Helen Of Troy Needs To Find Margin Leverage

By Stephen D. Simpson, CFA | July 10, 2012 AAA

Helen Of Troy (Nasdaq:HELE) is a classic second-chance stock. Between management's aggressive M&A philosophy and the ups and downs of the value-priced home and personal care market, these shares are surprisingly volatile for a company that markets shampoo, deodorant, garlic presses and the like.

I do like the relative scarcity value of this company, not to mention the leverage potential of acquiring neglected brands and pushing them through a surprisingly strong retail distribution network. Accordingly, while these shares are not a screaming bargain today, they are starting to look interesting for more risk-tolerant investors.

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A Disappointing Start to the Fiscal Year
Helen of Troy didn't get its 2013 fiscal year off to a great start. The company did OK on reported revenue (up more than 10% to $300 million), but organic growth was an unimpressive 1.5%. The housewares business continues to grow nicely (rev up 14%), but the personal care (down 4%) and healthcare/home (up 2% organic) weren't all that strong at all.

Where I was most disappointed was at the gross margin line. At 40.4%, gross margin was consistent with the prior quarter's and down just 10 basis points from last year, but part of the bull thesis on Helen of Troy has revolved around stronger margins built around innovation-led price increases. Unfortunately, input-cost inflation remains a significant headwind. Helen of Troy did relatively better on its SG&A line, but operating income only grew about 1%.

SEE: Understanding The Income Statement

Can Helen of Troy Boost Prices Without Heavy Promotion?
Helen of Troy may find that boosting gross margin through stronger pricing is a tough goal to realize. Nielsen data has shown a lot of promotional activity from much larger competitors like Unilever (NYSE:UL), Procter & Gamble (NYSE:PG) and Clorox (NYSE:CLX), and it may be harder for shoppers to justify paying a little more for a PUR pitcher or Vidal Sassoon shampoo if they're holding a coupon for Clorox's Brita or Unilever's TRESemme.

Similarly, Helen of Troy's performance doesn't look so dramatically different than its larger rivals. Input cost inflation has been problematic for Church & Dwight (NYSE:CHD), Henkel, Beiersdorf, Reckitt, P&G and just about everybody else in the broader home and personal care space. Moreover, these companies are seeing a lot of the same private label intrusion as packaged food companies. What makes Helen of Troy different, then, is largely its balance sheet and the company's need for greater margin leverage to meet targets.

SEE: Earning Forecasts: A Primer

The Bottom Line
Management missed the average Wall Street guess by about 12 cents, but only lowered its full-year guidance by 10 cents. This tells me that management expects conditions to get better later this year, and that's a familiar theme from companies in this sector. I'm not completely convinced, though, so I think investors might do well to regard this guidance as "optimistic."

That said, I still do see some long-term value in this story. I do like management's basic operating philosophy, and I think many investors will be surprised to see the brands that they market. Helen of Troy isn't quite cheap enough to meet my standards for a new buy, but it's getting close and this is a name that I could see myself owning if the stock were to pull back into the mid/high-$20s, or if margins start to improve.

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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