Upside & Downside Risks for L’Oreal’s Stock

L’Oreal (PINK:LRLCY) is the largest manufacturer of cosmetics and beauty care products in the world and competes with others such as Estee Lauder (NYSE:EL), Revlon (NYSE:REV) and Procter & Gamble (NYSE:PG). We value L’Oreal with a $23.27 Trefis price estimate of its stock, which is slightly below the current market price. Here we take a closer look at two scenarios for L’Oreal’s stock.

10% Upside Scenario: $25.40 Trefis Price Estimate for L’Oreal

Steeper Rise in L’Oreal’s hair care market share (+3%):

We currently forecast L’Oreal share of the hair care market to remain relatively flat, rising from 22.3% in 2010 to only 23% by the end of our forecast period. However, given L’Oreal’s sound cash balance favoring extended periods of discounts and promotional pricing as it expands in the emerging market, we expect market share to rise to about 26% despite competition from regional players from increasingly aggressive mass-market players such as Procter & Gamble and Unilever in these markets. This could lead to a 3% potential upside to our Trefis price estimate.

More robust growth in L’Oreal’s skin care market share (+5%):

We currently forecast L’Oreal share of the skin care market to grow marginally from 12.9% in 2010 to just under 14% by the end of our forecast period. An innovation driven market, particularly the anti-aging skin care segment can be expected favor more, one of the largest R&D spenders within beauty care – L’Oreal at roughly 3.5% of sales compared to 2.7% for Procter & Gamble and 1.7% for Revlon. L’Oreal’s skin care could command 16% market share by the end of our forecast period leading to a 5% potential upside to our Trefis price estimate.

Expanding EBITDA margins for The Body Shop (+2%):

The Body Shop segment’s EBITDA margin improved from under 12% over 2008-09 to 13.6% in 2010.

The EBITDA margin for The Body Shop is still significantly lower than the company’s average at around 20%. Given the costs associated with company-owned retail outlets (rentals, staff salaries, maintenance etc) and the lack of flexibility on account of it, we expect The Body Shop to increasingly franchise its outlets as it expands in South Asia and the Middle East. This could lead to operating margins rising to about 18% by the end of our forecast period, resulting in slight upside to Trefis price estimate.

2% Downside Scenario: $22.81 Trefis Price Estimate for L’Oreal

Shrinking hair care segment’s EBITDA margin (-2%):

We currently estimate L’Oreal EBITDA margin on hair care products to rise from 20.7% in 2010 to 22% by 2017. While there are reasons to believe that scale benefits would favor moderately expanding margins in the long-term, given that L’Oreal plans sourcing volumes from emerging markets at competitive price-points, we can expect it to pass any cost benefits to the consumer resulting in stagnant margins and a 2% potential downside to our Trefis price estimate.

View our detailed analysis of L’Oreal’s stock here.