launched its own Hydro Flask tumbler in order to benefit from shifting consumer trends. HELE saw good strength in the tumbler sale in the first few weeks of its launch and expects this launch to support the brand moving forward. So, I believe increasing investments in new product launches and product portfolio improvement as per the changing consumer preferences should also help the company in improving sales despite lower discretionary spending.

The normalization of the retail inventories, the increase in replenishment orders, and the company's efforts to gain market share through promotions and new product innovations in the first quarter give me some confidence around revenue recovery in the coming quarters. While I expect YoY sales to decline for Q2 FY24 as well given the continued softness in the discretionary categories, I believe the company should be able to post positive Y/Y revenue growth beginning in the third quarter of fiscal 2024 as the comparisons ease. So, revenue decline should bottom in the second quarter and improve from there. In a nutshell, I am optimistic about the medium to long-term sales growth prospects of the company.

Margin Analysis and Outlook

In the first quarter of fiscal 2024, HELE saw continued headwinds from operating deleveraging from lower sales generation. However, the company was able to more than offset it through cost-saving initiatives, lower inbound freight costs, and a favorable product mix within Beauty & Wellness, reflecting the benefits of SKU rationalization over the past fiscal year. This resulted in a 380 bps YoY increase in adjusted gross margin at 45.4% and a 30 bps YoY increase in adjusted operating margin to 13.9%.

Looking forward, the company should continue its margin expansion as it continues to benefit from lower freight costs, increasing cost-saving measures, and improving its business portfolio mix.

Over the last couple of quarters, the company has been experiencing moderation in commodity and freight costs, which is helping the company improve margins. The company is projecting savings from lower freight and commodity costs to accelerate in the second half of fiscal 2024. This should continue to support margin growth in the coming quarters as well.

In addition to lower input costs as compared to fiscal 2023, the company is also progressing well with its cost-saving initiatives. To support its margin recovery, HELE launched Project Pegasus in Q2FY23, a 3-year cost-saving initiative, which aims at achieving annualized pre-tax operating profit improvements of $75 million to $85 million by the end of fiscal 2026. The company expects to realize ~$20 million in cost savings in fiscal 2024 under this initiative with accelerating benefits to be realized in fiscal 2025. The company launched the Design to Value ((DTV)) initiative in conjunction with the project. The DTV approach should help HELE in standardizing raw materials, as well as develop new product designs that are engineered to deliver better performance at a lower cost. Furthermore, the company's new Tennessee distribution center is assisting it in reducing supply chain challenges and better managing inventory in accordance with end-market demand. The company also intends to reshore manufacturing in the United States in order to reduce its reliance on China and further simplify the supply chain network. This should result in efficiency gains and also support margin growth. Moreover, the company also reduced a total of 18% SKU's in fiscal 2023 to improve its product portfolio. These SKUs were lower performing and had low-margin products, and exiting them has improved the overall portfolio mix. This should also help in margin expansion in FY24.

Clearly, the first-quarter results demonstrate the success of new management efforts in implementing these cost-saving initiatives. While the year-over-year headwind from higher depreciation and annual incentive compensation costs should adversely impact margin growth, I believe the company is well-positioned to offset them through its restructuring and cost-saving initiatives and the new management team is also performing up to expectations. So, the company should be able to expand its margins further moving forward.

Valuation and Conclusion

Helen Of Troy is currently trading at a 15.06x FY24 consensus EPS estimate of $8.85 and a 13.06x FY25 consensus EPS estimate of $10.21, which is below its historical 5-year average forward P/E of 16.71x. Previously, I preferred a wait-and-see approach to HELE's growth prospects due to near-term uncertainties in the discretionary product categories, as well as constant changes at the management level, which could have impacted the implementation of cost-cutting initiatives. However, the retail inventory normalization, increase in replenishment orders globally and the company's efforts to increase market share through improvising new products developments as per the changing consumer demand have given me some confidence around the sequential recovery of revenue moving forward and on the medium to long term revenue growth prospects.

Moreover, the new management also seems to be doing well in executing the cost-saving initiatives as demonstrated by the margin growth in the first quarter. This successful implementation of cost-saving measures along with lower commodity and freight costs should help in continued margin expansion. As a result, I believe the low valuation and improving growth prospects make HELE stock attractive. While the stock saw a good run-up after the Q1 FY2024 earning release, I believe further upside is possible given the sequential recovery of revenue and margins. In addition, the company is also doing a good job in reducing its debt and improving its leverage profile along with effectively managing its inventory levels. The company ended last quarter with a net leverage ratio of 2.56x which was an improvement compared to 2.81x at the end of the fourth quarter. I am upgrading my rating on HELE stock to a buy based on improving fundamentals.

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