Operating margins for mass market cosmetics maker Revlon (NYSE:REV) have been on a downward trajectory in the past three fiscals, declining from 15.1% in 2010 to 13.2% in 2012. In addition to declining margins, the company’s top line growth witnessed a slight slowdown in growth, with a year-on-year growth rate of 3.2% in 2012 compared to 4.5% in 2011.
For the nine months reported in 2013, Revlon registered a top line decline of 1.3% from a comparable period in 2012. However, revenues grew 1% from January – September period in 2012 in constant currency terms. Operating profit margin for the company expanded to 14.5% in the three quarters in 2013, from 10.3% in 2012.
In this note, we take a look at Revlon’s business performance by product category and analyze the upside potential in margins for the company. We have a $24 price estimate for Revlon, which is in-line with its current market price.
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Color Cosmetics – Revlon derives a majority (~67% of total revenues) of its revenues from the sale of mass-market color cosmetics products across brands such as ColorStay, ColorBurst and Super Lustrous. In the nine months so far in 2013, Revlon generated $678 million in revenues from the sale of its color cosmetic products. The same period in 2012 yielded revenues of about $680 million. While reported revenues registered negligible growth between the nine months in 2012 and 2013, constant currency revenues for the company in fact were up, boosted by higher net sales in its acquisitions such as SinfulColors and Pure Ice cosmetics. The higher net sales from these acquisitions were offset to a degree, though, by lower net sales from its Almay brand.
Beauty Care And Fragrances – The beauty care and fragrances division of Revlon comprises an array of women’s hair color, beauty tools, antiperspirant deodorants, fragrances and skincare products. Revenues from the division stand at approximately $343 million (~33% of total revenues) for the nine months in CY13, compared to $355 million in the same period in CY12. Geographically, the Latin American market was the only market that saw higher net sales in the beauty care and fragrances division, with sales in the Asia-Pacific and Europe, the Middle East and Africa (EMEA) regions coming in lower than Revlon’s expectations. We believe shifting consumer buying preference from mass-market cosmetics to prestige products to be the reason for a lower sales figure in these emerging market regions.
Can Revlon Expand Its Margins Going Forward?
As stated above, operating profit margins for the company have declined by approximately 2 percentage points over the last 3 fiscal years. Despite signs of a recovery in operating margins in the nine months in 2013, we believe there is limited scope for expansion in margins for Revlon, primarily due to its retailer-oriented mass-market business model. Revlon’s principal customers are large mass volume retailers and chain drug stores, such as Wal-Mart, Walgreens, CVS and Target in the U.S., Boots in the U.K., Shoppers DrugMart in Canada and A.S. Watson & Co. in the Asia-Pacific market. The company reports that Wal-Mart and its affiliates alone account for about 22% of Revlon’s revenues across the world. 
This skewered model of revenue generation from a few very large mass retailers significantly decreases Revlon’s ability to negotiate prices, leading to low margin levels. This gravitated shift towards large retailers for its business offsets Revlon’s ability to leverage its strength in the color cosmetics products through higher mark up margins that color cosmetic products generally have. However, with the acquisition of The Colomer Group (TCG) in the latter half of 2013, Revlon stands a chance to boost its margins with an additional sales channel. TCG is a leading manufacturer of professional hair color products, including Revlon Professional, Llongueras and Revlon Flex. Through the acquisition, Revlon would also gain a strong footing in the EMEA market, where TCG derives about 50% of its revenues.
Going forward, we expect to see a slight improvement in terms of margins for Revlon, wholly due to the TCG acquisition. However, we expect core product margins for its color cosmetics and beauty care and fragrance products to remain under some pressure due to the high influence of very large mass volume retailers such as Wal-Mart.Notes: