These Two Factors Could Significantly Decrease Revlon’s Stock Price

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Revlon (NYSE:REV), the mass market cosmetics manufacturer, delivered a healthy 2014 primarily after integrating The Colomer Group (TCG), into its operations. With the TCG consolidation, Revlon has diversified its product portfolio with the addition of Professional cosmetics products. The robust growth from the Professional segment had masked the weakness in Revlon’s own Consumer line of products. [1]

Revlon’s full year 2014 revenues were $1.94 billion reflecting a 1.7% year on year growth as compared to pro forma revenues of 2013.  For 2014, the XFX growth rate (which excludes the impact of foreign currency fluctuation) was 4.7% on a year-on-year basis. [2]

In this article, we discuss two scenarios that could possibly decrease Revlon’s price estimate by over 30%.

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Our current price estimate of $31 for Revlon’s stock is below the current market price.

 

Professional Segment Growth Might Not Be Sustainable In The Long Run (~20% Downside)

Revlon’s Professional segment witnessed impressive growth in 2014, primarily due to the acquisition of The Colomer Group (TCG). Professional segment net sales in 2014 were $502.7 million, reflecting an 8% growth in Pro Forma net sales over 2013. Professional segment profit in 2014 was $104.8 million and it grew by 49.5% year-on-year, on a constant currency basis.

TCG helped diversify Revlon’s product mix. 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.

However, the growth rate from Revlon’s Professional segment might not be sustainable in the long term because of the following reasons.

  • Revlon’s Competitors In The Professional Segment Have Stronger Innovation Frameworks

Revlon’s Professional products compete with similar products sold from more renowned players such as L’Oreal (OTC:LRLCY) and Estee Lauder (NYSE:EL). These competitors, with their stronger research and innovation capabilities, solid financial resources, and wider distribution channels, will provide formidable competition to Revlon in the Professional Segment.

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, up by 1.6% as compared to the previous year.

Estee Lauder’s research and development costs totaled $157.9 million in fiscal 2014 (ended in June 2014), which reflected a 7.5% year-on-year growth.  Estee Lauder employed around 700 employees for research and development activities during the same period. [3]

In contrast, Revlon’s innovation pipeline for the Professional segment is inconsistent and irregular. Hence, it is difficult to predict the impact of innovation spending in the coming quarters. In our opinion, Revlon witnessed exceptional growth in the Professional segment in 2014, due to the TCG acquisition. However, year-over-year growth would slow down in the future quarters, as was witnessed in Q1 2015. In the first quarter of 2015, the company reported flat sales and a 15.3% year-on-year decline in EBITDA, on a constant currency basis. Revlon’s reported sales declined by around 7% on a year-on-year basis to $438.5 million. [4]

  • Declining Loyalty From Principal Customers

Additionally, Revlon’s principal customers for the Professional segment include Beauty Systems Group, Salon Centric, and TNG Worldwide, as well as individual hair and nail salons and other distributors. The industry norm is such that none of these customers are obligated to continue purchasing products from Revlon. In the event that these buyers find more favorable products or favorable terms of doing business with other sellers, they can switch loyalties. [5] It is possible for Revlon’s stronger competitors in the Professional segment to lure away its primary buyers.

Revlon’s Professional segment is comprised primarily of the brands which it acquired through TCG Colomer Acquisition, including Revlon Professional in hair color and hair care, CND-branded products in nail polishes and nail enhancements, and American Crew in men’s grooming products. Revlon’s market share in global hair color segment increased from 0.66% in 2013 to 1.29% in 2014, as a result of the TCG acquisition.

In view of its Colomer acquisition, we currently expect Revlon’s global market shares in hair color to gradually rise from 1.29% in 2014, to around 1.33% by the end of our forecast period. Similarly, for color cosmetics the 2014 estimated market share of 3.4% is expected to reach around 3.6% by the end of our forecast period.

However, in the event of Revlon’s failure to maintain its growth momentum in the Professional segment in the coming years, the market share for hair color and color cosmetics could decline to 1.2% and 3%, respectively, by the end of our forecast period. Then there could be a 20% decline in our valuation of Revlon.

 

Losses Due To Currency Fluctuations (~10% Downside)

TCG increased Revlon’s exposure to international markets. For 2013, the company derived approximately 56% of its revenues from the U.S. and the remaining 44% from other geographies (reported revenues). This ratio changed to 53% for U.S. and 47% from international geographies in 2014, owing to the fact that TCG generates more than 50% of its sales from the EMEA (Europe, the Middle East, and Africa) region. [6] Going forward, this revenue distribution between the U.S. and International markets is expected to normalize close to the half-way point. This is because TCG’s revenues are growing at a much faster pace than Revlon’s core business.

Currency headwinds have been a major roadblock to the performance of cosmetics companies in recent times. In 2014, Revlon’s net sales for international operations declined by 2.2% to $919.1 million, mainly due to the international currency depreciation with respect to the U.S. dollar. International net sales increased by 4% in a constant currency basis.

The ongoing effect of the depreciation of international currencies against U.S. dollars can adversely impact Revlon’s profitability in the long run. We have forecasted Revlon’s EBITDA margin to reach 20% by the end of our forecast period, however, if the EBIDTA margin declined to 19%, then there could be an over 10% decline in our price estimates.

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Notes:
  1. Revlon’s Q4 2014 Earnings Call Webcast, Seeking Alpha, March 12, 2015 []
  2. Revlon Reports 2014 Results []
  3. Estee Lauder Form 10K, for the fiscal year ended June 30, 2014 []
  4. Revlon’s (REV) CEO Lorenzo Delpani on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, May 7, 2015 []
  5. Revlon Form 10-K for the year ended December 31, 2014 []
  6. Revlon Reports 2014 Results []