Ric Dillon’s Diamond Hill Capital has reported ownership of about 770,000 shares of Steiner Leisure Limited (NASDAQ:STNR) or 5.3% of the company, according to a filing with the SEC. Diamond Hill had owned a little over 700,000 shares at the end of September per its 13F filing for the third quarter of 2012 (see more of Dillon’s stock picks). Steiner is a spa and beauty services company; it sells beauty care products, operates personal care schools, and provides services on cruise ships, at resorts, and at beauty facilities. The market capitalization is about $670 million, but with an average of about 50,000 shares traded daily and a current share price of over $45 there is over $2 million in daily dollar volume.
Revenue was up 14% in the third quarter of 2012 compared to the same period in 2011, led by growth in services. This was in line with trends from the first half of the year. Margins contracted a bit but Steiner Leisure Limited still produced 7% growth in net income, and thanks to share buybacks earnings per share came in at 85 cents versus 77 cents a year earlier. However, nearly all of the company’s growth seems to have come from acquisitions of laser hair removal facilities in the United States, rather than from organic factors. Additional revenue growth came from the acquisition of some beauty schools. As a result these headline growth rates overstate the prospects of the business. We would expect that sales and earnings will be flat at best barring substantial changes in market demand. Currently the largest segment is spa operations, responsible for 63% of revenue in Q3 2012.
Steiner Leisure Limited trades at 13 times trailing earnings, and we would say that the trailing period is composed almost entirely of time that the recent acquisitions were contributing to the bottom line. The current-year P/E is 12 as Wall Street analysts agree that growth will be minimal. It’s possible that the company will continue to generate EPS growth through buybacks even if earnings remain flat- Steiner appears to only need about a third of cash flow from operations for capital expenditures- but we’d rather not rely on that point. In addition Steiner does not appear cheap in terms of cash flow metrics: the EV/EBITDA multiple is 9.0x.
We can compare Steiner to Regis Corporation (NYSE:RGS), a primarily lower-end owner and franchisor of hair salons (including, for example, Supercuts). Regis’s revenue was down 10% last quarter from its levels in the fourth quarter of 2011, and earnings were quite low. We’d note that activist investor Jeffrey Smith of Starboard Value has a substantial position in the company (find Starboard’s favorite stocks and read our coverage of its recent purchase). Regis’s stock trades at 29 times forward earnings estimates, obviously a very large premium to Steiner’s valuation; over 20% of Regis’s outstanding shares are held short. It’s possible that some traders are forming a pair trade by going long Steiner and short Regis, and depending on the cost to borrow Regis shares to short that might be an interesting play. It’s certainly the case that Steiner appears to be a better value.
If we leave aside relative value possibilities, then we are less positive on Steiner. Even with the potential for continued buybacks, we would prefer to see more growth in the business; if we strip out the recent acquisitions the company actually seems that it might be shrinking at least in terms of operating income. We certainly find the industry attractive, and it seems intuitive to us that beauty care products and services should be a growing business. Perhaps Steiner is best placed on a watch list as a value stock- not interesting enough to buy for now, but with some strengths to its name and a good prospect if it does demonstrate organic growth.
Disclosure: I own no shares of any stocks mentioned in this article.
