2023-09-14 11:14:15 ET
Summary
- Investors have an unfavorable view of the consumer discretionary sector's prospects, and this translates into lower valuation multiples for consumer discretionary stocks like Sally Beauty Holdings.
- I deem Sally Beauty Holdings to be a resilient business in difficult times, considering the company's product exclusivity strategy and its new store concept targeting value-conscious consumers.
- I revise my rating for Sally Beauty Holdings to a Hold, taking into account both the company's strategies and the market environment.
Elevator Pitch
I assign a Hold investment rating to Sally Beauty Holdings, Inc. ( SBH ) stock. In my prior July 3, 2023 article , I wrote about SBH's guidance for the current fiscal year and the company's loyalty membership.
My decision is to downgrade Sally Beauty Holdings' rating from a Buy previously to a Hold now. Investor sentiment for the consumer discretionary sector is pretty weak, and this justifies a valuation de-rating for SBH. However, a Sell rating is unwarranted. I deem SBH to be a relatively more defensive play within the sector, considering its recent quarterly operating metrics and the new value-focused Happy Beauty retail store format.
The Market Has A Negative View Of The Consumer Discretionary Sector
SBH's stock price fell by -13.5% in the last one month. This represents a significant degree of underperformance as compared to the S&P 500, which rose marginally by +0.1% during the same time period.
Sally Beauty Holdings' recent share price underperformance can't be solely attributed to the company's Q3 FY 2023 (YE September 30) earnings release.
The company's shares only declined slightly by -0.9% on August 3, 2023, the day when SBH announced its recent quarterly results on the same day in the morning before trading hours. The actual third quarter top line and bottom line for Sally Beauty Holdings missed the Wall Street analysts' consensus financial forecasts by -1.7% and -2.0% , respectively. But Sally Beauty stuck with its earlier FY 2023 sales guidance, and the company even raised the mid-point of its full-year operating margin guidance from 9.0% to 9.2%.
Instead, it seems that negative investor sentiment regarding the consumer discretionary sector has hurt Sally Beauty Holdings' shares. On the company's Seeking Alpha stock profile page, SBH is highlighted as being a stock that belongs to the consumer discretionary sector.
A recent September 12, 2023 S&P Global Market Intelligence article noted that "consumer discretionary remains the most-shorted sector on all major US stock exchanges" and "topped all sectors for lowered corporate guidance." Seeking Alpha News also reported on September 9, 2023 that the "prevailing" market view is that "consumer discretionary spending headwinds will hold back share price returns" for retailers this year and early next year.
The market's unfavorable opinion of the consumer discretionary sector is reflected in the changes to Sally Beauty Holdings' consensus financial estimates and price targets.
Even though SBH left its FY 2023 net sales guidance unchanged as mentioned earlier, five of the six sell-side analysts covering SBH's shares cut their Q4 FY 2023 top-line projections for the company in the past three months. In specific terms, the fourth quarter revenue forecast for Sally Beauty Holdings was revised downwards by -2.6% in the recent month.
Also, Wall Street's consensus target price for Sally Beauty Holdings was reduced by -20% from $15.70 at the beginning of August this year to $12.60 now. During the same period, SBH suffered from meaningful valuation multiple de-rating, as the stock's consensus forward the next twelve months' normalized P/E decreased from 6.1 times to 4.7 times.
In a nutshell, investors are becoming increasingly cautious about the economic outlook, and they have a negative view of the consumer discretionary sector as a result. This is one of the key factors leading to the underperformance of SBH's shares in recent times.
But I See SBH As A Good Company In A Bad Sector
Consumer discretionary is now perceived to be a "bad" sector, as this sector's performance is highly correlated with economic growth. But I will argue that Sally Beauty is one of the "good" investment candidates in the consumer discretionary sector, as I think that SBH is relatively more resilient than other consumer discretionary businesses in the face of macroeconomic pressures.
An August 25, 2023 Seeking Alpha News article cited Piper Sandler's most recent "quarterly salon survey" which indicated that SBH achieved "better survey results" than its peers, which makes it "a well-hedged business in the (weak) macro" environment. The sell-side research firm's findings appear to be consistent with Sally Beauty Holdings' most recent quarterly operating performance.
At its third quarter results call last month, SBH disclosed that the Beauty Systems Group (professionals) segment witnessed a +1% growth in comparable transactions in Q3 FY 2023, while comparable transactions were flat for the Sally Beauty Supply (consumers) segment for the recent quarter. Sally Beauty Holdings referred to these decent operating metrics achieved in a difficult economic environment as evidence of "a healthy ongoing engagement we have with our customer base" at its most recent quarterly earnings briefing.
Product exclusivity is a key strategy that enables SBH to retain the company's existing clients. As revealed in the company's Q3 FY 2023 results presentation , approximately half and a third of Beauty Systems Group and Sally Beauty Supply's products are "from brands under exclusive/limited distribution agreements" and "owned brands", respectively.
More significantly, SBH has made a shrewd move to put itself in a better position to survive and thrive in a weak economy with a new store format. In the company's Q3 FY 2023 earnings release , Sally Beauty Holdings disclosed the "launch of Happy Beauty Co., a unique new retail store concept" with products "priced under $10." At its most recent quarterly earnings call, SBH stressed that the Happy Beauty stores will be aimed at catering to the needs of "millennials, value seekers of all ages, discount beauty buyers," and those "from households making under $60,000 a year."
In summary, while I acknowledge that the consumer discretionary sector as a whole is likely to be under pressure in the current macroeconomic environment, SBH has what it takes to perform reasonably well during tough times like these.
Concluding Thoughts
Sally Beauty Holdings, Inc. is likely to fare better than most of its consumer discretionary peers going forward. The company's recent quarterly comparable transactions numbers were decent, and its new Happy Beauty stores are expected to allow Sally Beauty Holdings to grab a greater share of value consumers' beauty budgets.
But SBH isn't immune to negative market sentiment for the consumer discretionary sectors, and it will be challenging for Sally Beauty Holdings to witness a favorable re-rating of its valuations in the short term. Therefore, I have chosen to award a Hold rating to Sally Beauty Holdings.
For further details see:
Sally Beauty: Tough Times For A Good Business (Rating Downgrade)