Revlon: What’s the Way Ahead?

+245.91%
Upside
3.90
Market
13.49
Trefis
REV: Revlon logo
REV
Revlon

Revlon (NYSE: REV) manufactures color cosmetics, hair color, skin care, fragrances, antiperspirants and deodorants and beauty tools and sells them through mass retailers and chain drug stores such as Wal-Mart (NYSE:WMT), Target (NYSE:TGT), Walgreens (NYSE:WAG) and CVS (NYSE:CVS) among others, across the globe with close to 60% sales still coming from the US alone.  Revlon competes with L’Oreal (PINK:LRLCY)Avon (NYSE:AVP), Proctor & Gamble (NYSE:PG) and Estee Lauder (NYSE:EL), and we have a price estimate of $9.85 for Revlon.

Debt Limits Flexibility

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But, here’s our concern… Revlon’s balance sheet is heavily loaded with debt, so much so that in 2007, the interest payments due exceeded its operating profit (as measured by EBIT) for that year. Even in 2009, the interest payments exceeded 60% of EBIT, making the earnings highly volatile and vulnerable to market fluctuations and interest rates. As a result, Revlon’s R&D spending at 1.7% of sales amounting to $24 million is dwarfed by L’Oreal’s 3.7% at $666 million. Also, given Revlon’s sales at close to $1.3 billion compared to $24 billion for L’Oreal and $7.9 billion for Estee Lauder leaves it with much less money to spend on marketing, a crucial factor for success in cosmetics industry.

What catches our attention is not just the high level of indebtedness that limits the marketing and advertising budget and leaves the business with little scope for investment in R&D, but we do not see the management focusing the limited funds available to a preferred product category while being spread thinly across all product segments.

In the current scenario, we forecast Revlon to lose share in the future across all product segments due to its inability to match the competition in marketing and R&D. Hence, focusing the limited funds available on a few preferred product categories presents a more viable option for the future.

What if Revlon Focused on Color Cosmetics and Phased Out Skin Care and/or Fragrances?

Revlon is most well known for color cosmetics and commands a significant market share of over 20% in US, which itself constitutes over 18% of the global market for color cosmetics. Given, the company average EBITDA margin for color cosmetics and moderate growth rates in excess of 3%, it would be reasonable to focus on this product segment and to further strengthen Revlon’s market share in the same. We estimate that color cosmetics constitute over 60% of Trefis price estimate of Revlon’s stock.

Skin care is the fastest growing segment within personal care, primarily on account of anti-aging skin care. The leading players in the industry, L’Oreal, Estee Lauder, Procter & Gamble are investing heavily in R&D to come out with more innovative anti-aging solutions.

We believe Revlon is not well equipped to take on the bigger players in skin care on account of limited R&D budget. Fragrances as a product segment demand high marketing and advertising spending and here again, Revlon loses out to the other bigger players. We believe, Revlon continuing in these segments with miniscule and further-dwindling markets shares, while consuming R&D and Marketing & Advertising budget, presents a wasteful proposition for Revlon.

We estimate that focusing R&D and marketing on color cosmetics leading to a moderate rise in its markets share (to about 3.20% by 2012 eventually reaching 3.30% by 2017) has a 37% potential upside, while gradually phasing out skin care and fragrances (from 0.37% market share in 2009 to 0.25% by 2017) has a 10% potential downside to our current Trefis price estimate of Revlon’s stock. With the result, we can still expect Revlon’s stock to gain 27% in the above case.

You can drag the graphs to see the impact on Revlon’s stock price.

You can see our detailed analysis of $9.70 Trefis price estimate of Revlon’s stock here.