Sally Magnificence: A Deep-Worth Winner, No one Is Speaking About (NYSE:SBH)

Founded as a single New Orleans store during 1964, Sally Beauty Holdings, Inc. (NYSE:SBH) has grown to 4,000 stores in 12 countries today. $3.8 billion in annual sales and 27,000 employees round out the background story, with one of the biggest retail footprints in America. The business focuses on hair and beauty products marketed directly to consumers online and through physical stores. A second avenue for revenue generation revolves around a list of thousands of beauty-care products wholesaled and sold to salons and professional stylists.

Unfortunately for long-term shareholders, the stock quote has zigzagged lower for nearly two decades, after peaking in the mid-$50s during 2005. In addition, the company doesn’t pay a dividend for those patiently remaining long a position.

For a bullish catalyst, the Q2 FY 2024 earnings release is scheduled for early morning on May 9th. My thinking is a positive readout could bring attention to its radically undervalued shares. For sure, a trailing free cash flow yield of 12%, with a loyal customer base (77% of sales are tracked to repeat shoppers and businesses), and a history of slowly rising results with inflation (on a per-share basis), are worth something to an owner.

In my research, Sally stands out as a retail sector bargain. And, following several months of share price decline, a reversal into a bullish trend is looking more probable by the day. Technical trading momentum is signaling the stock is just waiting for some positive company news to bounce higher.

I purchased a stake this week, anticipating a solid earnings report and or better guidance for the year from management. If such plays out, Sally’s $10-11 quote over the past week could rise +50% or greater closer to the early 2023 high number of $18 by the end of this year. Here’s some of my thinking in a nutshell.

Undervaluation Setup

Using basic fundamental valuation analysis, a trailing price to earnings ratio of 6.7x and price to sales reading of 0.31x have rarely been lower over the last 17 years (as far back as YCharts will go). Excluding last autumn’s lower valuation, you have to go back to the recession lows of 2008 and 2020 to find similar ratios. Both P/E and P/S numbers are roughly 50% discounts to their 10-year averages.

The truly bullish valuation data is found after we take into account falling debt totals over time. The enterprise value sum of total equity value, plus total debt, minus cash on the balance sheet, highlights a significantly lower real-world valuation if the company were taken private or acquired by another beauty-based business. Honestly, the current EV to EBITDA ratio of 5x and EV to Revenue multiple of 0.55x are entering deep-value territory. Since 2007, only readings during September and October of last year were cheaper for new share buyers than May 2024. That’s right, the valuation now is an even bigger bargain on the whole business and financial setup than previous recession lows!

In addition, the enterprise undervaluation is a real eye-opener vs. peer beauty product retailers or hybrid manufactures with some in-house retail operations (online or physical stores). There is really no valuation comparison in my peer sort group of Ulta Beauty (ULTA), Bath & Body Works (BBWI), Estee Lauder (EL), e.l.f. Beauty (ELF), Coty (COTY), Inter Parfums (IPAR), and Edgewell Personal Care (EPC).

Seeking Alpha’s Quant Valuation Grade for SBH is listed as an “A” vs. the sort universe of thousands of equities. A comparison of various valuation stats to Sally’s 5-year underlying fundamental averages and current readings from peers and competitors are part of the ranking formula.

Final Thoughts

One excuse for Sally’s ultra-low valuation is it carries a fairly high net financial debt total of $900 million (excluding store leases) vs. an equity market value of $1.1 billion at $10.59 per share. However, net financial debt is down from $1.8 billion in 2017, while a very large negative tangible book value number of -$7.58 per share in 2017 has risen close to breakeven at -$0.48 a share in 2024. All of this has been accomplished while repurchasing 30% of shares outstanding over the last decade.

The conclusion is shares were both MORE leveraged in the past and MORE richly valued than today. That’s the opposite of how things usually work. When leverage comes down, valuations usually RISE. So, the disconnect at Sally Beauty is getting a little absurd.

Even with rising interest expense on debt, earnings are expected to climb nearer $2 per share next fiscal year (ending in September), on only slight revenue gains. What if sales beat expectations? Won’t earnings grow even faster? With an ability to buy SBH shares today at a low-balled 5x forward EPS, shouldn’t you seriously consider this undervalued proposition when the overall U.S. equity market is priced at 25x?

A building bullish technical narrative is also hard to ignore. Below, I have drawn an 18-month chart of trading activity. The first point to make is On Balance, Volume bottomed in September and has performed extremely well since. Negative Volume Index readings bottomed in October, likely signaling less overhead share supply may now exist.

The most interesting part of the chart readout is the 20-day Chaikin Money Flow calculation just flipped to a positive number after several months of steady selling. And, this turn is happening right on its 200-day moving average (possibly acting as support). My gold arrows and circles highlight past patterns in the CMF indicator turning positive after several months of consistent selling. Each of the previous instances pinpointed a price bottom had just been reached or was only weeks away (example September 2023).

What are the downside risks of owning a position? I suppose the quick answer is a severe recession would put real stress on the business. Yet, I doubt Sally Beauty Holdings is going away in a serious recession. It has already survived at least 7 recessions over 60 years.

The retail business model is Sally takes a small percentage of sales, with the ability to close weaker stores, and adjust costs vs. demand/traffic with changing labor wages and employee hours worked. Steady consumer demand, even during recession, alongside some flexibility to control costs, have allowed the company to survive and thrive over many decades.

Otherwise, the share valuation is so low, trading under last year’s multi-decade enterprise valuation low may be difficult. I am using $7 a share as my worst-case scenario for downside potential (-35% investment return). For upsides, a rise to $20 a share (nearly +100% investor gain) is not impossible over the next 12-18 months, if the U.S. economy continues to expand and SBH beats sales/EPS expectations. $20 would get SBH back to 10-year average valuations. Better than analyst-projected 5% sales expansion and 10% income gains for 2024-25 might be the catalyst to get shares rerated higher in price. That’s why Thursday’s quarterly update carries real opportunity.

I rate Sally Beauty shares a Buy and own a small position in my diversified portfolio.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.