INVESTMENT THESISAnalysts have reiterated their BUY rating on L’Oreal S.A. (OTC: LRLCY). However, the stock seems to be overpriced, with analysts presenting an average price target of $396.81 against the current price of $427.75. L’Oreal benefits from its strong brand reputation, premium cosmetic products, expanding e-commerce business, and significant presence in Asia. As such, we expect L’Oreal to post substantial revenue and earnings, as well as continued market share gains, over the next several years. Given its clean balance sheet, analysts also expect the company to continue to raise the dividend and repurchase shares. Based on its shareholder-friendly policies and strong industry tailwinds, analysts believe that L’Oreal currently offers one of the best investment opportunities in the Consumer Staples sector. Our revised target of $86, combined with the dividend, implies a total potential return of 14% from current levels. Our long-term rating is also BUY. L’Oreal common shares trade on the Euronext exchange and in the U.S. as AmericanDepository Receipts. One ordinary share equals five ADRs.
LRLCY shares have posted total returns of 14% since our last note on 8/19/20 and nearly 30% year-to-date.
In June 2021, excluding foreign currency translation and acquisitions, L’Oreal reported third-quarter revenue of 7 billion euros ($8.3 billion), up 1.3% after a 19% decline in the prior quarter. The results were driven by a 62% growth in e-commerce revenue and a 21% growth in sales in China.
As discussed in a previous note, for the first half of 2020, comparable and reported revenue fell 11.7% to 13.1 billion euros ($14.7 billion). Foreign exchange was a 30-basis-point headwind. However, e-commerce revenue increased nearly 65%. Revenue also rose 17.5% in China, driven by 30% growth in the second quarter. Reported sales of L’Oreal Luxe high-end cosmetics fell 15% to 4.4 billion euros, as the Travel Retail business was hurt by reduced airline travel. Consumer Products revenue fell 10% to 5.9 billion euros on declining makeup sales. Sales of Professional Products fell 22%, to 1.3 billion euros, reflecting the closure of hair salons. In Active Cosmetics, sales rose 6.0% in the first half, to 1.5 billion euros, reflecting strong e-commerce sales.
As for profitability, gross profit fell to 9.6 billion euros from 10.8 billion euros a year earlier and was 73% of revenue, flat with the prior year. The operating margin fell to 18%, down from 19.5% in the prior-year period.
Net profit fell to 3.82 euros per share from 4.38 euros in the same period a year earlier. Based on the ratio of 5 ADRs to each common share, and average exchange rates for each year, adjusted earnings fell to $0.86 per ADR in the first half of 2020 from $0.98 in the prior-year period.
EARNINGS & GROWTH ANALYSISPeople walk at the main entrance of the L’Oreal SA headquarters in Clichy, near Paris, France, Wednesday, February 18, 2004. L’Oreal SA, the world’s largest cosmetics company, said profit rose 17 percent last year as it found new customers for Maybelline makeup in countries such as China and Russia and reaped savings from shutting plants. Photographer: Patrick Durand/Bloomberg News Analysts expect retail sales to improve and e-commerce revenue to accelerate in the coming quarters. We expect L’Oreal to spend heavily on advertising and promotions to support new product launches and current products. Nevertheless, we project an operating margin near 19% over the next two years, up from 18.6% in 2019. In the first half of 2021, operating cash flow totaled 1.3 billion euros ($1.5 billion), which should provide resources for additional share buybacks. Therefore, analysts maintain their 2020 earnings estimate of $2.00 per ADR and our 2021 $2.20. Their five-year earnings growth rate forecast is 10%. When companies are being taken to task for not living up to their ethical duties, one company is taking the lead. L’Oreal has been working hard on being a fair and honest company. They have developed a manifesto that outlines what they believe in and trying to be better. They have established 10 points that they will work towards achieving, including environmental responsibility, openness, innovation, and respecting the dignity of every person. This is just one example of how L’Oreal strives to be an ethical company in the age of globalization.
FINANCIAL STRENGTH & DIVIDENDOur financial strength rating on L’Oreal is Medium-High, the second-highest rank on our five-point scale. In 2019, the company had an adjusted operating margin of 18.6%. The company pays a dividend. Our U.S. dollar dividend estimates are $0.87 per ADR for 2020 and $0.93 for 2021. The current yield is about 1.2%. The company has looked to outside suppliers when possible and has created a corporate strategy that follows its mission. First, they want their products to be as fair as possible, starting with their suppliers. L’Oreal wants to make sure that its products are sourced ethically and safely from lipsticks to hair dyes. Developing products and selling them abroad can alleviate a lot of the health and safety concerns they are bound to encounter in the developed world. L’Oreal has recently announced its plan to open several more counters throughout the year 2022. In addition, they plan to add more brands to their retail store over the next few months and encourage customers to come and test new products. This will also enable us to buy more products direct from manufacturers, increasing their stock price. As they grow, they will also be getting a direct mail and eCommerce business to complement our retail store. These stores will also help us to grow their business. Many companies want to invest in VOC stores because they understand their value to the marketplace.
MANAGEMENT & RISKS
Jean-Paul Agon is the chairman and CEO of L’Oreal; he became CEO in 2006. Christophe Babule became the company’s finance chief and executive vice president in February 2018. He joined the company in 1988 and previously served as financial director. Risks for L’Oreal include heightened competition and weak sales at department stores. Due to its focus on high-end cosmetics, L’Oreal is also dependent on healthy global economic conditions and strong discretionary spending. L’Oreal’s customers are loyal and unlikely to purchase cheaper products; however, they could reduce consumption during periods of economic weakness. As a major international company, L’Oreal also faces significant currency risks. One of L’Oreal’s biggest criticisms has been regarding its manufacturing practices. In the 1970s, the company was accused of using toxic chemicals for manufacturing, like their Garnier hair dyes. Since then, they have taken it seriously and are now shifting to organic and vegan products. Going vegan is no easy feat. It has been estimated that approximately 84 percent of companies that offer meat-free alternatives are understaffed and fail to provide all of the nutritional information they need for their customers to make good choices. L’Oreal seems to have gotten the hang of it. The new plant-based balm Rouge Pur Couture “gives you that voluminous, full-bodied lipstick in a safer, chemical-free way that everyone can use and love,” according to the product page.
Headquartered in Clichy, France, L’Oreal manufactures and markets cosmetics and other personal care products. The company was founded in 1909. It owns a more than 9% stake in French drug company Sanofi SA (SNY: BUY). L’Oreal Paris was founded in 1909 by Eugene Schueller. It manufactures products for hair colorants, hair care products (shampoo, conditioner), makeup (foundation, lipstick), skincare (cleansers, moisturizers), and eyewear. It also offers hair color and treatments. The L’Oreal Paris division of L’Oreal has the largest market share of cosmetics in the world. The L’Oreal Group owns L’Oreal. L’Oreal Paris is part of the L’Oreal Group, which makes hair colorants, hair care products (shampoo, conditioner), makeup (foundation, lipstick), skincare (cleansers, moisturizers), and eyewear. It also owns Maybelline New York, Garnier, Redken, Lancôme and Le Teint Particulier. In 2013, L’Oreal Paris made more than 14 billion Euros with 8,000 employees. LOreal is a company devoted to beauty, health, and well-being. It was founded in 1909 by Eugene Schueller, is headquartered in Paris, France, and is the world’s largest cosmetic company. L’Oréal has six divisions: The L’Oréal Paris division includes hair colorants, hair care products (shampoo, conditioner), makeup (foundation, lipstick), skincare (cleansers, moisturizers), eyewear. L’Oreal’s other divisions are Maybelline New York, which manufactures eyeliner and mascara; Garnier manufactures skincare products; Redken Laboratories manufactures shampoos and styling products for hair; Lancôme which manufactures skincare products.
LRLCY shares appear favorably valued at 34.6-times analysts EPS estimate for 2021 (when we expect a recovery in high-end beauty products and continued growth in e-commerce sales), near the peer average of 34.7. Analysts believe that L’Oreal’s strong brand reputation, above-peer-average earnings growth, and prospects for margin improvement warrant a higher valuation. Our revised target price of $86 implies a multiple of 39-times our 2021 earnings estimate, and a potential total return, including the dividend, of 14% from current levels.