Beauty product giant L’Oréal SA (PINK:LRLCY) performed reasonably well in its first half 2013 despite a slowdown in the cosmetics industry which affected other beauty players like Avon Products (NYSE:AVP) and Revlon (NYSE:REV). Globally, the cosmetics industry grew between 3.5% and 4% in constant $ terms during the first half of 2013, with L’Oréal company reporting a better-than-industry top-line growth of 6.4% h-o-h in constant $ terms to reach $15.4 billion in sales.
Of sales, 5.4% came from organic growth of existing products and the remaining 1% growth resulted from acquisitions made in the first half. However, currency headwinds impacted the revenue growth by (-1.7%) during the first half of 2013. In view of the strong depreciation of EM currencies, L’Oréal expects currency headwinds to strengthen during the second half and impact reported revenue growth by approximately (-3.7%) for the entire year.
Lower cost of sales due to the consolidation of existing acquisitions in the L’Oréal group saw gross margins improve by approximately 70bps. On the operating expenses front, L’Oréal continued to invest heavily into R&D. The company recently unveiled a new Research & Innovation Center in India aimed at studying the demographics in the region. This has resulted in 22bps expansion in the percentage share of R&D expenses in total operating expenses. Capital expenditures for the first half of 2013 stood at $689 million. Similarly, SG&A expenses increased by 22bps following the increase in number of staff due to the acquisitions completed in 2013 and a strengthening in sales force in China, Brazil and Russia.
However, investments in advertising and promotional as a percentage of total operating expenses declined by 50bps over H1 2012. The decline is attributed to the gradual transformation in advertising from the traditional form to the relatively less costlier digital advertising format. Despite the incremental additions in R&D and SG&A expenses, the strong growth in sales and lower advertising expenses ensured that operating margins expanded by approximately 50bps. This has helped the company expand its bottom-line as a percent of sales by 7bps despite the $125 million increase in income tax due to the acquisitions.
Strength In Other Markets Offsets Asian Industry Weakness
The weakness in Asia was comfortably overcome by the other markets of Western Europe, North America and New Markets of Latin America and Middle East & Africa. New Markets, which comprised 39% of L’Oréal’s sales, continued to show strong growth patterns in spite of the weakness in Asia Pacific. The region’s sales grew at 10.3% compared to the industry growth rate of 5.6%. Sales growth from the Asia Pacific region slowed down from 12.5% in H1 2012 to 8% in H1 2013.
However, the remaining geographies in L’Oréal’s portfolio grew faster than the industry due to improving macroenvironments in Europe & North America and deeper penetration in the New Markets. Western and Eastern Europe sales’ grew at 2% and 8.4% respectively in constant $ terms compared to industry growth rates of -0.9% and 1.8% respectively in the regions. Similar signs of growth were observed in the rapidly growing Latin American market where constant $ sales grew 15.2% compared to the market growth rate of 9%. Sales from Middle East & Africa grew at 16.2% compared to 7.5% industry growth during the first half of 2013.
We expect a shift in focus to other geographies from the Asia Pacific region in the short-term as depreciating currencies cut deep into the margins for the company. China remains particularly resilient to the currency weakness prevailing in Asia, and this has flourished luxury product sales for the company in the Chinese market. Sales from L’Oréal Luxe in China grew at 25.9% compared to a growth of 16.7% in the luxury cosmetics industry in the region.
Product Innovations and Roll-outs To Continue
In the first half of 2013, L’Oréal has completed the roll-out of various skin care and hair care products like Advanced Hair Care Total Repair 5, Elvive, Revitalift Laser X3 and Age Perfect along with the globalization of Garnier Olia and Garnier Nutrisse. Within the Asian markets, the company launched two new products L’Oréal Men Expert Hydra Energetic and Garnier Men Acno Fight specifically formulated for Asian men.
The popularity of specific skin care and hair care products in increasing and the increase in R&D expenses is a step in the right direction for the company. Products in the pipeline for the remainder of 2013 include skin care products from L’Oréal Paris, Garnier, The Body Shop and Vichy, makeup products from Maybelline and fragrances from Lancome Paris, Ralph Lauren and Giorgio Armani. With growing investments in R&D and the construction of regional manufacturing facilities, we believe that locally relevant products help L’Oréal expand its market share across various product lines.
Decelerating Growth For Galderma and The Body Shop in 2013
Sales from The Body Shop and L’Oréal’s dermatology joint venture Galderma saw steep decelerations in the first half of 2013. Like-for-like sales for The Body Shop fell from 5.4% in H1 2012 to 0.5% in H1 2013. Although the holiday season of the second quarter is more profitable for the skin product retailer, sales this year are guided to remain weak due to the persistent weakness in Asia and difficult operating environments in the UK.
Galderma witnessed intense competition from the likes of GlaxoSmithKline and Novartis in the US in the first half of the fiscal which resulted in a steep deceleration in sales growth, from 11% in H1 2012 to 0.3% in H1 2013. The dermatology company completed the acquisition of Spirig AG, a manufacturer of dry-skin and sun-protection creams in December 2012 to increase its product offerings.  However, the company is not as big as its competitors and intensifying competition in the skin care and dermatological treatment space could further reduce growth prospects and also squeeze margins.
We are revising our price estimate of $28 for L’Oréal to factor in trends from the latest half yearly results.Notes:
- Galderma Agrees to Buy Spirig to Gain Skin-Care Treatments, Bloomberg, Dec 2012 [↩]