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).
Revenue Outlook Improves in 2011
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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.
Refinancing Measures Help Reduce Interest Expense
Taking advantage of the favorable fund raising environment, Revlon refinanced its outstanding $792 million loan in May 2011 with an $800 million loan while reducing its effective interest rate and extending its maturity (to Nov 2017 from Mar 2015). In June 2011, it also refinanced its existing revolving credit facility that was set to expire in March 2014, pushing its new $140 million revolving credit facility to June 2016 while securing better financing terms from the banks underwriting these loans.
Is Revlon Attractive For Acquisition?
High debt levels typically make a business unattractive for an acquisition as acquirers have difficulty raising additional debt against the business, and the associated volatility related to the future cash flows also raises the cost of capital for acquisition. However, if Revlon reduces its debt levels, given its strong brand name, it could become a take-out target by big players like Procter & Gamble and Unilever exploring options of inorganic expansion in the personal care category.
If Revlon pays down its debt while lowering advertising and R&D expenses to get its fiscal house in order, that could make it more attractive as an acquisition candidate; but that might come at the expense of its market share. We believe that upside exists from spending its additional resources on initiatives to maintain its brand value, especially in the color cosmetics where it possesses a strong market presence and has a good chance of defending its current market share.
We believe Revlon could sustain its current debt levels while investing in R&D and marketing so as to gain – or at least defend – its current market share. If Revlon maintains its leverage and continues to invest in color cosmetics, we can reasonably expect the market share to rise to its historical levels in the coming years.
We value Revlon stock with a $17 price estimate, almost in-line with the current price.