Beauty Health: Time For The Rally To Get Some Beauty Rest

Summary

• Beauty Health reported Q3 earnings highlighted by strong growth momentum for its HydraFacial skin treatment system.
• Shares sold off on the report, with the market likely focusing on higher operating costs which pressured the adjusted EBITDA.
• While Beauty Health remains an impressive growth story, a lofty valuation and earnings uncertainty likely limit the near-term upside in the stock.
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The Beauty Health Company (NASDAQ:SKIN) commercializes the "HydraFacial" skin treatment system and related personal care products. The company has generated strong growth over the last two decades, largely creating the category for non-invasive skin resurfacing becoming a standard in the spa and beauty industry. The stock has been a big winner this year since the May SPAC reverse-merger IPO with shares up over 100% in the last six months. Indeed, the company just reported its latest quarterly result highlighted by impressive sales momentum and positive guidance from management. We like the products and believe the company will continue to benefit from the climbing demand for spa services in the broader theme of health and wellness. While the long-term outlook is positive, a demanding valuation likely limits the near-term upside in the stock and warrants caution. Climbing expenses to fund an international expansion add uncertainty to the earnings expectations.

(Seeking Alpha)

SKIN Q3 Earnings Recap

The first point here is that shares of SKIN traded sharply lower on the earnings release, falling by as much as 13%. That said, the move is in the context of the stock previously trading at an all-time high and up nearly 20% in just the past month. The broader market weakness was also trading down on the day, likely adding to the volatility.

Q3 EPS of -$1.63 missed the consensus estimate by $1.61 although this was largely based on an accounting impact of a change in the fair value of warrant liability. Nevertheless, the adjusted net income of $2.5 million climbed from $0.9 million in the period last year. Revenue of $68.1 million climbed 97% year-over-year, and also up 72% on a two-year stacked basis against Q3 2019 as a pre-pandemic benchmark. Management noted continued strength in the U.S. and significant growth in the APAC region despite some ongoing Covid disruptions.

(source: company IR)

Favorably, the gross margin has been strong, reaching 67.6%, or 71.5% on an adjusted basis from an adjusted 68.3% in Q3 2020. The company has been able to drive higher pricing for the HydraFacial delivery system which is the core piece of equipment sold to spas, dermatological clinics, hotels, and resorts where estheticians apply the treatments to consumers. Unit sales climbed 128% y/y to $36.2 million which ends up supporting a higher base of demand for the consumables going forward. On that point, consumables net sales which include single-use serums, tips, and boosters increased by 72% y/y to $32.0 million.

(source: company IR)

Higher costs were also a theme this quarter. SG&A expenses climbed 182% y/y which ended up pressuring earnings. The company has also been investing in R&D for the next generation of technology. The adjusted EBITDA margin at 8.5% fell from 21.9% in the period last year although the expectation is for this trend to stabilize as the company benefits from scale.

The company ended the quarter with $719 million in cash and equivalents against $1.1 billion in total liabilities. In September, Beauty Health issued $750 million in convertible senior notes with the intention of funding growth opportunities including potential future acquisitions. We view the balance sheet and liquidity profile as a strong point in the company's investment profile.

In terms of guidance, management expects full-year net sales between $245 million and $255 million, which was revision higher compared to the prior midpoint estimate of $235 million. Similarly, the company now expects adjusted EBITDA of approximately $30 million, up from the prior guidance of $25 million. Overall, management is confident that the growth momentum will extend through 2022.

(source: company IR)

SKIN Stock Forecast

Data suggest that U.S. medical spa services are expected to grow 11.1% on average per year through 2025. The number of new spa facilities in the U.S. is also growing around 6.4% which is a core driver of new delivery system hardware with an expectation that these facilities will need a HydraFacial unit. These are positive tailwinds for Beauty Health.

(source: company IR)

The real attraction here is the international opportunity considering the treatments are available in over 87 countries including 15 that are directly covered by Beauty Health operations. The understanding is that as more consumers experience the treatment for the first time, many will return as repeat customers representing a growing installed base. This is part of the company's growth flywheel supporting a competitive advantage based on brand recognition and customer engagement. The company notes that 15% of users get 4 or more HydraFacial treatments per year.

(source: company IR)

For the actual spas, clinics, treatment centers that purchase the system, the value proposition is an impressive payback period of just 5 months acting as an incentive for the industry to remain on the platform. The company continues to invest in a next-generation system that will integrate with a consumer mobile app adding to some monetization potential. From a high-level perspective, several themes are favorable for the business model, including a growing awareness of the health benefits of the treatments that complement other types of skincare solutions. There is also a thought that the company will benefit from an expanding demographic of users worldwide, including a growing proportion of male users.

(source: company IR)

As it relates to the stock as an investment, the challenge here comes down to valuation. Management's revenue guidance for 2021 implies SKIN is trading at a 15x forward sales ratio which is a pricey premium in our opinion. According to consensus estimates, SKIN is forecast to reach an adjusted EPS of $0.07 this year implying a forward P/E of 382x. On one hand, these multiples can be justified considering the strong growth and recognizing the company's industry dominance. Still, getting into 2022, SKIN will begin to face what is a tough comparison period against the 2021 results evident by a slowdown in growth forecasted at 23%. Our take is that the stock will begin to look expensive by next year as the growth stabilizes against a 1-year forward P/E of 273x based on the consensus EPS estimate.

(Seeking Alpha)

Putting it all together, we are skeptical that the growth momentum can be maintained over the next 5-10 years to justify the stock's current ~$3.7 billion valuation. Assuming Beauty Health has already captured the "low hanging fruit" of targeted clinics that purchased the HydraFacial unit in the U.S. and early adopters in international regions, there is a risk that sales underperform going forward with more of the business shifting towards consumables.

Final Thoughts

There's a lot to like about Beauty Health which has emerged as a "MedTech" and wellness leader benefiting from several growth tailwinds. The outlook is fine but, in our opinion, not strong enough to take a bullish view on the stock at the current level even considering the recent pullback. The cost pressures this quarter driving a lower adjusted EBITDA margin raise uncertainties regarding the long-term earnings potential.

We rate SKIN as a hold with a $25.00 price target considering the current market cap and 15x forward sales ratio as a fair value. On the downside, any further correction under $20 may set up a new tactical buying opportunity with an improved reward to risk setup. Looking ahead, we expect the stock to remain volatile and highly sensitive to growth estimates.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.