Last October I contemplated a long/short investment in Sally Beauty Holdings (NYSE: SBH) and Ulta Salon Cosmetics (Nasdaq: ULTA). The question I had was which stock was which. Ultimately, I determined that Sally was the long and Ulta wasn't a short, but Medifast (NYSE: MED) might be. It's eight months later, so I thought I'd readdress the idea to see if anything has changed and what, if any, market-neutral hedge exists in the world of beauty.
IN PICTURES: Digging Out Of Debt In 8 Steps

Five Beautiful Companies


YTD Return

1-Year Return

Ulta Salons (Nasdaq:ULTA)



Steiner Leisure (Nasdaq:STNR)



Sally Beauty Holdings (NYSE:SBH)



Regis (NYSE:RGS)



Elizabeth Arden (Nasdaq:RDEN)



S&P 500



Quarterly Revenues
With the exception of Regis, all five companies increased revenues in the latest quarter, with Steiner Leisure leading the way up 24.6% and Ulta close behind, up 19.1%. Steiner's successful quarter was helped by a 62.8% increase in its products segment, thanks in large part to its December 2009 acquisition of Bliss Spas and skin care products from Starwood Hotels (NYSE: HOT). In addition, its spa operations, which provide a majority of its total revenues, saw a 17.9% increase. As for Ulta, its same-store sales were up 10.8% in the quarter. There's nothing short about either company.

Operating Profits
Logic dictates that Steiner Leisure and Ulta most likely grew operating profits the most, and in fact, they did with Ulta's up an amazing 158.9% and Steiner's up 37.6%. Elizabeth Arden improved operating profits in the quarter by 80.1%. Unfortunately, it still generated a $1 million operating loss, down from $5.1 million the year before. Regis again came out on the short end of the stick with a decline in operating profits. A pattern is definitely starting to emerge.

Debt Levels
When investing in any stock, I like to see a margin of safety in a company's debt levels. Some people use debt-to-equity, but I prefer EBITDA to total debt because it eliminates issues involving book value that can cause you to misinterpret financial health. A classic example is Mead Johnson Nutrition (NYSE: MJN), which was spun off by Bristol Myers Squibb (NYSE: BMY) in 2009. Its book value per share is negative $2.92, the result of its special dividend to Bristol Myers. Its stock is up 120.6% since its IPO in February 2009, and it should be book value positive sometime in 2012. Anyone who uses debt-to-equity would have missed these gains. It doesn't happen often, but it's important to keep in mind when doing stock screens.

Some investors like companies with little or no debt. I personally lean that way also, but I don't mind leverage when used effectively. To maintain a margin of safety, I look for companies with trailing 12-month EBITDA greater than total debt. Of the five studied here, only Ulta and Steiner meet this condition. In 2009, I considered Sally the better long position, but that's no longer the case. Its debt levels are just too high.

My long position comes down to Ulta or Steiner. The valuation metric I'll use to determine the winner is free cash flow. In the past five years, Ulta has achieved positive free cash flow just once, in 2010. Steiner, on the other hand, has done so in all five years. In this period, Ulta invested $383 million to generate $388 million in cash from operations, while Steiner invested $171 million to generate $289 million. Steiner's free cash flow is 12.7% of sales, which is 410 basis points higher than Ulta. In my opinion, Steiner is the better long position. As for the shorts, nothing really grabs me. Elizabeth Arden has the worst free cash situation of the three possibilities, but its current ratio sits comfortably above two. Regis and Sally both have their issues, but they continue to generate free cash. Until this changes, I'd have a hard time betting against them.

Bottom Line
It appears not much has changed in eight months, except that I now consider Ulta the better long over Sally. Steiner, however, is the best buy of the five due to its diversified revenue streams. It's a beautiful company indeed. (For more stock analysis, take a look at Alternatives For Yield.)

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Tickers in this Article: ULTA, SBH, STNR, RGS, RDEN, HOT, MJN, MED, BMY

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