L'Oreal (LRLCY)

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WHAT HAS CHANGED?

The year 2016 ended on a strong note for L'Oreal having been boosted by positive growth (~4%) in the global beauty market. The company outperformed the performance of the global beauty market. L'Oreal's luxury segment, L'Oreal Luxe, remained its best performer with its innovative products and iconic line of products, while the mass markets recovery continued due to the adaptation of the segment to the contemporary market demands. Though its Active Cosmetics segment slowed down a bit towards the end of last year, it was still a growth driver. With L'Oreal's recent acquisitions of three brands under this category, its strong leadership position in this segment might continue to flourish.

L'Oreal's Professional segment continued on its weak note but it is expected to show signs of improvement as the hair color market starts gaining momentum and the new product launches by the company last year starts picking up sales. Along with this, there has been management restructurings for further boosting the performance of the Professional division. L'Oreal's e-commerce sales' impressive growth continued in both its mature and New markets. The year 2016 was one where L'Oreal boosted its market dominance and growth with the help of organic and inorganic growth along with its digital initiatives. L'Oreal is the most advanced beauty company when it comes to digital progress.

However, one of the biggest highlights of its Q4 2016 earnings call was that L'Oreal has started looking for strategic alternatives for its The Body Shop brand. With over 3,000 stores across 66 countries, The Body Shop, which was once a celebrated brand, has been suffering in its performance lately. In 2016, The Body Shop witnessed a 5% decline in its top line to reach €920.8 million. The slowdown in sales in strategically important regions such as Saudi Arabia and Hong Kong were attributed to its weak performance.

L'Oreal's growth engine seems to be going ahead at full steam. After a strong 2016, the company reported a 4.5% like-for-like growth in its total sales to reach €19.5 billion for the first nine months of 2017. The star performers as usual were the Active Cosmetics and the L'Oreal Luxe segments. L'Oreal's strategic acquisitions are proving to be key drivers of its performance. One of the key brands driving its Active Cosmetics Segment's growth was its 2017 acquired brand, Cera Ve. The four most important brands for the growth in the Luxe segment had been: Lancôme, Yves Saint Laurent, Giorgio Armani, and Kiehl's, along with its 2016 acquisition, IT Cosmetics. Geographically L'Oreal's new markets are some of the best performers, particularly the Asia Pacific market in which China stole the limelight. It is noteworthy that Estee Lauder's recent performance was also boosted by China. The country is emerging as one of the most important markets for the growth in beauty sales. Western Europe was also another key market that drove L'Oreal's growth.

  1. Strategic investments are a key to L'Oreal's success

    • In January 2017, in an effort to further grow its active cosmetics segment, L'Oreal announced its intention to acquire the skincare brands, CeraVe, AcneFree, and Ambi from Valeant Pharmaceuticals for a sum of $1.3 billion.
    • The acquisition of the active cosmetics brands might help L'Oreal further strengthen its leadership position in the active cosmetics market. These brands are quite popular with health professionals and are expected to almost double the revenue for L'Oreal's active cosmetics division in the U.S. According to a recent report by Research and Markets, the global cosmeceutical market is expected to grow at a CAGR of nearly 6% between the period of 2017 to 2021.The company's influence in other geographies gives it the opportunity to expand the footprints of the acquired brands beyond North America.
    • The year 2016 was an active one for L'Oreal in terms of acquisitions. In July 2016, the company announced the decision to acquire 1. premium fragrance brand, Atelier Cologne, 2. the France-based spa group Société des Thermes de Saint-Gervais-les-Bains, 3. the US based prestige beauty company, IT Cosmetics (for $1.2 billion), and 4. the license to use the Saint-Gervais Mont-Blanc beauty brand.
    • In May 2016, L'Oreal announced a partnership with Founders Factory, a global digital accelerator and incubator based in London. The exclusive partnership enabled the companies to invest in Beauty tech startups across the world along with the opportunity to co-create two new companies every year. In January 2017, L'Oreal and Founders Factory selected five startups to further help them with their growth. The selected companies range from those helping businesses improve social media reach and with online campaigns, to those selling customized skincare and nail art. L'Oreal's own digital initiatives and innovative product pipeline might receive a boost as a result of these investments.
    • Currently, the beauty giant is planning on launching a program in Paris that will involve the collaboration of start-ups in order to produce more products like 'smart' hairbrushes and skin patches. The company aims at developing a site in Paris where 10 to 12 startups might work in collaboration with L'Oreal to develop more innovative technology for beauty every year.
    • In January 2016, L’Oreal launched a stretchable skin sensor called My UV patch. The product, which is currently in beta form, is designed as a wearable, and it will help educate users about their exposure to ultraviolet rays. The patch will be released under the company's dermatological skincare brand, La Roche-Posay. Guive Balooch, L'Oreal's Global VP of Technology Incubator, has indicated that this might be a start for the company to bring more sophisticated hardware and software technologies into its products. My UV Patch is the first attempt by a beauty company to introduce wearables among beauty users.
    • Also in January 2016, L'Oréal USA, the biggest subsidiary of L'Oréal Group, signed an agreement for acquiring key assets from Raylon Corporation, a full-service family owned wholesale distributor of salon professional products. This is L'Oréal's first acquisition for the year 2016, and this is the company's initiative to further strengthen its professional products segment and distribution coverage against rising competition.

    • L’Oreal is currently conducting research towards connecting its makeup products through the Internet of Things. The Internet of Things is the network of objects or “things” which can collect and exchange data with the help of their embedded electronics, software, sensors, and network connectivity. The successful implementation of this technology will allow L’Oreal to give connectivity to its makeup products, such as lipsticks, nail polishes, or mascaras. This, in turn, will help the company to better track its consumers.
  2. L'Oreal Sells Off The Body Shop

    • Recently, L'Oreal sold off its The Body Shop brand to the leading Brazilian beauty company, Natura Cosmetics, for €1 billion. The Body Shop brand has been persistent in its weak performance under L'Oreal's umbrella, hence, selling it off seemed like a good decision for L'Oreal. In 2016, The Body Shop's sales declined by 5% y-o-y to around €921 million and its operating profit declined by 38% y-o-y to €34 million.
    • POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

      L'Oreal's Market Share of Global Hair Care Market: Hair Care Market Share for L'Oréal declined from 24.3% in 2009, to 22% in 2012, and was around to 24%, 23%, and 20% in 2013, 2014, and 2015 respectively. In 2016, the company's market share stood at 20%. The company pulled out its Garnier brand from China in a bid to focus exclusively on prestige beauty products in the region. We currently forecast L'Oréal's share of the Hair Care market to reach 23% by the end of our forecast period. There could be a marginal downside to the Trefis price estimate if the market share remains flat at the current level.

      L'Oreal's Market Share of Global Skin Care Market: L'Oréal's Skin Care Market Share expanded from 12.3% in 2009 to close to 14% in 2014 before declining to around 12% in 2015 and 2016. We currently forecast L'Oréal's share of the Skin Care market to grow to about 15% by the end of our forecast period. There could be a marginal downside to the Trefis price estimate if the market share were to remain flat at the current level.

      BUSINESS SUMMARY

      L’Oreal is the largest manufacturer of cosmetics in the world. It manufactures and sells makeup, fragrances, skin care, and hair care products through over 30 global brands. It caters to consumers across all income levels and distribution channels spanning mass volume retailers and drugstores, to upscale perfumeries, pharmacies, department stores, company-owned stores, and e-commerce websites.

      L’Oreal reports and segments its products range on the basis of price range and distribution channel into: Professional, Consumer, Luxury, and Active products.

  3. Professional Products constitute ~15% of net sales and are meant for professional hair care by stylists at hair salons. The main brands include: L’Oreal Professional, Kerastase, Matrix, Mizani, and Redken.

  4. Consumer Products constitute approximately 50% of cosmetics sales and are sold through mass volume retailers and drugstores. Consumer products include makeup, skin care and hair care products, competitively priced and distributed through mass-market retailing channels. The main brands include: Garnier (skin and hair care for men and women), L’Oreal Paris (skin care, makeup, hair care, and hair colors under Studio-Line, Dermo-Expertise, and Elseve product lines), Maybelline New York and Softsheen-Carson (hair care for African ethnic descent consumers).

  5. Luxury Products constitute about 30% of cosmetics sales and comprise prestigious brands and premium service through department stores, upscale perfumeries, travel retail outlets, as well as free standing stores and e-commerce websites. The main brands include Lancome, Biotherm, and Kiehl’s.

  6. Active Productsconstitute about 8% of cosmetics sales and include dermo-cosmetic (cosmetics with medicinal ingredients and recommended by pharmacists and dermatologists) skin care products sold exclusively through pharmacies, specialty drugstores, medi-spas, and even dermatologists. The main brands are La Roche-Posay, Skinceuticals, Vichy, and Sanoflore.

  7. The Body Shop
constitutes about 1% of net sales and includes a chain of over 3,100 free standing ‘The Body Shop’ stores in over 60 countries across the globe. Acquired in 2006, The Body Shop range of cosmetics is well known for its products based on natural ingredients and the brand’s strong ethical commitments and fair-trade practices.

L'Oreal also has ~ 9% stake in Sanofi Aventis, the dividend from which contributes significant value to L'Oreal's stock.

Despite L’Oreal’s global presence, about 35% of its cosmetics revenue comes from Western Europe and over 25% from North America. Asia accounts for about 23% of its cosmetics sales. Latin America and Eastern Europe currently contribute around 8% and 6%, respectively.

L'Oréal's main competitors include other major global beauty care products manufacturers such as Revlon, Estee Lauder, Avon, Shiseido, and Procter & Gamble, among others.

SOURCES OF VALUE

Leading market share in Skin Care, Fragrances, and Makeup

L'Oreal has the largest market share in the Skin Care segment, the largest and fastest growing segment within Beauty Care (on account of anti-aging skincare and skin care for men), as well as in the Fragrances and Makeup segment.

Second largest market share in hair care, the second largest product segment (after skin care) within beauty care

Hair care is a stable and growing market, and L'Oreal commands the second largest share in the segment, after Procter & Gamble. Hair care accounts for about 20.5% of L'Oreal's net sales.

Highest R&D as percentage of net sales and marketing expenses in the beauty care industry which ensures market leadership

Launching new and innovative products is crucial to growing or even maintaining share in the beauty care industry. L'Oreal spends more on R&D as a percentage of sales as compared to its competitors. This has helped L'Oreal remain a leader in the cosmetics market.

On the basis of revenue, L'Oreal (at ~$30 billion) is much larger than Revlon ($2 billion), Avon ($9 billion), and Estee Lauder ($11 billion). Therefore, L'Oreal has more money to spend on marketing, which is an extremely important factor for success in the cosmetics industry.

KEY TRENDS

Booming Skin Care due to anti-aging creams

Anti-aging creams and anti-cellulite skin care products are in high demand among the aging populations in developed countries, notably Japan (oldest demographic), the U.S., and Western Europe. A big chunk of L'Oréal's skin-care business comes from anti-aging products. The anti-aging market comprises of those products that can treat multiple signs of skin aging at one time, and is a fast-growing segment under the anti-aging beauty products.

Growth of natural products categories and "Masstige" segment as well as male product lines

There is a growing demand for natural / organic products in most countries, a trend led by the developed markets in the U.S. and Western Europe. Additionally, there is an increased preference for less synthetic, eco-friendly, and more natural products and packaging.

There is a growing trend towards the so-called "Masstige," or premium brands sold at lower prices through mass distribution. In addition, beauty care products focused on men is the latest niche being targeted by most players globally. In developed markets, particularly in the U.S. and Western Europe, the introduction and extension of the men’s product lines is a major source of growth.

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