Emerging Markets Support L’Oréal’s $33 Fair Value

by Trefis Team
+1.27%
Upside
33.69
Market
34.12
Trefis
LRLCY
L'Oreal
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Quick Take

  • We have revised our price estimate 20% higher to $33 for L’Oréal to reflect its strong relative growth in the first half of the year.
  • The acquisition of Magic Holdings in China will further strengthen L’Oréal’s footing in the region. We are waiting for the deal to finalize deal and haven’t accounted for this acquisition in our estimates.
  • We believe that high demand for hair care products in Latin America can be supported by expanded manufacturing capacity such as its new facility in Mexico.
  • The acquisition of Urban Decay will strengthen its Make-up products portfolio. Franchisee launches such as Si from Giorgio Armani, Red from Ralph Lauren to bolster fragrance sales.
  • We have changed our capital expenditure forecast methodology and net working capital estimates to better reflect management guidance which added about 10 percentage points of the change in our revision.

L’Oréal SA (PINK:LRLCY) recently reported its first half results that were reasonably good considering the slowdown in the global cosmetics industry. The global cosmetics industry grew at an estimated 3.5%-4% in the first half while L’Oréal posted organic h-o-h growth rate of 6.4%. Net income for the group grew by $660 million from $1.6 billion in H2 2012, partly resulting from the acquisitions completed in 2012 and 2013.

Despite the dilutive effects on margins, strong performances from acquired companies such as Interconsumer Products (ICP) in Kenya, Vogue in Columbia and Urban Decay in the U.S. accounted for 1% of the 6.4% growth seen in H1 2013. Sales for Urban Decay grew 34% in the first half of 2013, after its acquisition by L’Oréal in December 2012. We believe that the strength in the new brands could overcome the possible decline in growth of -3.7%, due to increasing currency volatility in new markets to boost overall top line for the company.

Although L’Oréal posted growth that was higher than the industry growth rate, the stock has been largely range-bound in the $33 region over the last three months. Our new estimates are in line with the current market price. In this note, we highlight key areas for L’Oréal that contributed to an almost 20% revision in our earlier estimate of $28.

View our analysis for L’Oréal

Emerging Markets To Push Skin Care and Hair Care Sales Higher

Globally, the skin care and hair care markets grew at 4% and 4.4% annually between 2007 and 2012 to reach $100 billion and $75 billion respectively by 2012. The rapid growth witnessed in emerging economies in the past decade has caused a change in purchasing patterns resulting in higehr demand for personalized and locally relevant products. The strong growth in sales in emerging economies can be attributed to higher product volumes along with higher price points for technologically advanced products.

Market research firm Euromonitor predicts that almost $11 billion of the projected $16.5 billion growth in the skin care segment in the next five years will result from the expanding middle class in the Asia-Pacific region. [1] A similar trend is visible in the smaller hair care market. In 2012, emerging markets accounted for 92% of the growth in global hair care sales, compared to 88% in 2011, and are expected to account for more than 60% of the total hair care sales by 2016. [2]

The huge growth prospects in skin and hair care segments present L’Oréal with opportunities to capture market share from its competitors Procter & Gamble (NYSE:PG) and Unilever (NYSE:UL). The company has invested strategically into new manufacturing facilities in Indonesia in November 2012 and Mexico in December 2012. [3] The acquisition of ICP in Kenya has opened doors for L’Oréal to assess the long-term value in the sub-Saharan African region.

We expect the recent acquisitions made by L’Oréal to support an annual revenue growth rate of 7.45% for the skin care segment until 2020, compared to an expected CAGR of 4.3% for the skin care market. In the hair care segment, L’Oréal faces strong competition from industry leader Procter & Gamble in the Latin American market which has seen the highest growth rate in recent times. However, we expect the new manufacturing facility in Mexico to aid in the production of lower priced products for the Latin American hair care market. This could result in a gradual increase in the hair care market share enjoyed by L’Oréal in the future, although further acquisitions could create more upside for the company.

Better Inventory Management Practices To Cater To Growth In Demand

Although sales from the Asia-Pacific region slowed from 12.5% in H1 2012 to 8% in H1 2013, other 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. To cater to higher demand from the fast-growing new markets and due to a recovery in developed markets, L’Oréal plans to improve its available working capital for the fiscal 2013 by €200 million. [4]

We expect slower inventory turnover in 2013, as demand for beauty products pick up steam and estimate a reduction in inventory turnover ratio to 9.8. Additionally, we believe that L’Oréal could soften terms with its suppliers and distributors through a reduction in accounts payable days and an increase in accounts receivable days. Following these adjustments, we expect working capital to increase from $313 million in 2012 to $590 million for the company in 2013.

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Notes:
  1. Skin Care Market Radiant for Foreseeable Future, GCI Magazine, September 2012 []
  2. Hair Care on the Verge of a New World Order, GCI Magazine, July 2013 []
  3. L’Oréal’s CEO Discusses Q4 2012 Results – Earnings Call Transcript, Seeking Alpha, February 2013 []
  4. L’Oreal SA Management Discusses H1 2013 Results – Earnings Call Transcript, Seeking Alpha, August 2013 []
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