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MagicDiligence (< 20)

Revlon Is Not Quite Pretty Enough



April 19, 2013 – Comments (0) | RELATED TICKERS: REV

Revlon (REV) is a familiar name in women's beauty products. The company has an extensive product line of cosmetics, hair color products, beauty tools, deodorants, fragrances, and skincare. Products are sold mainly through the big retailers (Walmart contributes 22% of sales), drug and grocery stores. Revlon's well-known brands include the eponymous cosmetics and hair color lines, other cosmetics lines including Almay and Pure IceCharlie and Jean Nate fragrances, Mitchumdeodorants, and Ultima II and Gatineau skin care products. Revlon is an international company, with 44% of sales originating outside of the United States.

MagicDiligence likes consumer products businesses like this. Revlon's products are consumable, reasonably non-discretionary, and purchased over and over again. The company has strong brands, with leading market share in mass retail cosmetics and hair color, which provides a sustainable competitive advantage. Measured international expansion (particularly in South America), new products (such as the recent purchase of Pure Ice), and price increases should allow the firm to continue to grow sales in the mid-to-low single digit percentage range. Revlon's margins have reliably been in the 15% range, which is comparable to competitors like L'Oreal. It is just a stable, predictable business.

There are two problems with Revlon as a Magic Formula® Investing (MFI) stock to buy now. The first is poor financial health. Revlon has, and continues to, operate under a mound of debt. The firm's debt burden is nearly $1.2 billion, offset by only $116 million of cash in the bank. Interest rates on that debt have been high - the company's interest coverage ratio (operating earnings / interest cost) is just 2.6, well below my minimum of 5. Considering the company only generates about $90 million in free cash flow per year, it's clear that continuous refinancings are going to be a fact of life here, making another credit crunch a very scary proposition for the firm.

To be fair, this is less of a concern after a recent refinancing. Revlon secured $500 million in senior notes back in February, due in 2021 and carrying a 5.75% coupon. With this cash, they tendered back about $200 million of the $333 million outstanding on previous 2015 notes at 9.75%, and paid down about $100 million on a term loan. In the process, the firm's default risk is lowered, as are interest costs going forward.

The second problem is simply that Revlon isn't quite cheap enough for my liking. Adiscounted free cash flow calculation, assuming 5-7% growth over the next few years, gives me a fair value of about $24 per share. A multiple-based valuation, using Revlon's long-term earnings yield of about 10%, gives me a similar number. With the stock currently in the low $20's, that's less than a 15% margin of safety. Considering Revlon doesn't (and won't) pay a dividend or buy back shares, and the fact that debt covenants make a buyout of the firm almost impossible, that's not quite enough for me. I might get interested in Revlon around the $17 mark, but until then there are better opportunities in MFI at present.


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