Revlon is expected to release its third quarter earnings this week. After the declining sales between 2007-09, Revlon has achieved a positive sales growth over the past few quarters. Yet, given Revlon’s heavy indebtedness, we’re still very cautious with regards to its course of action – we’ll paying particular attention to its EBITDA margins, overhead corporate expenses and operating working capital. Revlon competes with other consumer goods and beauty product companies like Procter & Gamble, Unilever, Colgate-Palmolive, L’Oreal, and Estee Lauder.
We value Revlon stock with a $17.750 price estimate, 25% ahead of market price.
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Last quarter, Revlon achieved 4% sales growth, benefiting from new successful launches like Revlon Age-Defying DNA Advantage and Revlon Colorburst and core product line up in color cosmetics. It also benefited from Sinful Colors acquisition backed by effective promotional activity.
This contributed to a healthy sales growth given the 4% year-on-year revenue decline between 2007-09 that turned around in 2010 with a 2% sales growth. We expect the revenues to continue to improve with encouraging sales in major markets like the U.S. and Asia Pacific. Yet, it is likely to be offset by some decline in Europe, Middle East, Africa and Latin America. We will also be watching out for the gross margins that suffered a decline last quarter, unfavorably impacted by product mix, higher SG&A and inventory costs.
Heavy Indebtedness Still a Concern
Revlon’s business is characterized by its heavy indebtedness of over $1.13 billion with just $1.3 billion in annual sales (2010). This leaves it with much less money to spend of marketing and advertising compared to L’Oreal’s $24 billion and even Estee Lauder’s $7.9 billion in sales. Revlon’s limited R&D budget at 1.7% of sales amounting to $24 million, is too low compared to L’Oreal’s budget of $667 million at 3.7% of its sales. This disadvantage is part of the reason we forecast modest market share declines going forward. We’ve previously discussed our concern regarding Revlon’s gradual reduction in leverage that has restricted funds allocated to R&D and advertising. We also expect Revlon to work on improving its credit structure by refinancing its loans as last quarter.
Revlon is focusing on paying its debt to get its fiscal house in order makes it a more attractive as an acquisition candidate, but it might come at the expense of market share. We believe that upside exists from spending 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.