Sunday, February 5, 2017

An AIM International Fund holding: L’Oreal (LRLCY) by Nico Delia. “No Need to Makeup Anything for this French Beauty"

L’Oreal SA ADR (LRLCY, $36.57): “No Concealer Necessary for this Cosmetics Giant”
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.


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.

• Investors have raised concerns in response to the proliferation of small brands entering the cosmetics market, especially online. Extensive research by Nielsen should quell these fears, as the majority of consumers value functionality, trust, quality, and value for money, all metrics in which L’Oreal scores highly.

• 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.

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