Revlon, Inc. (NYSE: REV) surprised the market with several transactions with creditors, which boosted the stock price from $2 to about $8 per share. I understand the optimism aroused by the title, but I invite investors to be cautious about the stock. Without enough innovative beauty products in new collections and without agreements with creditors, REV could be overvalued. According to my DCF model, the sum of future free cash flow projections through 2030 is less than the total debt obligations due from 2023 to 2025.
Founded in 1932, Revlon, Inc. is a multi-brand owner and marketer of cosmetics, skin care, fragrance and personal care products. Revlon’s brands include American Crew, Elizabeth Arden, CND or Almay, which could be valued at millions of dollars due to the money invested in marketing over the years.
Introductions being made, note that Revlon has become quite an interesting stock after going from nearly $2 in June 2022 to around $8. Before delivering the news that sent stocks soaring, take a look at the company’s stock charts.
In June, Revlon provided information on new debt facilities worth $375 million, which I believe may explain the recent price dynamics:
The story does not end there. In another press release, Revlon noted $575 million in new debtor-in-possession financing. I appreciate the optimism shown by market players. However, I believe that investment research seems necessary to explain the current financial situation. Given the total amount of debt, in my opinion, the current valuation is difficult to justify.
Upon receipt of court approval, the Company expects to receive $575 million in debtor-in-possession financing from its existing lender base, which, in addition to its existing working capital facility, will provide liquidity for support daily operations. the strong support of the Company’s lenders will help the company overcome the current macroeconomic challenges and thus enable it to better serve its customers. Source: Revlon takes a step towards reorganizing the capital structure as the company continues to implement its strategic plan
Even taking into account recent comments from management on the strong consumer demand reported in June 2022, investors should have a clear understanding of the current capital structure:
Today’s filing will allow Revlon to provide our consumers with the iconic products we have offered for decades, while providing a clearer path for our future growth. Consumer demand for our products remains strong – people love our brands and we continue to have a healthy market position. But our difficult capital structure has limited our ability to manage macro issues to meet this demand. Source: Revlon takes steps to reorganize the capital structure as the company continues to implement its strategic plan
Balance sheet: Total debt includes $3.3 million in long-term debt
As of March 31, 2022, the company reports $2.3 billion in total assets and $3.3 million in long-term debt. The company’s balance sheet is not good at all. We are talking about a company that is going through a reorganization process due to its level of indebtedness. The reorganization received so much market attention that I decided to research the company.
Optimistic investors can say that the company may be preparing to reduce its long-term obligations as it happened in 2005. That said, in my opinion, it seems relevant to note that Revlon has not reduced its debt long term in 2022.
Assessment of Net Sales, EBITDA Margin and Operating Margin
As of 2018, Revlon’s net sales, EBITDA margin, and the operating margin look impressive. Median net sales growth is 4%-5%, median EBITDA margin is close to 13%, and operating margin is close to 3%-4%. Take a look at the numbers reported by Revlon as I will be using these numbers in my financial models.
With sales growth close to 4.9%, an EBITDA margin of 13% to 14.7% and an operating margin of around 4% to 5%, the 2030 EBIT would stand at 167 million of dollars.
From the year 2000, the evolution of the need for working capital/turnover varied from -16% to nearly 8%. With that in mind, I think a change in working capital/sales of about 2% seems reasonable.
From 2022 to 2030, I assumed increasing depreciation and amortization as well as decreasing capital expenditure. My numbers included a 2030 D&A of $305 million, 2030 working capital changes of $64 million, and investments of $19 million in 2030.
Note that my free cash flow expectations seem generally very optimistic. However, the sum of free cash flow does not seem sufficient to pay the total amount of debt. Free cash flow resulting from my assumptions included free cash flow close to $184-353 million. Using a 10.5% haircut, the net present value of future free cash flow is $1.3 billion. If we get even more optimistic, at a 4.5% discount, the implied sum of FCF is $1.7 billion.
Revlon may have to pay almost $3.4 billion in 2023, 2024 and 2025, which is more than the potential FCF that could be generated from 2023 to 2030. I really don’t see Revlon paying all of its debts.
Assessment if Revlon receives additional financing or if creditors are offered a deal
Under very optimistic conditions, Revlon will likely offer more innovation and more communication, which could lead to revenue growth. Note that I assume that management will find new debt financing to operate these activities. With the current amount of cash, I don’t think management is well prepared to conduct operations as in the past:
Strengthen its iconic brands through innovation and relevant product portfolios; second, build its capacity to better communicate and connect with its consumers through the media channels where they spend the most time; and third, to make its products available where consumers buy, both in-store and increasingly online. Source: 10-Q
Also, I suspect the company’s Global Growth Accelerator program will help the company improve its free cash flow margins. The result would be that more and more investors will look at the company’s funding performance:
The company continued to meet the objectives of the Revlon Global Growth Accelerator program, which includes the right-sizing of our organization with the objectives of improving profitability, cash flow and liquidity. The Company is also managing the business to conserve cash and liquidity, while focusing on stabilizing the business, growing e-commerce, and laying the foundation for future growth. Source: 10-Q
Finally, I think Revlon may soon reach an agreement to sell some assets, which would bring in a significant amount of cash. Note that management is already exploring transactions:
MacAndrews & Forbes and the Company continue to explore strategic transactions involving the Company and third parties. Source: 10-Q
With a discount of 7.5%, which is more bullish than other investment advisors, I got an implied enterprise value of $3.59 billion. Note that I am using an output rating of 11x, which is extremely optimistic for a company like Revlon. It has a lot of debt, so I wouldn’t be surprised if Revlon trades at 2x or even 4x EBITDA. Finally, the equity valuation would be close to $220 million. The implied price of the stock would remain at around $4 per share.
Inflation risks and lack of new products could also destroy EBITDA margins and push the stock price below $4.
With inflation, Revlon’s EBITDA margin and free cash flow could drop significantly. If management cannot raise its prices without affecting demand for its products, EBITDA will likely decline. Supply chain issues or delays from raw material suppliers would also affect business operations. Revlon disclosed these risks in its last annual report.
The Company purchases raw materials, including essential oils, alcohols, chemicals, containers and packaging components, from various third-party suppliers. Substantial cost increases. Delays and unavailability of raw materials or other commodities, as well as higher costs for energy, transportation and other necessary services have had and may continue to adversely affect margins beneficiaries of the Company if it is unable to offset them in whole or in part, such as by realizing cost savings in its supply chain, manufacturing and/or distribution activities. Source: 10-K
If Revlon does not design innovative beauty products or if customers do not appreciate the new collection, revenue growth may decline. In the worst case, the company’s EBITDA margin would drop significantly, which could push the company’s fair price below $4.
The company has a rigorous process of continuous development and evaluation of new product concepts, led by executives from marketing, sales, research and development, product development, operations, legal and finance. However, consumer preferences and spending habits change rapidly and cannot be predicted with certainty. There can be no assurance that the Company will anticipate and respond effectively to beauty product trends. Source: 10-K
I understand the recent optimism about Revlon given the new loans reported and negotiations with creditors. If management reaches an agreement and secures more debt financing, the stock price may rise further. With that, without enough innovative products and third-party transactions, future free cash flow is unlikely to be sufficient to pay the total outstanding debt. Given the results of my DCF model, I think the company is quite overvalued and could decline in the near term.