ESLOF - EssilorLuxottica: Time To Put This One On Your Watchlist Even A 'Buy'

Summary

• EssilorLuxottica is my latest foray into the consumer Discretionary segment, namely in the industry of Eyewear and eye care.
• EssilorLuxottica is a vertically integrated business in the luxury segment, that came to be as a result of a non-trivial merger between a French and Italian business.
• In this article, we'll look at what price you could own a piece of this attractive business profitably.

Dear readers/followers,

I view EssilorLuxottica ( ESLOF ) as one of the more interesting companies in the consumer discretionary space. The company is the global, undisputed market leader in the eyewear subsegment, being by far the largest player around, and being fully vertically integrated. As someone wearing glasses as well as sunglasses, I'm not only aware but a user of the company's products.

In this article, I mean to provide you with a base thesis for investing in the company and a good price for when we could expect a good longer-term RoR going forward.

So, let's see what we could do about buying EssilorLuxottica, and when.

EssilorLuxottica - from A to Z.

EssilorLuxottica started out as the name would suggest as Essilor, a French eyewear company, and Luxottica, an Italian eyewear company. The company generates revenues of over €14B, and it's most well-known for being the brand company for a variety of world-famous eyewear brands, both in glasses and sunglasses.

The company, as the advantages would suggest, has a global footprint and a massive leadership position. It owns 11,000 related patents and files 3,500 new patents every year across the world.

The company owns over 150 brands, with a combined heritage of over 6000 years, including products like Frames, Lenses, Instruments, Equipment, contact lenses, Smart Glasses, Readers, Banners, and AFA. The company has professional solutions in wholesale in over 150 nations, but also operates a strong DTC business, with a global footprint.

Most of the sales revenue is generated in NA at 46%, with 37% in EMEA and 12% in APAC - 5% in LATAM. The company is a "Youthful" business, with 46% of employees under 35 years of age, 60% women, and a strong employee shareholding at over 35%. The company has 180,000 employees across its various 150 countries.

EssilorLuxottica is, as mentioned, fully integrated with 53 mass-production facilities, and 564 prescription and mounting facilities. Its strong, global distribution is backed by 57 distribution centers. The company has been through years of "hardening" and turning its SCM into the sort of operation that can handle a global pandemic with relative ease. This is how the company's current manufacturing and targeting look.

The company is in the midst of another transformation, however. With the world moving into the digital age, the company is focusing on things like E-lenses, near-vision, advanced single-vision solutions, and light management solutions. This is not even mentioning the focus on smart glasses and smart products aimed at the company's various segments.

The eyewear market is a tricky beast. 80% of the market is represented by prescription, and more than 50% is served by independent ECPs, which creates both advantages and challenges for a full-range solution provider like EssilorLuxottica. The company has solutions across all markets and all price segments, and the independent aforementioned ECPs serve as the backbone for the company's ambitions for further growth.

EssilorLuxottica has some of the most attractive brands on the planet, including licensing some of the most attractive brands around. Here is a selection of the company's brands.

The company controls around 75% of the top-20 rated brands, with Ray-Bans obviously being among the most well-known and well-loved.

Eyewear and sight correction is a more common issue than you might believe. According to the Vision council, nearly 70% of all Americans aged 18+ need some form of vision correction, and 64% of all adults use some form of it (Source: The Vision Council). This can mean either something like a pair of glasses, lenses or corrective surgery. This is also obviously a number that goes up with advanced age, as its common older people to need some sort of corrective vision. In fact, once you hit 65 and above, the percentage goes to over 90%.

Those are some pretty impressive numbers for a world-leading company to essentially work with. The company's fundamentals are absolutely stellar, and an investor into EssilorLuxottica has done extremely well for themselves for the past 20 years. The company has a credit rating of A, a modest yield of 1-2% as a range, and tends to trade at premium luxury multiples between 25-28x.

EssilorLuxottica has averaged 10.18% compounded growth for the past 18 years, which outperforms the S&P average of 7.7% by a fair margin. Investors have seen their capital grow by nearly 500% in the meantime. No surprise here, really. The company services a need that's not going anywhere, it's a market leader and while dislodging EssilorLuxottica isn't impossible per se, because nothing is impossible, I would be willing to bet money that the company isn't really going anywhere in the near or close term. There's too much good happening here and too much strength in what the company is.

The reason EssilorLuxottica is set to further dominate the market is that most ambitions that are likely needed to compete with the business, can only be done by a business with a significant amount of vertical integration. I'm talking about the creation of virtual try-on platforms, AI, lens configurations, and other digital customizations that might become necessary to remain competitive going forward, which the company is already working on.

The company is now targeting revenues going up well above €20B per year, while managing an adjusted OM above 16%, even with inflation and cost increases.

EssilorLuxottica expects that by 2026, that revenue will start creeping towards €30B, while the adjusted OM due to increases in efficiency and verticality, will be expanded upon to almost 20%. These sales increases are set to come from the following areas.

There is additional growth potential in solutions outside China, Smart glasses, and advances in e-commerce. Investments in its retail store network are also likely to drive this, together with developing the currently somewhat under-developed markets, pushing R&D, and general improvements that we've seen in other companies as well.

The company has a conservative fiscal policy and has a very low leverage of around 20%. Overall, this is a very attractive company at the right price. At the right valuation, I argue that EssilorLuxottica becomes a "MUST-BUY" and "Must-own".

Let's see what sort of valuation means that we should definitely "BUY" this company.

EssilorLuxottica - The valuation where the company is attractive

The company is on a solid growth trajectory for the time being, with a massive growth forecast in 2023, and an average of 16-17% per year until 2025E. That means even on a 25.8x P/E forecast, the upside here is continual double-digits, and even higher than the company has performed on average.

So, generally speaking, there's something to like here. Analysts following the company come to an average PT of around €188/share, with 14 out of 19 analysts either at a "BUY" or equivalent positive rating here. This indicates a 15% upside to the average fair-value price target. These targets also haven't been changed to any marked degree for the past 1-2 years. Analysts are fairly consistent with their expectations, and this has also translated to very good accuracy when we look at FactSet here, with a 2-year forecast margin with a 20% MoE with a 92% accuracy ratio. So I would say that outside of the COVID-19 drop, which affected the company, there is a decent accuracy forecasting this company.

The long-term accuracy for the company is solid.

In terms of peers, there aren't any direct public comps in eyewear. Instead, we'll compare the company with luxury comps like LVMH ( LVMUY ), Hermes, Richemont, Ralph Lauren ( RL ), V. F. Corp ( VFC ), and others. In terms of multiples, this company isn't that much lower than peers, though it's lower than LVMUY and Richemont, but higher than Burberry, VFC, Ralph Lauren, and others. The same is true for P/E - lower than some, but higher than others as well. This is generally the picture we'd like to see when investing here, though it also means that we're at a slight premium here, with an ADR multiple of nearly 32x P/E, compared to the 18-year of around 28.5x. Because of growth expectations, there is some upside to be had here, even when forecasting at lower multiples. If the company manages to maintain around 30-32x P/E, that's not an unlikely market-outperforming thesis with a potential of almost 20% per year here.

We've had a 2022 earnings call for the company, where the thesis for the business was mostly confirmed. Why do I say this? Record revenues, record OM, record operating profit and record net profit.

Looking at numbers. Last year, we managed to grow the total revenue of our group by EUR 3 billion, 1.6% at constant currency. The pace of growth of 7.5% at constant currency in the full year were consistent with our long-term target. The adjusted operating income was on track, with 11% growth versus 2021, and the margin up to 16.8%, progressing by 70 basis points.

(Source: EssilorLuxottica, Call, Franscesco Milleri)

Thanks to the company's growth targets, we have some fairly trackable targets of the company, which include integration, innovation and new store and product rollouts. As long as these numbers continue to deliver, I don't see a reason to question the company's trajectory, and it makes a case for "Buy" for the company quite a bit stronger here, despite the premium that we see the business trading at.

We shouldn't underestimate what the company actually managed here - because the comps for 2021 were not easy to beat, yet the company managed it anyway.

Because risks are quite limited for the business at this time, the one thing I'd want to keep an eye on is the overall inflationary pressure. EssilorLuxottica has probably done one of the most impressive jobs of any company I've followed through the past 1-2 years of managing the inflationary pressure here. We want to make sure that the cost side of things continues to be managed, so we don't see a sudden increase here - and for now, company forecasts call for this to be relatively consistent.

Because of these general positives, and I really can't find a fault in the growth thesis here, my initial stance for this luxury company puts it at a similar multiple and expectation as I see in LVMUY. That means that EssilorLuxottica actually, and despite its high valuation, comes in at a "Buy" with the following basic thesis.

Thesis

• EssilorLuxottica is a world-leading eyewear company - in fact, it's the world-leading eyewear company, with convincing longer-term upside due to incredibly strong fundamentals, strong growth trajectories, and strong recent overall performance. We want to keep an eye on costs here, but I do see the very real potential for continued growth and even outperformance in this investment.
• I'll continue to provide coverage for the company here, and I consider it a solid investment at anything below a €175/share conservative PT, compared to its current share price of €163/share.
• For me, therefore, this one is a "Buy" here.

Remember, I'm all about:

• Buying undervalued - even if that undervaluation is slight and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn't go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.

While EssilorLuxottica cannot be called "cheap", it still fulfills 4 out of 5 criteria for a positive, profitable investment at this time, which means I'm at a "Buy" rating here.

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