Monday’s news Amazon (NASDAQ:AMZN) was launching a beauty store for professionals did nothing for Amazon stock, or at least for its stock price.
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However, Sally Beauty (NYSE:SBH) and Ulta Beauty (NASDAQ:ULTA) lost 17% and 3% respectively as investors ran for the exits. After all, Amazon’s scale and size make it an industry crusher.
It’s not the news any retailer wants to hear. That Amazon is opening a store geared toward your vertical. While Sally Beauty could get hurt by the news, Ulta is not going to be bothered by Amazon’s latest move. It’s just not.
Amazon’s Move Won’t Hurt ULTA
Ulta Beauty CEO Mary Dillon has built a tremendous omnichannel business full of loyal customers who spend more online and off combined than if the company operated its online and in-store businesses independent of each other. It’s more about the experience while providing reasonable prices for its end-user customers.
That’s because Ulta’s customer isn’t the beauty professional, it’s the beauty enthusiast, “a consumer who is passionate about the beauty category and has high expectations for the shopping experience,” states its 2018 10-K. “We estimate that beauty enthusiasts represent approximately 57% of shoppers and 77% of spend in the U.S. beauty category.”
To purchase products in the Amazon beauty store, a customer must have a state-issued cosmetology, barber, or aesthetician license. It’s an entirely different kettle of fish.
If you own ULTA stock, you can breathe a little easier. If you own shares of SBH stock, you might be in for a wild ride over the next few days and weeks. If you own Amazon stock, it’s not a material announcement by any means.
However, the latest move by Amazon could provide a buying opportunity for Sally Beauty stock. Here’s why.
This Will Hurt SBH
Although this was initially supposed to be a story about Amazon stock, I couldn’t help but think of the value proposition investors have been handed with Sally Beauty due to Amazon’s ever-reaching tentacles.
I’ve said it before: Amazon wants to own your home.
Not literally mind you, but everything you use and purchase to run your home, you’ll buy from or through them. And while the latest move suggests that Amazon also wants to gain a more significant piece of the business-to-business market (excluding AWS), which is excellent news if you own AMZN stock, it puts downward pressure on SBH stock because of company’s business model.
According to DA Davidson analysts, Amazon’s entry will directly affect 19% of Sally Beauty’s operating profit while an additional 33% could be under duress to the increased competition.
That’s not good news if you’re a company like SBH that’s seen sales and operating profits go sideways over the past five years; revenues have grown by 1.7% annually while operating profits have declined by 2.4% annually over the same period. By comparison, Ulta’s increased the top line by 20.3% annually and operating earnings by 21.1% per year over the same five years.
As the company continues to work on turning around its business, SBH shares have continued to fall losing 24.2% annually over the past three years; it’s down 27.9% year to date through June 24.
The latest move by Amazon has added salt to an open wound.
That being said, where others are fearful provides opportunity.
It’s Getting Cheaper By the Day
In Sally Beauty’s latest six months ended March 31, it generated an operating profit of $222.3 million on $1.94 billion in revenue. Both revenues and operating profits were flat year over year.
Sally Beauty’s Achilles heel has always been its long-term debt.
Back in 2017, I compared SBH to ULTA. There was no comparison. While ULTA had $415 million in net cash, SBH had $1.8 billion in net debt. The gap hasn’t changed in the two years since.
However, something caught my eye from my 2017 article that suggests aggressive investors consider SBH stock.
In May 2017, it was trading at 8.5 times cash flow while free cash flow accounted for 11.4% of its annual sales. Flash forward to June 2019 and Sally Beauty is trading at less than five times cash flow while free cash flow as a percentage of sales has declined to 5.4%.
That right there is why only aggressive investors ought to consider buying SBH stock. Without free cash flow, it’s going to be challenging to reduce its long-term debt, which currently accounts for 115% of its market cap.
Although the company expects to generate just $220 million of free cash flow in fiscal 2019, down from $287 million in 2018, its multi-year transformation continues to make progress, especially on the e-commerce front where revenues are growing by 30% a quarter.
The Bottom Line on the Amazon News
The gamble at this point is whether Sally Beauty can do enough on the ecommerce front to combat what Amazon’s doing with its professional beauty store while continuing the company’s transformation.
At a free cash flow yield of 7.1% [free cash flow of $220 million divided by $3.1 billion enterprise value], if you’ve got a gambler’s streak in you, SBH looks like it’s entering value territory.
For everyone else, buy Amazon stock and call it a day.
At the time of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.