Steiner Leisure Sinks (Fool Plate Special) October 29, 1999

An Investment Opinion

Steiner Leisure Sinks

By Brian Graney (TMF Panic)
October 29, 1999

Steiner Leisure Ltd. (Nasdaq: STNR), which provides spa services and skin and hair care products aboard cruise ships, bought a one-way ticket to Stock Loser Island this morning after warning that it will hit choppy waters on the earnings growth front in the coming year.

On the bright side, the company posted Q3 EPS of $0.35, up from 18% a year ago and $0.02 ahead of the First Call mean estimate. However, the earnings growth did not keep up with a revenue rise of 28% in the period, as gross margin slid to 26% from 27% a year ago. Unfortunately for the company, the margin erosion is expected to continue in 2000 and result in a 5% earnings growth rate next year instead of the 19% growth previously expected by analysts. As a result of the lowered expectations, traders tossed the stock overboard and sent its share price down by more than a third this morning.

While the company isn't the stuff of dreamers, there are worse business ideas than providing spa services to a captive audience such as vacationers on cruise ships. Steiner Leisure has built a fairly defensible business around serving the face cleansing and back rubbing needs of those aboard 104 ships owned by some 28 cruise lines. These services are very popular with cruise ship patrons, many of whom often book their pampering sessions well in advance. As health and wellness have become increasingly more popular societal themes, the company seems to have found a good niche to serve. After all, a person can only drink so many Mai-Tais and play so many games of shuffleboard.

Since the company doesn't have to plunk down the money to actually build and run the ships where it offers its services, the business model is rather light and returns have been excellent. In fiscal 1998, the company sported return on average invested capital of 31%. That return will take a hit in 2000 as the company said negotiations with three cruise lines will likely result in lower margins. In a sense, the company is sacrificing margins in order to secure long-term agreements with cruise lines and maintain its dominant market position. The company believes this strategy will work out in the end, although the earnings waters in the short-term will look about as murky as Boston Harbor.

The company tried to offset the bad news by authorizing the repurchase of an additional 1 million outstanding shares, bringing its total buyback authorization to just under 1.7 million shares. This move may seem a bit drastic, considering the high returns nature of Steiner Leisure's business. Even assuming zero operating earnings growth next year and an invested capital ramp-up of 50% from the company's Q2 levels, Steiner Leisure is on track to realize a return on invested capital of 17% in 2000 -- easily beating the firm's perceived all-equity cost of capital of 12%.

Evidently, management is confident that the share price is attractive enough to earn a higher return than the return that could be generated by reinvesting cash flow back into the business. With earnings estimates sure to decline in order to take into account 5% growth instead of 19% growth, Steiner Leisure is probably looking at about $1.33 per share in earnings in 2000. After this morning's freefall, the company is trading at a multiple of around 11 times next year's downward-adjusted earnings expectations. At those levels, investors may want to use this opportunity to take a closer look at Steiner Leisure and decide whether they should follow management's lead in the share purchase department.

Related Links:
Fool on the Hill, "Why Share Buybacks Matter," 03/27/98
Fool on the Hill, " More on Share Buybacks," 03/31/98