INVESTMENT THESIS
We are reiterating our BUY rating on L’Oreal S.A. (OTC: LRLCY) and raising our price target to $86 from $76. 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 strong revenue and earnings, as well as continued market share gains, over the next several years. Given its clean balance sheet, we also expect the company to continue to raise the dividend and repurchase shares. Based on its shareholder-friendly policies and strong industry tailwinds, we 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 common share equals five ADRs.
RECENT DEVELOPMENTS
LRLCY shares have posted total returns of 14% since our last note on 8/19/20 and nearly 30% year-to-date.
On October 22, 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 62% growth in e-commerce revenue and 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 ANALYSIS
We expect retail sales to improve and e-commerce revenue to accelerate in the coming quarters. To support new product launches and current products, we expect L’Oreal to spend heavily on advertising and promotions. Nevertheless, we project an operating margin near 19% over the next two years, up from 18.6% in 2019.
In the first half of 2020, operating cash flow totaled 1.3 billion euros ($1.5 billion), which should provide resources for additional share buybacks. We are maintaining our 2020 earnings estimate of $2.00 per ADR and our 2021 estimate of $2.20. Our five-year earnings growth rate forecast is 10%.
FINANCIAL STRENGTH & DIVIDEND
Our 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%.
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.
COMPANY DESCRIPTION
Headquartered in Clichy, France, L’Or†šal 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).
VALUATION
LRLCY shares appear favorably valued at 34.6-times our 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. We 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.
On December 30, BUY-rated LRLCY closed at $76.84, up $0.69
Source: Argus
