Building a business isn't always (or perhaps even often) a clean, smooth process. Management teams have to adapt to whatever circumstances come along, whether or not they happen to be convenient at the time. In the case of Helen Of Troy (Nasdaq:HELE) that means buying assets when they become available and suffering the short-term consequences in terms of margins, liquidity, and returns on capital. If this works, though, and management can fit these pieces together and start driving synergies in manufacturing and distribution, the long-run returns could be impressive.

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A Fourth Quarter with Familiar Themes
Helen Of Troy's fiscal fourth quarter was largely a lot of history repeated. Revenue rose 24%, but largely on the back of acquisitions. The housewares business saw nearly 9% topline growth, while personal care saw sales fall over 3%. "Health and home" was up roughly 80%, though, because of the impact of the Kaz and PUR acquisitions.

Margins have been deteriorating ever since the Kaz deal, and that happened again this quarter. Gross margin fell about two points this quarter, and adjusted operating income rose 16% as the company managed to recoup some of the gross profit pressure through tighter SG&A.

Unfortunately Helen Of Troy gives only a truncated balance sheet and no cash flow statement with its earnings report.

SEE: 12 Things You Need To Know About Financial Statements

Foreign Sales Aren't the Only Problem
Although management mentioned weaker foreign sales as a cause of the personal care revenue, the fact remains that the U.S. market isn't all that strong either. Both Procter & Gamble (NYSE:PG) and Unilever (NYSE:UL) reported pretty uninspiring volume performance in North America in the first quarter, and it looks like Helen Of Troy has incrementally less pricing power. Some of that may be due to the fact that a lot of its sales go through Walmart (NYSE:WMT) and Target (NYSE:TGT), but it may also speak to relative brand power.

Along those lines, Nielsen data suggests a lot more promotional activity has been going on lately, with companies like Clorox (NYSE:CLX), P&G, and Unilever being some of the most active. That also seems to be translating into incrementally higher market share, which may be partially responsible for some of the slack sales at Helen Of Troy. At the same time, it's not as though Helen Of Troy has the leverage to really move into emerging markets in a big way and replicate the double-digit growth that Unilever is seeing there today.

Can Helen of Troy Find the Scale?
One of the keys to the Helen Of Troy story working out for shareholders will be the ability for the company to integrate these acquisitions and leverage better operating performance out of a larger sales base. Luckily, one of the hardest things for smaller companies, retail distribution, is not a problem here.

What may be a problem, though, is the fact that about 80% of the company's cost of goods is tied to China. China has been seeing definite wage growth and there's always the risk of more rapid changes in the dollar-yuan exchange rate. This presents a real risk to future synergy, as does the scale of the company's operations (P&G, for instance, has a roughly eight point lead in gross margin, though the businesses are admittedly not identical).

That said, Helen Of Troy does have the advantage of giving more attention and professional management to these acquired brands; PUR may have been non-core to P&G and thus less likely to get full investment, but it will be more of a priority at Helen Of Troy. Long term, then, I think Helen Of Troy can get these improved synergies, but investors need to realize that they are key to the stock working.

SEE: The 4 R's Of Investing In Retail

The Bottom Line
The bad news about this stock is that even high single-digit compound free cash flow growth is not enough to produce an exciting target price today. Fair value seems to sit close to $40 and the company will have to start delivering better margins before the stock really looks worth accumulating.

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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