For Regis, the Unkindest Cut of All

An earnings warning shaved 10% off the salon outfit's shares on Mar. 22. The culprits: Inventory woes and a "protracted long-hair cycle"

It was the Wall Street version of a bad hair day. On Mar. 22, beauty salon operator Regis watched its shares skid 10%, touching a 52-week low before closing down $3.93, at $33.49.

The stock's recent buzz cut started with just a trim. On Mar. 21, Regis (RGS) lowered its earnings outlook for its fiscal third and fourth quarters, forecasting flat to lower results compared to 2005. The move quickly led to analyst downgrades from William Blair, KeyBanc Capital Markets, Piper Jaffray, and RBC Dain Rauscher. A Regis spokesman didn't return calls prior to deadline.

Regis owns or franchises 11,086 beauty salons, 90 hair-restoration centers, and 35 beauty schools worldwide. They include such brands as Supercuts, Jean Louis David, Vidal Sassoon, MasterCuts, SmartStyle, Regis Salons, Cost Cutters, and Hair Club for Men & Women. As recently as Jan. 10, Regis shares were trading at a 52-week high of $43.49.


 Regis is the $150 billion hair-care industry's biggest player, but it may not be the only one going flat. "The salon industry continues to face a challenging retail and service environment," Regis Chairman and CEO Paul Finkelstein said in a statement. Rivals such as Sport Clips are privately owned, however, so it's difficult to make comparisons.

To some extent, salons have simply fallen victim to fashion, analysts say. The culprit is "a protracted long-hair cycle," writes William Blair analyst Sharon Zackfia. With more and more potential customers opting to let their hair down, salon companies like Regis have been left with empty stools.

Another key part of Regis' business -- the sale of hair-care products through its salons, which accounted for 30% of total revenues in fiscal 2005 -- is causing investors some discomfort. Lower margins on its lineup of shampoos and other preparations are expected to shave about five cents per share off third-quarter earnings. Suppliers Joico, KMS, Back-to-Basics and Nioxin, which together make up 12% of Regis's product sales, recently repackaged their products. To clear existing inventory, the company has been selling items in the old packaging at a discount.


  New packaging isn't the only factor weighing on margins. Increasingly, customers have been buying on-sale items. Roughly 24% of Regis's third-quarter product sales to date were at a discount, compared to 20% the prior year. That's excluding repackaged offerings.

Too much inventory has long mussed Regis's performance, analysts say. "We see continued lax inventory management as a risk factor to the business," writes KeyBanc Capital Markets analyst Jeffrey Stein (see BW Online, 3/22/06, "KeyBanc Cuts Regis to Hold from Buy").

A pending acquisition could straighten out a few kinks. Hair-care product maker Alberto-Culver (ACV) agreed in January to sell its Sally Beauty retail chain -- which primarily supplies the salon trade -- to Regis in a $2.2 billion stock deal. "Potentially, Regis will have higher clout with their vendors, and they can increase their margins through that," says Standard & Poor's analyst Michael Souers.


  Still, the deal has its pitfalls. For one, Alberto-Culver said in a statement on Mar. 22 that it's reviewing the transaction following Regis's earnings warning. If the acquisition goes through, Alberto-Culver shareholders would hold a 54.5% stake in Regis.

Some analysts question whether Regis already has its fingers in enough different enterprises, including its business schools, hair club, and international ventures. "We believe Regis could be distracted from its core operations during the upcoming acquisition," writes Piper Jaffray analyst Mitchell Kaiser (Piper Jaffray makes a market in Regis shares).

Current woes aside, Regis' long-term prospects don't appear so dismal. Shaggy tresses will someday go out of vogue. In the meantime, the company has responded by positioning its stylists as long-hair experts. Regis has also raised prices on some of its products, analysts say, which would help improve margins. Demographic trends may also favor the salon giant. The graying population could mean an increase in customers. "Regis does very well with an older demographic," says William Blair's Zackfia.


  But in the short term, the company's erratic performance continues to weigh on the stock. The latest earnings guidance isn't the first time Regis has disappointed investors. After underwhelming results in the two previous quarters, the company cited hurricane disruptions and holiday promotions as reasons for lackluster results.

For the shares to claw their way back, the company has to deliver a more consistent performance. While customers may be satisfied with the trendiest salon styles, Wall Street is looking for something more permanent.

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