The post's goal is uncovering companies improving productivity, profitability and capital structure. Improving these component drivers will ULTIMATELY lead to a higher ROE (a higher stock price). Warren Buffett commented the returns a company gets on equity is the key factor for a profitable investment. Simply, ROE reports how well a company is doing. My discovery process helped uncover several potentially interesting companies. For today I will focus on Regis Corp. (NYSE:RGS).
Regis Corp is the beauty industry's global leader in hair salons and cosmetology education. It owns, franchises and operates beauty salons that offer haircutting, hair coloring and markets a wide selection of professional haircare products to its customers. The Company owns, franchises or holds ownership interests in nearly 9,000 worldwide locations operating under concepts such as Supercuts, SmartStyle, MasterCuts, Regis Salons, Sassoon Salon, Cost Cutters and First Choice Haircutters.
Above, I mentioned this post started with a search for companies improving productivity, profitability and capital structure. Essentially, companies driving a future higher ROE before the stock price reflects improved results. (more on this below).
Why is Regis an attractive investment?
Let's start with the current historical and industry cheap valuation; EV/EBITDA= 6.03, P/S = .30 versus related industry = 1.70, P/B = 1.10 versus related industry = 9.50, 52-week stock price change = -19.02%, cash per share = 3.36, more current valuation measures in the table underneath.
The stock gets exciting during 02/2017 earnings call. The company announced a deeper commitment to a thoughtful strategic transformation that increases its valuable successful franchise business. Sell targeted salons to franchisees and continue to close underperforming salons and operate a smaller base of profitable company-owned salons. Although, in the early stages Huron Business Advisory was formally engaged to assist delivering and speed up the expanded franchise business model. The initial focus will be on franchising underperforming company owned SmartStyle salons in Wal-Mart (NYSE:WMT).
For the recently reported quarter, royalty revenue increased 4.3% and franchisees produced 10 consecutive years of positive same-store sales increases. Management recognizes franchisees operate units more successfully based on local knowledge of their market, labor, lower corporate overhead and employee costs. Hence, this leads to part of the rationale for the strategy shift.
It is important to recognize the much higher market valuations for a successful franchise business. The Supercuts brand alone is worth more than the current valuation. Supercuts for years has been ranked one of the best franchises by Entrepreneur magazine.
2016 Top Franchises from Entrepreneur's Franchise 500 List
2017 ranking dropped to 13 after top 5 rankings in prior years.
Technology investments are paying off as online check-ins through supercuts.com and the Supercuts app doubled in the last year. Over 2.3 million check-ins occurred in calendar 2016. Digital check-in guests show stronger repeat visit rates. Since fiscal 2012, 1,900 underperforming salons were closed. During this same time, franchise business grew by adding over 500 salons. Additionally, steps push forward to continue franchising underperforming SmartStyle locations. Another benefit besides the higher valuation for a growing stable franchise business is the increased management focus on fewer company-owned profitable salons.
From the Q2 earning call on 02/2017. "Although, we are in the early stages of our work with Huron, we're moving forward with a sense of urgency. At this point, it is not yet possible to provide further details on the pace of franchise conversions of the potential financial impact on our results. In future quarters, as our plans are solidified and we gain greater visibility, we expect to provide additional clarity as to the pace and potential impact of our franchise expansion along with enhanced disclosures on the overall profitability and performance of our franchise business."
Back to RGS investment discovery process.
Warren Buffett's vocal commitment on a company's return on its equity emphasizes its importance in making a successful long-term stock investment. Return on capital succinctly captures operational performance.
Each fragment in the ROE equation has its own underlying drivers. So, specific business attributes drive ROE (profitability* productivity* capital structure). Each equation's part forms a critical link in driving a higher value. Each measure has its own detail interconnection.
For instance, gross margins and expenses drive profitability. Asset levels, quality and turnover drive productivity, while debt and new capital needs drive capital structure. Then, working back up the value chain intangibles such as market position, loyalty, brand strength and supply chain strength drive margins and expenses.
ROE Components: Profit/Sales * Sales/Assets * Assets/Equity = ROE Return on Equity. It is also called the DuPont formula (analysis).
A: Profit/Sales =Profit Margins (PROFITABLITY)
B: Sales/Assets = Asset Turnover (PRODUCTIVITY)
C: Asset/Equity (CAPITAL STRUCTURE)
A*B*C = ROE
Profitability (Profit/Sales) financial drivers are gross margins, SGA, operating margins.
Productivity (Sales/Assets) measures asset productivity and is simply the amount of sales generated per asset dollar deployed. For example; sales/AR, sales/inventory, sales/PPE, Inventory turnover, Fixed Asset Turnover.
Below are 3 tables supporting that Regis is moving in the right direction to drive a higher ROE and a future higher stock price.
Note the improving asset turnover
Note the improving operating margins, net margins, FCF margins, EV/EBITDA
Note the reduction in share count, debt per share, total liabilities
Continuation of the aggressive share count reduction at favorable prices.
Grow the franchise business as percentage of total revenues forcing a higher market multiple.
Sale of underperforming corporate owned units to existing franchisees or close.
Activist investors Daniel Beltzman of Birch Run Capital owns 10,655,170 shares or 23.02% of the shares outstanding. Beltzman forced changes, took a board seat, removed management and pushed for Daniel Hanrahan, a former executive at Royal Caribbean Cruises (NYSE:RCL), as CEO.
Disclosure: Long RGS