L'Oréal: Uncovering A Long-Term Growth Opportunity Amidst Market Challenges

seekingalpha07-29

L'Oréal's stock price dropped due to the CEO's comments on the beauty industry and French election results.My valuation analysis shows L'Oréal is fairly valued with strong revenue growth, margins, and...

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You can become one too! Share your best investment idea by submitting your article for review to our editors. Get published, earn money, and unlock exclusive SA Premium access. Click here to find out more »    Olivier DJIANN/iStock Editorial via Getty ImagesInvestment Summary A couple of weeks ago, the stock price of L'Oréal (OTCPK:LRLCF) - the world's largest beauty company - went down after its CEO's \"pessimistic\" (rather realistic) comments on the future growth of the beauty industry, alluding mainly to China's stagnant economy. Last week, the stock price fell even more after a surprising \"hard-left\" win in the French legislative election, reaching its lowest price of the year so far. The L'Oreal Group is a compelling investment opportunity in my view. As the world's largest beauty company, I believe L'Oreal's diversified business model, strong brand portfolio, and industry-leading innovation capabilities position it well for continued growth. Despite recent macroeconomic headwinds, L'Oreal delivered an impressive 11% sales increase in 2023, outperforming the global beauty market. The Valuation I did has a qualitative part and a quantitative part (a simple DCF model). Introduction The L'Oréal Group is a multinational cosmetics and personal care company headquartered in France. Founded in 1909, it has grown to become one of the world's largest and most diversified beauty product companies, offering a wide range of products across various brands and segments, including hair care, skin care, makeup, and fragrances. With a strong focus on research and innovation, L'Oréal has established a global presence, selling its products in over 150 countries and employing a workforce of over 80,000 people. The company's success is driven by its commitment to understanding consumer needs, investing in cutting-edge technologies, and continuously expanding its portfolio to cater to the evolving preferences of customers worldwide. In 2023, the Group experienced an 11% increase in sales, the strongest growth in 20 years (excluding the post-Covid rebound in 2021), outperforming the global beauty market by 8%. L'Oréal generated €41,182 million in total revenue in the year and achieved an operating margin of 19.8%, which was one of the highest among leading beauty conglomerates. Qualitative Analyses; Moats, Competitive Advantages L'Oréal has several strengths that have contributed to its current position. In the following paragraphs, I will analyze the group's main competitive advantages to forecast whether they are strong enough to help the company keep growing in the future: A balanced, multi-polar model (zones, divisions, categories, distribution, networks) First, L'Oréal's main moat lies in its diversification across divisions, product categories, and regions, which provides great protection against any economic downturn and market uncertainty. In my opinion, there is no other public beauty group in the world that comes closer in terms of having a strong, diversified portfolio of beauty and cosmetics brands as L'Oréal. This allows the company to “easily” and quickly shift its overall group strategy by putting more effort, focus, and priority on certain regions and product categories over others. I believe this is an extremely valuable asset to have in such a dynamic and changing industry as the beauty industry. L'Oréal divides its business into 4 divisions: the Consumer Products division has products that are accessible to more people, the Luxe division targets the upper-middle classes, the Dermatological Beauty division responds to the increasingly high demand for efficacy, and the Professional Products division (hair care). In terms of product categories, 40% of L'Oréal's total revenue came from Skincare, 21% from Haircare, 17% from Makeup, 12% from Fragrance, and 10% from Hygiene Products. Regarding sales by region, 24% of L'Oréal's revenue is in Europe, 29% in North America, 29% in North Asia, 9% in SAPMENA-SSA, and 9% in Latin America.   The Essentials - 2023 L'oreal Annual Report - page 15L'Oréal Group has a total of 37 brands in its portfolio, divided into 4 main divisions: Consumer, Luxe, Derma, and Professional Products. I have classified L'Oréal's main competitors into two categories: one category encompasses companies that only manufacture and sell beauty products, such as Beiersdorf, Shiseido (OTCPK:SSDOY), Estée Lauder (EL), or Coty (COTY); the other category includes companies that, in addition to selling cosmetics, also sell other consumer goods, such as Procter & Gamble (PG), Unilever (UL), or LVMH Moët Hennessy (OTCPK:LVMHF).  L'Oréal vs. Main Public Listed Beauty Companies in terms of Diversified Portfolio  In the first category of competitors - those enterprises that only sell cosmetics - L'Oréal is the main dominant player on my analysis, not only in terms of diversification across product categories and regions, but also in terms of revenue. Beiersdorf's (BEI.DE) consumer division ended up 2023 with a total revenue of €7,780 million; the company's main focus lies on mass market skincare products, with Nivea accounting for more than 50% of the Group's revenue, and prioritizing mainly the European and Latin American markets. Shiseido ended up 2023 with a revenue of €5,578 million. The company, which had already been struggling in the years before, had a very difficult 2023 due to the Fukushima contaminated water issue, which really hindered the performance of the group's Japanese brands in China. More than 50% of the group's revenue comes from China and Japan. Natura & Co (NTCO) is another group going through a difficult time as they are trying to simplify their business model by focusing on profitability instead of growth. They recently sold their two strongest brands, Aesop and The Body Shop. The group has a simple portfolio of a few brands, with almost 75% of their revenue coming from Latin America. In April 2023, L'Oréal reached a deal with Natura & Co to purchase Aesop for a value of US$2.525 billion Coty (COTY) ended up 2023 with a revenue of €5,200 million, and more than 60% of the revenue comes from their fragrance category. Estée Lauder might be the only group that sells only cosmetics and gets closer to L'Oréal when it comes to diversification among product categories and regions. However, the group is still far from L'Oréal in terms of revenue (LTM of €14,139 million), and generally speaking, the group has a weaker portfolio in terms of brand power compared to L'Oréal, impacting their growth and margins. Among the second category of competitors - those Groups who sell other consumer goods apart from cosmetics - we can find competitors that have higher revenue than L'Oréal, although their Beauty/Cosmetics division makes only a small percentage of their revenue. Unilever closed 2023 with a revenue close to €60,000 million, with their Beauty & Wellness and Personal Care Division accounting for 25% (€26,295 million) of the total revenue. P&G's LTM is €77,500 million, although only 18% of their portfolio (approximately €14,000 million) comes from their Beauty division. LVMH Group, which focuses on Luxury brands among many product categories, ended 2023 with a total revenue of €86,153 million, although only €8,271 million came from their Cosmetics and Beauty division, which is the Group's Business Segment with the lowest operating margin (8.62%). One single business: beauty, nothing but beauty and all beauty Second, linked with the previous point, L'Oréal only focuses on manufacturing and selling Beauty/Cosmetics products, which allows the group to prioritize one sector - the Beauty and Cosmetics sector. This enables them to quickly identify new trends and invest in them, which is very useful in such a dynamic and changing sector. This is a great competitive advantage. Seizing new opportunities, identifying new consumer trends, and responding rapidly are very important in such a changing, dynamic, and highly competitive industry. In order to do that, it's important to have focus. Successful acquisition strategy Third, also highly related to their previous two points, by putting the focus on one single industry and having a diversified portfolio of brands and products, the group can quickly identify which trends are becoming hot at the regional and product category levels. L'Oréal has been known for years for implementing a very successful Acquisition strategy. Over the past few decades, L'Oréal has acquired many brands when they were hot and growing, investing in them and helping them become the powerful brands that many of them are today. The latest important acquisition the Group made was Aesop in 2023.   The Essentials - 2023 L'oreal Annual Report - page 14R&D, and lots of Innovation Lastly, L'Oréal puts a lot of emphasis on R&D and Innovation. In 2023, the Group invested €1,288 million in Research, Innovation, and Technology, and filed 610 patents. It has 20 cosmetics research centers, 37 factories worldwide, and over 400 employees in their Research Team. Additionally, having production centers close to its markets reduces production lead times and allows L'Oréal to be more responsive to customer demands and fluctuations, enabling them to quickly adjust production to meet changing market needs. This also provides the company with a better understanding of local markets, as producing goods close to the end consumers can give L'Oréal valuable insights into local market trends and regulations. Furthermore, it reduces transportation costs and ensures faster delivery times. (L’oreal Group 2023 Annual Report - page 39) (2023 L'oreal Annual Report) All the previous points are related to two concepts that are key in L'Oréal Group's strategy: Universalisation and Singularisation. The concept of Universalisation refers to L'Oréal's strategy of globalizing its brands while adapting them to local and regional characteristics. The aim is to serve and retain a vast consumer base of over 1.5 billion people worldwide. Singularisation, on the other hand, takes into account the growing global trend towards self-expression and individuality, catering to both men and women. This involves offering a diverse range of products and personalized solutions to meet the specific aspirations of consumers in different regions. Rather than a one-size-fits-all approach, the goal is to provide inclusive beauty by deeply understanding and respecting the differences in consumers' needs and preferences across the world. This is in contrast to mere standardization, and is based on close attention to the diverse voices and preferences of the company's global customer base. Universalisation and Singularisation would not be possible without a focus on a specific industry, understanding all the product categories within the industry at a regional level, and the ability to quickly adapt to emerging trends. Margins Comparison of Main Beauty Groups in 2023  Author's Calculations (Annual Reports of companies listed on the table) In my opinion, something common among the beauty and cosmetics groups presented is that their competitive advantage stems from having strong brand names in their portfolios. These powerful brand assets are a great intangible resource that contributes significantly to their growth and profitability. Therefore, across both beauty groups and other consumer goods categories, having the most number of influential brands in one's portfolio can make a substantial difference when it comes to margins, growth, and overall profitability. Brand name is a significant contributor to value, and intangibles are one of the main categories of moats. Regarding gross margin, L'Oreal stands out as the group with the highest gross margin on the list. This is likely because L'Oreal is focused solely on cosmetics, allowing them to benefit from economies of scale. Additionally, their strong brand portfolio enables them to charge higher prices and maintain greater pricing power compared to more diversified consumer product companies. In terms of operating margins, L'Oreal is the clear leader among the cosmetics-focused groups. While Estee Lauder is not far behind in gross margin, L'Oreal's operating margin of 19.80% is nearly double Estee Lauder's 9.50%. This suggests that L'Oreal's portfolio of powerful brands allows the company to be more efficient in its marketing and promotional expenses, requiring less investment to maintain its market position. On the other hand, among the more diversified consumer goods companies, Unilever performs similarly to L'Oreal in terms of operating margin, while P&G exhibits the strongest operating margins in the group, potentially due to the mass-market nature of their brand portfolio. Risk Factors Although L'Oreal is one of the leading beauty companies in the world and has several competitive advantages, the company is also exposed to various risk factors that could impact its market-leading position and, consequently, my investment thesis as well. The following paragraphs outline the main risk factors that L’oreal is facing: Economic and Political Uncertainty The global business environment has faced considerable uncertainty in recent years. As a multinational corporation, L'Oreal's operations are impacted by various political and economic disruptions across the regions where it operates. The ongoing war in Ukraine or the volatile US-China relationship have all contributed to an unstable geopolitical landscape, creating uncertainty for the company. Broader consumer spending patterns also pose a concern for L'Oreal. Factors such as general economic conditions, inflation, interest rates, energy costs, and consumer confidence can all influence purchases of beauty products, which could impact the sales of L'Oreal's products. Furthermore, disruptions in local or global business conditions, stemming from events like pandemics, conflicts, or natural disasters, can have short-term and long-term effects on consumer spending, consequently impacting L'Oreal's overall performance. Intense Competition within the Beauty Industry The beauty industry is highly competitive. As mentioned earlier, L'Oreal has a strong, diversified portfolio of brands across product categories and regions. However, this does not mean that there cannot be new competitors challenging L'Oreal's position in certain markets or product categories in the short term. Nowadays, due to rapid technological changes and the digital economy, the proliferation of new brands is easy. In important markets for L'Oreal, like China, it is becoming increasingly harder to compete due to the proliferation of local competitors such as Proya or Botanee Group. Additionally, there are new emerging groups that are challenging L'Oreal in some of its divisions or product categories (for example, Puig Group in Spain, which went public this year and focuses on luxury cosmetics and fragrances). All this, without considering L'Oreal's current major competitors mentioned in this analysis, which also have strong brands in their portfolios and are innovating to become more competitive. Therefore, if L'Oreal does not keep innovating, adding new brands to its portfolio, and strengthening its current brands to keep up with new consumer trends, other competitors will, affecting L'Oreal's sales and market share. Local cosmetics brands are gaining market share in China due to the growing nationalism of society, quality increase, and better understanding of consumer taste Failing to Adapt to Shifting Consumer Trends L'Oreal's continued dominance in the Beauty Industry relies on its ability to quickly adapt to shifting consumer preferences for any of the company’s divisions, product categories, and regions. The company must be proactive in developing, manufacturing, and marketing new products that cater to evolving trends and demands. However, the reality is that consumer tastes are highly unpredictable and can change rapidly, especially nowadays, often driven by the spread of information and opinions through digital and social media. If L'Oreal fails to anticipate and respond to these dynamic market conditions, it risks significant financial setbacks. Acquisition Strategy One of L'Oreal's key competitive advantages is its strategic acquisition of emerging or growing brands and transforming them into powerful global brands after the acquisition. This acquisition strategy has been a cornerstone of L'Oreal's success, allowing the company to quickly expand its portfolio and capitalize on consumer trends. However, there is no guarantee that the acquired brands will continue to grow as anticipated after joining the L'Oreal portfolio. The integration process and aligning the brand's identity, products, and operations with L'Oreal's established practices can be challenging. Additionally, the fast-paced and unpredictable nature of consumer preferences means that the expected growth trajectory of the acquired brands may not always materialize. L'Oreal must remain vigilant in nurturing these new additions, while also retaining the unique appeal that made them attractive acquisition targets in the first place. Striking the right balance between leveraging L'Oreal's resources and preserving the brand's distinct identity will be crucial to ensuring the long-term success of its acquisition strategy. Product Quality and Safety The quality and safety of L'Oreal's products are crucial to the company's continued success. If any of their products are found to be defective or unsafe, it could severely damage customer and consumer relationships. This is a very important risk to take into consideration in an industry where intangible assets like brand reputation are a key competitive advantage. The appeal of L'Oreal's brands could be diminished, leading to lost sales and potential liability or legal claims - any of which could have a significant adverse impact on the business. Maintaining the integrity and reliability of their product portfolio is essential for L'Oreal to protect its hard-earned brand equity and continue delivering value to customers. Proactive quality control, transparent labeling, and robust brand protection measures are critical to mitigating these risks and upholding L'Oreal's commitment to providing safe, effective, and trustworthy products. Brand Reputation in the Digital Age Negative information (proven or not-proven to be real) regarding any of the brands within L'Oreal's portfolio could affect the company's sales, especially in the current digital era, where news spreads quickly on social media all over the world. In this highly connected environment, even unsubstantiated claims or rumors can quickly gain traction and erode consumer trust in a brand. Similarly, negative behavior or comments from employees, especially key employees such as the CEO or members of the Board of Directors, could directly damage the company's reputation and consequently have a negative impact on its sales. L'Oreal must remain vigilant in monitoring and promptly addressing any potentially harmful information or actions that could undermine the carefully cultivated reputations of its brands. The Importance of Sustainability in the Beauty Industry There is growing consumer awareness and preference for beauty and personal care products that are made with eco-friendly, natural, and ethically-sourced ingredients, with minimal environmental impact. Failing to meet these evolving consumer demands could lead to a loss of market share and revenue for companies that do not prioritize sustainability in their product development and manufacturing processes. As the beauty industry faces increasing scrutiny over its environmental footprint, L'Oreal must proactively align its product portfolio and operations with the rising consumer demand for sustainable and socially responsible offerings. Investing in research and innovation to develop greener formulations, using recycled and recyclable packaging, and implementing ethical sourcing practices will be critical for L'Oreal to maintain its competitive edge and appeal to environmentally conscious consumers. Integrating sustainability as a core tenet of the company's brand identity and product strategy will be essential for safeguarding long-term growth and market leadership. Recruiting and Retaining talented Personnel L'Oreal's success is partly contingent on the company's ability to retain its key personnel, including its executive officers and senior management team. The unexpected loss of these critical employees could adversely impact L'Oreal's operations. L'Oreal's success also depends on the company's ongoing capacity to identify, recruit, train, and retain talent across all levels of its organization. Intense competition for employees poses a challenge, and L'Oreal may struggle to attract, integrate, and retain the necessary personnel in the future, which could have a significant detrimental effect on the company's business. Disruptions in Supply Chain and Operations As a global company, L'Oreal's operations around the world face various risks. These include currency fluctuations, differences in laws and regulations between countries, unreliable legal systems in some regions, or weather and natural disasters. Any of these global factors could significantly impact the company's business performance. In addition, L'Oreal's extensive manufacturing and distribution activities also make it vulnerable to operational disruptions. Potential issues include industrial accidents, supply chain issues, regulatory compliance, and issues regarding important suppliers or key ingredients. Disruptions to the company's suppliers or operations could have adverse effect on the business. Legal and Regulatory Risks As a global company, L'Oreal must navigate a complex web of laws, regulations, and policies across the many countries in which it operates. These can include trade restrictions, immigration/travel rules, operational limitations, investment controls, currency exchange regulations, import/export requirements, tariffs, sanctions, and tax policies. Some jurisdictions also lack well-established or reliable legal and administrative systems, adding to the legal uncertainty. Failures to comply with applicable laws and regulations could expose L'Oreal to significant penalties, legal liabilities, and reputational damage. The company must closely monitor evolving legal environments worldwide and adapt its practices accordingly. Changes in the legal and regulatory landscape present an ongoing risk that could disrupt L'Oreal's global business activities and financial performance if not properly managed Valuation (simple DCF model) Author's Calculations (L'oreal Annual Report) I have performed a simple DCF model focusing on the following inputs: Revenues, Operating Margins, Taxes, Sales-to Capital ratio, and Discount rates. Regarding the Revenue Growth Rate, I have assumed a 7% revenue growth rate for the forecast period. For the Operating Margin, it is held constant at 19.10% throughout the forecast period. The tax rate is assumed to be a constant 22.20% across the forecast years, which is the current tax that L'Oreal pays in France. NOPAT (Net Operating Profit After Tax) is calculated as EBIT * (1 - Tax Rate), which remains in the range of €6,333.78 million to €9,175.27 million over the forecast period. The reinvestment amounts are provided in the table, ranging from €1,726.21 million to €2,421.10 million. FCFF (Free Cash Flow to Firm) is calculated as NOPAT - Reinvestment, which increases from €6,333.78 million in Year 0 to €6,754.17 million in the Terminal Year. The discount factor starts at 0.95 in Year 1 and declines to 0.78 in the Terminal Year, reflecting an increasing risk as the forecast period progresses. The present value of the FCFF is calculated using the discount factors, resulting in a sum of present values of €224,194.41 million. The terminal value is calculated using the Gordon Growth Model, with a terminal growth rate of 2.37% and the final year's FCFF of €11,793.41 million. I ended up choosing a Risk-Free Rate of 2.37%, which is Germany's 10-year Bond rate. I used Germany because it is the only country within the European Union with a AAA Sovereign Rating by Moody's (France has a Sovereign Rating of Aa2 by Moody's). 6.22% is the Equity Risk Premium I chose, which is the US bond rate plus France's default spread; 0.70% is the chosen beta. The WACC obtained is 5.08%. As for the Terminal Rate, I have used Germany's 10-year Bond Rate of 2.37%. France has a credit rating of Aa2 from Moody's. Overall, the data suggests a growing and profitable company with consistent financial metrics and a strong projected cash flow outlook. On a per-share basic, I got a stock value of €411, which is close to L’Oreal current stock value of €408 (as of 12 July 2024), therefore is fair to say that L’Oreal is fairly valued at this moment. Final Comments Let's not forget that about a month ago, prior to the L'Oreal CEO's comments and the General Elections, L'Oreal's stock value was around €450 per share, which is likely to be the price L'Oreal will jump back to in the following weeks or months, once things become a bit more stable. Therefore, now (or maybe one week ago) could have been a good time to buy shares of the company. It's true that L'Oreal's stock value seems overvalued or priced, but I think this is something quite common among companies that have intangible assets (brand power in this case) as their competitive advantages. I firmly believe the value of their stock price will increase consistently over the next few years, backing up my statements on the points reviewed previously, which in summary are: Strong revenue growth history and future projections; one of the healthiest gross, operating and net margins in the industry, thanks to economies of scale, pricing power, and a focus solely on the beauty/cosmetics industry; a strong, diversified portfolio of brands across divisions, product categories, and regions, allowing the company to shift focus quickly and efficiently; a focus on innovation and a successful brand acquisition history; competing in a very resilient industry (Beauty is an essential need for humanity. It has always existed since the beginning of humanity; the desire for beauty is a universal aspiration that transcends time, borders, and cultures, and even plays a very important role in social interactions). Therefore, I believe it is worth purchasing L’Oreal’s stock now and holding it for the long term, especially since the stock price has experienced a drop in the past few weeks and is currently at its lowest price of the year. I do not expect to see incredible short-term growth, as the company has already achieved maturity. However, it could be a great stock option to keep in your portfolio in the long term, as the company has strong fundamentals and I foresee it continuing to grow steadily and consistently over the next few years.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2455655586"}