CapEx Investments Aimed At Increasing Production Volumes And Plant Efficiencies For L’Oréal

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LRLCY: L'Oreal logo
LRLCY
L'Oreal

L’Oréal (OTC:LRLCY) is the leading cosmetics and beauty care player globally and competes with other notable pure-play cosmetics manufacturers like Estee Lauder (NYSE:EL), Shiseido, Avon Products (NYSE:AVP) and Revlon (NYSE:REV). The company also competes with cosmetics products from global consumer product companies such as Unilever (NYSE:UL), Procter & Gamble (NYSE:PG) and Beiersdorf.

L’Oréal reported FY13 revenues of approximately $30.5 billion. Geographically, L’Oréal derived approximately 25%, 35% and 40% revenues from North America, Western Europe and Emerging Markets, respectively,  in 2013. Comparatively, these revenue shares were approximately 27%, 47% and 26% in 2005. The rapid expansion in revenue share from emerging markets over the past decade was fueled by an enormous increase in consumer appetite for discretionary products.

In this note, we take a look at L’Oréal’s strategy behind its capital investments over the past decade. We have a Trefis price estimate of $34 for L’Oréal that is approximately inline with its current market price.

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View our detailed analysis for L’Oréal here

Rising Emerging Market Demand, Cost Savings Prompt CapEx Investments

Capital expenditures as a percentage of L’Oréal revenues have averaged close to 4% over the past decade. In absolute terms, L’Oréal spent over $750 million each year over the past decade in property, plant and equipment investments. Between 2011 and 2013, cash outflow relating to property, plant and equipment increased from €866 million (~$1.2 billion) to €1,061 million (~$1.4 billion). L’Oréal’s new manufacturing facilities in Indonesia, Mexico and Egypt, which began operating in early 2013, have contributed in part to the expanding CapEx outflow. Apart from new investments into building factories, L’Oréal has also invested into expanding production capacities and improving operational efficiencies in existing facilities.

According to data collected from L’Oréal’s annual reports, the unit production rate (in terms of volumes) between 2005-2013 has increased by 26%. The company reported having produced 4,379 million units in 2005. This means approximately 5,518 million units were produced in 2013. The increase in units produced is a result of the strong demand from Emerging Markets over the past decade. The expansion in revenue share from 26% to 40% for Emerging Markets is indicative of strong demand. As far as capital investments are concerned, L’Oréal could have achieved the 26% increase in production volumes by investing into expanded facility capacities or increasing production rates or both.

In addition to increased production capacities, L’Oréal also invested into improving production facility efficiencies. During the 2005-2013 period when production volumes increased 26%, water consumption for its operations and transportable waste output have reduced by 27% and 20% respectively. Water is used extensively for manufacturing and cleaning operations in industrial facilities. Additionally, the company has a commitment towards using 100% plant-based raw materials for its products by 2020. By 2013 end, 43% of raw materials used by L’Oréal were plant-based, and this proportion is set to expand in the future. Steadily increasing production volumes and lower wastage indicates constant improvement in process efficiencies from L’Oréal.

Additionally, increased usage of renewable raw materials with a greater emphasis on green cosmetics should drive R&D investing higher. In the future, these new green cosmetics products requiring lower raw material and producing lesser waste could indirectly contribute to this process optimization for L’Oréal.

Going forward, we expect the company to focus more on further improving plant functionality and efficiencies in comparison to entering new geographies with new manufacturing facilities. We expect capital expenditures to taper down marginally from 4.6% of sales in 2014 to 4.3% of sales in 2020. However, capital expenditures are expected to grow modestly in absolute terms in the future.

Moreover, products currently in the company’s R&D pipeline could result in raw material cost savings and add to plant efficiencies. These new products should help drive top line and margins higher for the company in addition to improving manufacturing efficiencies.

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