By:
Dominic Delia, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
• L’Oreal SA ADR (OTC:LRLCY) engages in the manufacture and sale of
hair and beauty products. Headquartered in Paris, France, the world’s largest
cosmetics company operates through the following segments: Professional
Products, used and sold in hair salons, Consumer Products, sold in mass-market
retail chains, L’Oreal Luxury, sold in department stores, and Active Cosmetics,
sold in pharmacies and drugstores.
• Recently, LRLCY proven
resilient despite secular headwinds, registering organic sales growth of 5.6%
through increased volumes.
• On January 10th,
LRLCY purchased three of Valeant’s skincare brands for $1.3B in a move that is
expected to double revenues in the firm’s Active Cosmetics Division in the U.S.
• The firm has
strategically positioned itself to take advantage of the shifting consumer
preference toward online/specialty retailers through investments in e-commerce,
bolt-on M&A, and its “Omni-channel” initiative.
Key
points: The acquisitions of U.S. skincare brands CeraVe, AcneFree, and Ambi from debt-
burdened Valeant Pharmaceuticals (VRX) are expected to double L’Oréal’s
Strategic Skincare segment revenues, while allowing the firm to compete
directly against Nestlé’s Cetaphil brand in “accessible price segments”,
coincidentally an area where consumers felt the firm had room to improve.
The
largest portion of the acquisition, CeraVe, has demonstrated rapid growth over
the past two years (>20%) compared to the high single digit growth of
Cetaphil. L’Oreal is beginning to realize sales growth from its investments in
both new brands and digital initiative, growing its market share in the U.S.
and Western Europe by ~100 bps over the past twelve months.
What
has the stock done lately? Recently LRLCY has weathered both
secular and forex headwinds to post industry leading sales growth through
increased volumes rather than price. The company has registered significant
market share gains across all business segments, due in part, to management’s
focus on remaining at the forefront of innovation through strategic bolt-on
acquisitions.
LRLCY’s luxury segment surprised to the upside during 3Q16 mostly
attributable to the rapid growth of its Urban Decay and Yves Saint Laurent
brands. Globally, the “selfie” generation has propelled makeup sales at a
record level of 15% for the category as a whole. China and France are two
markets to monitor going forward as the launch of the firm’s new Magic facemask
brand has been a drag on growth in the mass consumer segment.
Past
Year Performance:
Over the past year,
L’Oreal has rallied 9% to $36.57 off lows of $33.55. Management has remained
true to their word, taking the 70 bps gross margin expansion and reinvesting 40
bps in R&D and A&P. Operating margins have remained impressive at
18.3%, outpacing competitors Beiersdorf, Unilever, and Estee lauder by more
than 300 bps.
The firm’s net debt to equity has remained at ~10% despite a slew
of acquisitions including Societe de Thermes, Atelier Cologne, and IT Cosmetics.
The 1Q repurchase of 3.2 million shares helped strengthen LRLCY’s peer leading
9.8% shareholder return.
Source: FactSet
My
Takeaway Opportunistic bolt-on acquisitions, a focus on
digitalization through its Omni-channel initiative, and a surge in millennial
demand for makeup will allow L’Oreal to continue to dominate the cosmetics and
personal care sector for years to come. Management has used their expertise in
the realm of M&A (25 deals in the past 5 years) to quickly integrate new
brands and realize synergies almost immediately. E-Commerce has been the
fastest growing segment of the beauty industry and has accounted for 40% of
L’Oreal’s sales growth.
The company has strategically positioned itself at the
forefront of shift away from traditional sales channels in favor of online and
specialty stores. While the stock is currently trading at a premium relative to
its Staples peers, the stronghold L’Oreal maintains over the perceptions of consumers
will insulate the firm from market fragmentation, validating a price tag of 24x
forward P/E to own a share of this cosmetics behemoth.
