Two Scenarios That Can Impact L’Oreal’s Valuation In Opposing Ways

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L’Oreal’s (OTC:LRLCY) recent acquisitions have been strategically significant in nature and can give the company the scope to expand its market share and profitability. However, L’Oreal has tough competition in both ends of the beauty spectrum. In the mass segment, there are companies like Procter & Gamble (NYSE:PG), Unilever (NYSE:UL), and Revlon (NYSE:REV). Revlon has now also entered the professional segment to offer further competition. In L’Oreal’s luxury segment, Estee Lauder (NYSE:EL) is its most formidable competitor. In this article, we see how L’Oreal’s acquisitions might help expand its valuation in the future. However, we also talk about the competitors’ strategies which might hinder L’Oreal’s progress and adversely impact its valuation.

L’Oreal’s Current Brand Value

In its recent annual study, Brand Finance, a strategy consulting firm, named L’Oreal Paris, a brand from the L’Oreal  house, as the most influential and valuable cosmetics brand. The study called ‘Brands Cosmetics 50’ rated L’Oreal in the top position with a brand value worth $11.2 billion, reflecting a 15% growth over 2014. L’Oreal Paris has been successful in its mass marketing strategy while simultaneously maintaining its aura of exclusivity. The total brand value of the world’s top 50 cosmetics brands grew by 13% year on year to $123 billion in 2015. [1]

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Our  $33 price estimate for L’Oreal is slightly below the current market price.

See our complete coverage of L’Oreal

L’Oreal’s Acquisitions Stimulating Its Future Profitability (~10% Upside)

How Will The Acquisitions Aid L’Oreal?

  1. Global Dominance 

China

L’Oreal faced pressure from domestic players within the mass-market cosmetics space and has bowed out of the Chinese hair care market by shutting down its Garnier brand. Instead, to retain its market share, L’Oreal accepted an ‘acquire to grow’ strategy and acquired Magic Holdings, its largest acquisition in the China market. Magic Holdings is the leader in the Chinese facial care market, with annual revenues that grew by 14% on a constant currency basis to reach $220 million in 2013. [2]

Currently, L’Oreal enjoys the market leadership with a 13% share (in 2014) in China’s $25 billion skincare segment, which is expected to grow to $35 billion by 2019, according to Euromonitor. [3]

North America

L’Oreal acquired NYX Cosmetics to provide a boost to its weak North American market. NYX is a high-growth mass market makeup cosmetics brand with a presence in more than 70 countries. It is a direct competitor to Estee Lauder’s M-A-C brand of makeup cosmetics and has seen explosive growth in sales over the last two fiscal years. [4]

 

Brazil

L’Oreal’s acquisition of Brazil based Niely Cosmeticos, the largest independent hair care and hair coloration company in the country, is aimed at the middle-class mass market. Niely products have a large penetration in Brazil, and Brazil is currently the fourth largest beauty market in the world, with a number 1 position in hair care, hair colorants, and deodorants. [5] L’Oreal aims to improve its largest division, consumer products, through this acquisition.

  1. Research And Development Leadership

L’Oréal has the largest Research and Innovation team in the cosmetics industry with 3,782 researchers and a budget representing 3.4% of its sales. The R&D budget was over $1 billion in 2014.

According to L’Oreal’s estimates, the top two contributors for the global beauty market are skin care (34%) and hair care (24%). In December 2014, L’Oreal announced the acquisition of Israel-based hair research start-up, Coloright. L’Oreal has always been a pioneer in hair research, and this acquisition will further aid the company in being one of the forerunners in hair care related innovations.

In April 2015, L’Oreal entered into a skin tissue research agreement with the bio-printing technology firm, Organovo. The agreement will provide L’Oreal with exclusive rights to use the skin tissue models for the development, manufacturing, testing, evaluation, and sale of non-prescription cosmetic, beauty, dermatology, and skin care products. [6]

  1. Widest Distribution Channels

In April 2014, L’Oreal completed the acquisition of Decléor and Carita from the Japanese group Shiseido. Decléor and Carita hold a second position worldwide, in the global Professional Spa and Beauty Institute market. [7] The acquisition would ensure L’Oreal’s entry into new distribution channels in the professional beauty segment, such as day spas, resorts, and destination spas which specialize in skin care. [8]

In a move to further expand its African presence (where distribution was unstructured and hence cumbersome), L’Oreal signed an agreement with CFAO, the specialized distributor from Cote D’Ivoire, to cover the production and distribution of cosmetics in the Ivory Coast. The partnership will bolster L’Oreal’s distribution network as CFAO will be the sole distributor for L’Oreal products in French-speaking West Africa.

With its strategic acquisitions, R&D initiatives, and wider distribution networks, we can expect L’Oreal’s three largest segments: hair care, skin care, and makeup, to assume higher profitability in the future. We currently expect L’Oreal’s EBITDA margin for these three segments to marginally increase from 22% in 2014, to around 23% by the end of our review period. However, if, on account of its strategic initiatives, the EBITDA margins expand to 24% by the end of our review period, then there can be an almost 10% increase in our price estimates for L’Oreal.

 The Recent Shaking Up Of The Prestige And Professional Cosmetics Marketspace Can Adversely Impact L’Oreal’s Market Shares (~10% Downside)

  1. Prestige Segment: Estee Lauder and Unilever

The biggest challenge for L’Oreal is that it has a presence across all the segments of the beauty market. Whereas, Estee Lauder concentrates only on the premium category, thus giving it the edge to focus on one segment and excel in it.

In order to further strengthen its premium segment and also address some of the demand supply gap, Estee Lauder announced a string of acquisitions in the span of two months between October and December, 2014. The companies it acquired were: GLAMGLOW, a prestige skin care brand specializing in facial mask treatments; Le Labo, the high end fragrance and sensory lifestyle brand; Editions de Parfums Frédéric Malle, the storied fragrance brand established by the iconic perfumer Frédéric Malle; and RODIN olio lusso, a luxury skin care oil brand.

These products will offer solutions beyond the traditional skincare formulations like moisturizers and serums, to newer concoctions such as masks and oils. [9] These new brands can fulfill the current demands of the beauty users. Also, Estee Lauder’s strategic goals include gaining a lion’s share in the prestige skin care and makeup segment. The reformulation of the usual products through investment in its research and technological capabilities is one key element of its strategy. [10] and this strategy can be applied to the new brands, as well.

Additionally, Unilever, the world’s second largest consumer processed goods company, intends to consolidate its position in the personal care industry by making acquisitions in the premium personal care segment. [11] In 2014, personal care accounted for 37% of its total revenues. [11] Unilever named the expansion of the personal care segment through acquisitions as one of the top priorities in fiscal 2015. [12]

  1. Professional Segment: Revlon

Though L’Oreal is currently the leader in the professional segment, competition is not far away. Revlon entered the professional segment in a big way with its 2013 acquisition of The Colomer Group (TCG). Revlon’s Professional segment witnessed impressive growth in 2014, primarily due to the TCG acquisition. Erstwhile, Revlon had primarily been a specialty color cosmetics manufacturer, deriving more than 60% of revenues from Color Cosmetics. The acquisition of TCG diversified Revlon’s portfolio of products by adding a mix of Professional Products.

In case of increased market share by powerful competitors such as Estee Lauder and Revlon, or a market entry by Unilever, L’Oreal’s global market share might be hampered in its three main segments. In 2014, L’Oreal’s global market share in hair care, skin care, and makeup was estimated to be around 22%, 14%, and 18% respectively. We currently expect L’Oreal’s global market share in hair care, skin care, and makeup to increase to 24%, 17%, and 21% respectively, by the end of our review period. However if the growth is stunted and remains close to the 2014 levels, there can be a 10% downside to our Trefis price estimate for L’Oreal.

 

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Notes:
  1. L’Oreal Paris Named The Most Powerful And Valuable Cosmetics Brand, Cosmetics Design, April 9, 2015 []
  2. Revlon and Garnier exit the Chinese $22.8 billion beauty market, Telegraph, January 2014 []
  3. L’Oreal to lower imported product prices in China as tariffs cut, The Business Times, May 29, 2014 []
  4. L’Oréal signs agreement to acquire NYX Cosmetics, L’Oréal Finance, June 2014 []
  5. L’Oreal’s Annual Report 2013, L’Oreal Finance []
  6. Organovo (ONVO) Enters Research Collaboration Agreement with L’Oreal USA, Street Insider, April 7, 2015 []
  7. Draft agreement between L’Oréal and Shiseido for the acquisition of Decléor and Carita, L’Oréal Finance, October 2014 []
  8. L’Oréal Finalizes the Acquisition of DECLÉOR and CARITA, Day Spa Magazine []
  9. Estee Lauder’s Q1 2015 Earnings Transcript, Seeking Alpha, November 2014 []
  10. Estee Lauder’s Q4 2014 Earnings Transcript, Seeking Alpha, August 2014 []
  11. Unilever CEO says eyeing higher-priced personal care brands, Reuters, 4 December 2014 [] []
  12. Unilever 2014 Fourth Quarter Earnings Call Transcript, Seeking Alpha, January 20, 2015 []