Despite High Debt, Revlon Results Support $17 Value

After having seen its sales decline between 2007 and 2009, Revlon (NYSE:REV) regained some of its market share and margins in 2010-11. Even though U.S. sales remained negative in 2010, the trend reversed in 2011, particularly helped by the acquisition of Sinful Colors in March 2011. However, given Revlon’s heavy indebtedness, we’re still cautious about its course of action, whether it chooses to pay down debt at the cost of advertising and R&D expenses that could hurt its market share or it maintains debt levels to invest in defending and improving its market share, particularly in color cosmetics. Revlon competes with other consumer goods and beauty product companies like Procter & Gamble (NYSE:PG), Unilever (NYSE:UL), Colgate-Palmolive (NYSE:CL) and Estee Lauder (NYSE:EL).

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Revenue Outlook Improves in 2011

In 2011, Revlon’s sales grew by 4%-5% with improved sales in the U.S., which makes up over 55% of Revlon’s sales. The growth was primarily driven by the March 2011 acquisition of Sinful Colors as well as improved sales of Almay color cosmetics and Revlon Color Silk, partially offset by lower sales of Revlon color cosmetics and beauty tools and the losses from Venezuela’s June fire. The U.S. sales grew 4% in 2011, which was a healthy reversal in Revlon’s home turf, that showed a 3% decline in sales during 2010, following a 4% decline in 2009. Asia-Pacific (1/6th of Revlon’s sales in 2011) continued to be its fastest growing market, growing in double digits.

Improving Profit Margins

Revlon’s business restructuring and efficiency measures have helped it reduce its operating expenses and improve its profit (defined by EBITDA) margins, which grew from just under 18% in 2007 to around 20.5% in 2011. Revlon plans to implement these measures globally. With continued improvements in demand and supply forecasting and inventory levels, we expect Revlon to improve its margins to 21% over the next few years.

Debt vs. Market Share

Revlon’s business is characterized by its heavy indebtedness of over $1.1 billion and just $1.4 billion in annual sales. This leaves it with much less money to spend on marketing and advertising compared to L’Oreal’s $25 billion and even Estee Lauder’s $9.5 billion in sales. Revlon’s limited R&D budget of close to $25 million is a drop in the bucket compared to L’Oreal’s budget of $700 million.

Revlon progressively reduced its debt burden over 2007-09 which led to limited investments in advertising, R&D and capacity expansion, hitting its market share. However, Revlon has increased its advertising spend over the past few quarters hoping that if margins and pricing hold up, the company can use these additional resources to pay down debt. And it looks like this strategy could be working for the time being.