Regis Corporation’s (RGS) financials are messy. The company has been underperforming since the beginning of the last decade and was going through a transformation process before COVD hit them hard.
Noticing the deterioration of the business, management decided to transition to a fully-franchised business model, which according to management, would provide better returns on investment for shareholders due to the capital-light asset model. To understand the magnitude of the transformation and downsizing of the business, the company had 12,700 worldwide locations in 2010 of which 2,020 were franchised or approximately 16%. Today, the total number of worldwide locations has shrunk to 6,923 of which 5,209 are franchised or approximately 75%. Management expects to become a fully-franchise asset-light business by the end of fiscal 2021 (FY ends in June) by selling the rest of its company-owned salons to franchisees and closing down the remaining salons at their lease expirations or just terminating the lease if it makes financial sense.
The stock belongs to a speculative account only. We believe the biggest risk comes from the company’s lease obligations, which at the end of fiscal 20′ stood at $708 million. You see, as part of its business model, Regis takes the responsibility for the lease which is then sub-leased to the franchisee. Failure from this group could result in Regis being on the hook for the liability.
The bull case, on the other hand, concentrates on the company having the resources to survive the pandemic, while many independent salons and barbershops might not, therefore gaining market share in this fragmented market once the dust settles. We believe the transformation to a 100% franchise model should position Regis towards a profitable path on a mid-to-long-term timeframe, giving some sort of predictability to the company, which the market loves. That said, the short-term outlook looks tough. We are comfortable waiting for more clarity and remain on the sidelines for now. Still, more adventurous investors might find the stock interesting.
Quick Business Overview
Regis Corporation franchises, owns and operates beauty salons in the U.S., Canada, Puerto Rico, and the United Kingdom. Regis is the owner of brands such as Supercuts, SmartStyle, Cost Cutters, First Choice Haircutters, and Roosters. The company salons are mainly located in strip malls and Walmart Supercenters.
What lies ahead
The transition towards a franchised-based model would decrease revenues as the company would only recognize sales from royalties, fees, and product sales to franchised locations. Gross margins might also be affected as product sales on a wholesale basis command lower margins compared to retail sales. That said, the model should increase operating income margins as redundant overhead costs are eliminated and the resources needed to support the business remains relatively flat, allowing the bottom line to benefit from operating leverage.
While the market remains highly fragmented and there are no barriers to entry, therefore no sustainable competitive advantages, we believe the scale of Regis coupled with the asset-light business model been pursued, should translate to better efficiencies in the long term. For example, without the hassle of operating its own stores, the company can focus entirely on activities that can benefit from a bigger scale, such as marketing, advertising costs, and a unified CRM platform with thousands of locations as consumer touchpoints for data collection, which in turn can be used to improve services, up-selling opportunities and the overall customer experience. Regis has been focusing on this area by launching two programs: OpenSalon and OpenSalon Pro. The former is a proprietary platform that enables customers to reserve and check-in for various salon services via their smartphones or computers. OpenSalon Pro is a proprietary cloud-based store management and point of commerce solution. As part of the modernization process, the company opened a technology office in California during its fiscal ’19 investing in a product engineering team.
How can margins improve from such efforts? As the company increases ways to improve its customer experience by offering better services, salons should see an increase in sales and hopefully loyalty and repeat business. That in turn could fuel more franchisee demand translating to more royalty revenue and fees to Regis. As the amount of capital invested (R&D and advertisement) is spread across more locations, unit cost should decrease thus increasing profitability.
As expected, the pandemic has hit Regis hard. Getting a haircut is not something you can do online. As a result, fiscal year ’20 showed some steep declines. Adding fuel to the fire was the already decreasing top-line as the company continued to sell its owned-stores to franchisees.
Sales dropped by 37.4% during fiscal 2020. At the height of the pandemic (May to June period), the company reported Q4 sales decreasing by 76% on a year-over-year basis to just $60.1 million. Not so long ago, Regis was making approximately $1 billion in sales. For Q1, the company saw a sequential improvement by reporting $111 million in revenues, but still down 55% from its prior-year period. The company estimates it lost revenue of approximately $44 million in Q1 due to reduced traffic and store closures from the impact of COVID. Regis ended its first quarter with 95% of its salons opened but still operating at restricted capacity. The company had a negative operating cash flow of $86 million in 2020 and a negative $29 million in Q1 2021.
With that said, the company was handed a lifeline when it successfully amended its credit facility that now expires in March of 2023. The amendment provided relief for the maximum net leverage covenant and fixed coverage ratio. The amendment was a pivotal event, giving the company a fighting chance to survive:
We continue to believe that the successful amendment of our credit facility will provide the long-term flexibility we need to see our strategy through to completion and enable us to successfully navigate the uncertainties caused by this pandemic. And in my view, greatly increase the probability of our long-term success in this uncertain environment. – Q4 call
As of September, the company had $184 million in total liquidity consisting of $85 million in cash and $99 million under its revolving facility.
The Bottom Line
We believe it is too early to make an investment in Regis, but the stock remains on our watchlist as a high priority idea to revisit in the future.
The company has also recently appointed a new CEO with experience in the QSR market. As part of its resume, new CEO Felipe Athayde spent almost a decade at Restaurant Brands International (QSR), most recently serving as President for Popeyes leading the revitalization of the brand. The new CEO is already implementing a zero-based budgeting process at Regis with help from an outside consultant to create better visibility and cost control over expenses in order to align G&A with the fully franchised business model.
That said, this stock remains highly speculative, and in some sense, the survival of Regis remains outside of management control. If the pandemic continues to disrupt the economy, Regis would be the most affected. Risks are high so investors should be cautious.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.