I have noticed that the financial press has been looking favorably upon Ron Perelman’s Revlon stock, with even Barron’s describing “Revlon’s Beautiful Outlook.” The general argument in favor of Revlon is that its core beauty product lines seem recession-resistant, and it seems to be trading at a lower valuation than its peers Estee Lauder, Coty, and L’Oreal. At first glance, Revlon might seem like a worthwhile stock to consider.
As you can already guess, I don’t see it that way.
First, you should be aware of Revlon’s disastrous trading history. You might see the current price of $32 per REV share and compare it to the $24 IPO in 1996 and think: “Ok, so it hasn’t done much for shareholders.” The reality is far worse because Revlon executed a 1-for-10 reverse stock split in 2008. So, really, the effective price is $3.20 per share if you follow the reconfiguration of the equity structure. As a result, every $1,000 invested into Revlon back in 1996 would be worth only $124 today.
There are two reasons why Revlon stock has been such a terrible investment: (1) the brands aren’t as strong as you think, and (2) the company carries an eye-popping debt burden.
The core Revlon brands are: Revlon, Pure Ice, Mitchum, Sinful Colors, Jean Nate, and Almay. Collectively, they only generate 3.1% net profit margins. Meanwhile, Estee Lauder and L’Oreal have net profit margins in the 9-11% range. This is a justified reason why Revlon stock trades at a discount compared to its peers because their brands have inferior pricing power.
Relatedly, Revlon carries such an extreme debt burden that I automatically exclude it as a candidate for investment consideration. It carries $2.7 billion in debt against a current profit base of $70 million. That means the balance sheet is leveraged by a rate of 38 compared to its profits. That figure is so extreme that I cannot even process the investment merits. There is $600 million due this year, and another $600 million due in 2019. Most of those borrowing are at 5.75%. I expect rising interest rates and the deteriorating balance sheet to mean that any refinancing will come with even more disadvantageous borrowing terms. Right now, Revlon even has some debt in Europe that carries an extremely high 11% interest rate.
Usually, when you see businesses in this state of financial disrepair, the stock finds itself trading at such a substantial discount that you wonder whether all the bad news is more than priced into the stock. That has not happened here. Revlon, which hasn’t grown earnings in the last five years, is earning $1.35 in profits. The $32 price means that the valuation is 23.7x earnings. That is crazy. It is trading for a premium price despite no growth and enormous debt.
I suspect the reason for the premium is that investors expect the aging Perelman to sell the business to a suitor like Unilever or Procter & Gamble sometime in the next few years which could fetch the existing shareholder base a premium. That is a sound theory, and I have no opinion on whether that will happen.
But why would you ever buy ownership in a business where the theory for success relies upon someone else coming along and paying a more absurd price? There are 15,000 businesses that are publicly traded. Why not find one that is thriving and growing regardless of whether some suitor comes along down the road?
Revlon has an extraordinarily poor track record, the balance sheet weighs down all future growth prospects and makes it unlikely that Revlon could launch an aggressive advertising pitch, and the current brands are stale and earn profit margins much lower than its chief competitors. And plus, the stock is trading at a premium price. At this time, it is a candidate for long-term investment.
Originally posted 2017-01-16 23:13:56.