Silk Laser (ASX:SLA) is not as discretionary as you may think, so when will investors stop punishing the stock?

Silk Laser (ASX:SLA) is one company that has been sold off amidst the current bout of inflation.

Investors fear that consumers will be forced cut back their spending on laser treatments to meet more ‘non-discretionary’ needs. In reality, this has not been the case.

 

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Who is Silk Laser?

Silk Laser is an owner and operator of cosmetic injections and skincare clinics and products, with ~140 outlets across Australia and New Zealand.

The Adelaide-headquartered company began in 2009 and listed in late-2020. After initially performing post-IPO, shares have declined and are at a fraction of their $3.45 IPO price.

 

 

The company hasn’t been helped by private equity firm Advent selling roughly half its stake after the IPO. While it retains a 12% stake, there isn’t confidence that it will stick around.

Lockdowns, the Omicron wave and fears that high inflation will cause people (mostly women in the case of this company) to cut back spending on these products have also been a detriment to the company’s cause.

Granted, even though demand hasn’t declined, it hasn’t grown exponentially in the way that other retailers experienced.

 

Silk Laser is still growing its revenues and profit

Silk Laser appears to have bottomed out since its 1HY23 result, issued roughly a fortnight ago.

The company’s network cash sales in 1HY23 increased 35% to $102.8m and revenue grew 21% to $49m. The reason for the discrepancy is that it operates with a franchise model.

Silk Laser’s underlying profit increased 15% to $6.6m and its statutory profit rose 22% to $5m. It closed the period with 142 clinics, up from 122 just 6 months earlier, along with $19.4m in cash on the balance sheet.

The average customer spend was $679 and the company’s Net Promoter Score was 80.

 

More growth to come?

Silk Laser did not provide formal FY23 guidance, but told shareholders cash sales in the first 7 weeks of 2HY23 were up 10% on a like for like basis.

Turning to consensus estimates, there are 4 analysts covering the stock and they expect $97.5m in revenue, $25.8m in EBITDA and $0.22 EPS for the full FY23, each representing growth of 17-22%.

Looking to FY24, analysts call for $106.2m in revenue, $29.7m in EBITDA and $0.26EPS, each representing growth of 9-18%.

The latter trio of estimates mean the company is trading at just 4.4x EV/EBITDA, 7.6x P/E and 0.76x PEG right now. Furthermore, we estimate that FY24 results (if replicated) would represent a 28.8% ROE (Return on Equity) and a 17.1% ROA (Return on Assets).

However, analysts do not expect it to stay this cheap for long.

The mean target price is $3.13 per share, a 62% premium to the $1.93 intraday share price as of 12.30pm on Wednesday March 8.

 

The current share price implies low growth but the reverse will be true

We have built a DCF model for Silk Laser. We have used consensus estimates for revenue growth up to FY25, then used 3% going forward.

We assume expense growth roughly in line with inflation, which is significant over the next couple of years but moderates thereafter, although we stuck with 3.5-4% for conservatism’s sake.

We use a 12.8% Weighted Average Cost of Capital, derived from a 3.8% Risk free Rate of Return, a 6% equity premium and a 1.5x beta.

This generates an equity value of $347m, which is $6.58 per share – a ~240% premium to the current share price.

We have also experimented with various revenue growth figures.

The current share price implies that the investors are expecting very low growth in the years ahead.

The growth assumptions generating the valuation nearest to current share price implies just 5% growth in FY23 and 3% growth thereafter. But consensus estimates suggest 19% growth in FY23, 9% in FY24 and 6% in FY25.

As we noted above, we think the primary reason for this company’s underperformance is investor skepticism that Silk Laser’s sales will hold up in the current environment.

The company’s performance in 1HY23, a period where inflation was at 4-decade highs, suggests the opposite.

Investors might argue sales will drop in 2HY23 because this is when the pain of interest rate hikes will begin to be felt.

We would point out that average customer spend was $679 and suggest that consumers that would’ve given up treatments due to costs, likely would have done so several months ago.

 

Plenty of gems can be found

Many consumer discretionary stocks that have been sold off due to fears of inflation are not really discretionary at all.

There are plenty of bargains to be found that will re-rate as investors realise that they are an essential service to their customers.

And Silk Laser is one such company in this position. We expect the company to re-rate over the coming months as investors begin to understand this, helped in particular by its ongoing results.

 

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