Helen Of Troy Wilting Into The Fall

By Stephen D. Simpson, CFA | October 09, 2012 AAA

As a small, highly-leveraged company that must compete with brand-name goliaths such as Clorox (NYSE:CLX), Procter & Gamble (NYSE:PG) and Unilever (NYSE:UL) on a daily basis, it's not altogether surprising that Helen Of Troy (Nasdaq:HELE) shares can be very volatile. Today's poor growth numbers are certainly a concern, as are the company's long-term market position and cash flow leverage, but aggressive investors may see opportunity emerging in a company that has often been knocked down, only to rise once again.

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A Disappointing Fiscal Second Quarter
Helen of Troy's fiscal first quarter was also disappointing, and at the time I mentioned that I thought management's guidance for the year seemed optimistic. Apparently that is so, as sales look weak, and management has lowered full-year profit expectations.

Reported sales rose less than 4% this quarter, not only missing the average analyst estimate by 4%, but also showing marked deceleration from the double-digit growth of the fiscal first quarter. Revenue rose a reported 1% in housewares and more than 12% in healthcare/home environment, but fell more than 2% in personal care.

In point of fact, however, performance was worse. Stripping out the revenue tied to PUR (which the company bought from Procter & Gamble last year), organic revenue actually declined 6% overall (with a sharp 14% drop in the healthcare/home environment category).

Margin leverage also continues to be elusive. Gross margin did finally improve, growing about 20 basis points from last year and 30 basis points from the previous quarter. Operating income was up less than 2%, however, and the operating margin slipped slightly.

SEE: Find Investment Quality In The Income Statement

Transitory Problems ... Or Deeper Issues?
Three months ago, I speculated that the company was seeing (or about to see) greater pressure from increased promotional activities at major rivals such as Procter & Gamble, Unilever and Clorox. And now management has acknowledged some of that impact, at least in the personal care division.

While Helen of Troy does enjoy good placement at major retailers like Walmart (NYSE:WMT) and Target (NYSE:TGT), it's hard to gain share against the market leaders like P&G, Unilever, Conair and Colgate-Palmolive (NYSE:CL), when they're willing to sacrifice revenue/gross margin to hold share. So even though Helen of Troy's relatively higher weighting toward value pricing ought to help, that competitive promotional activity makes life harder.

I have some longer-term worries about Helen of Troy as well. By and large, nobody sees much growth potential in the North American personal care market anymore; companies like P&G and Unilever are increasingly having to tout their emerging market exposure to maintain investor enthusiasm. That makes me wonder about the extent to which these large companies will continue to use promotional to maintain share and cash flow, while using overseas markets to drive growth.

SEE: Industry Handbook: Porter's 5 Forces Analysis

The Bottom Line
I don't believe Helen of Troy is finished building its business; as Spectrum Brands (NYSE:SPB) showed recently in its deal with Stanley Black & Decker (NYSE:SWK), there's almost always someone looking to sell consumer brands at a reasonable price. What I do worry about, though, is whether the company can deliver the margin and cash flow leverage that is so critical to the stock working on a long-term basis.

If Helen of Troy can continue to post mid-single digit growth and boost the free cash flow margin into the double digits by 2022, this stock ought to be worth something close to $40. If the free cash flow margin only moves into the high single-digits, the target drops to the low $30s. This stock has rewarded prudent aggressiveness in the past, and I think it will do so again - this is certainly a rough spot in the company's history, but I do believe 2013 could be a better year for the company and this stock is worth a spot on the watch list of more aggressive investors.

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

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