LRLCF - L'Oréal Earnings: Continuous Momentum Into FY23

2023-04-25 16:27:55 ET

Summary

• L'Oreal's 1Q23 organic sales growth was 13%, well above Consensus estimates.
• Strong acceleration of travel retail contributed to 16.0% and 16.6% of LRLCF's growth in Europe and North America, respectively.
• While valuation is high, I do not think it is a major concern and believe any normalization would only imply 10+% downside.

Overview

L'Oreal ( LRLCF ) has performed very well since I last wrote about it, where I mainly discussed LRLCF's ability to continue growing in FY23. To start the year off right, LRLCF posted like-for-like ((LFL)) growth of 13%, which was significantly higher than the consensus estimates of 8.1%. Strong growth was fueled by LFL in the high teens in developed markets and the 20s percentage in emerging markets outside of China. Due to destocking in China and weak South Korean Travel Retail, North Asia saw weak but positive growth of 1.9%. It was a successful period for the majority of business units, with a blended volume growth of 5.2% and price growth of 7.8%. From a business perspective, March's signs of China's re-acceleration gave rise to optimism. Importantly, there has been no discernible slowdown in its Professional division, leading management to express confidence in the resilience of demand alongside rising consumer confidence in China and the United States. Overall, I expect LRLCF to continue growing, but it could face some headwinds in terms of FX in the coming quarters, and I continue to recommend a buy rating.

1Q23 Results

1Q23 organic sales growth for LRLCF was 13%, well above Consensus estimates, with growth in the Dermatological Beauty and Consumer Products segments contributing to the outperformance. Both L'Oréal's luxury and professional lines grew faster than anticipated and faster than the industry average (6.5% and 7.6%, respectively). The market should raise their expectations in response to those results, leading to higher EPS forecasts.

Europe and North America

Strong acceleration of travel retail contributed to 16.0% and 16.6% of LRLCF's growth in Europe and North America, respectively. That's in line with my assumptions as stated previously. LRLCF's pricing and volume growth in Europe were above-average, and the company's performance in Germany, the United Kingdom, France, Spain, Italy, Scandinavia, and Poland was particularly impressive. Maybelline New York, L'Oréal Paris, Garnier, and L'Oréal Professionnel have all contributed to the rapid expansion of the beauty industry in North America with their competitive pricing and constant stream of innovations. Given the inflationary environment, I believe LRLCF will continue raising prices whenever possible in FY23, so I anticipate the upward trend to continue.

China

While the Europe and North America story is playing out just as expected, the China recovery story is still ongoing. Sales were dismal in December and January, and inventory adjustments likely contributed to the -20% drop in shipments recorded in January. However, growth in the months of February-April was in the double digits. This indicates to me that LRLCF has completed the process of absorbing surplus inventory and is once again growing at a rapid pace. Management has pointed out that LRLCF has been able to outperform the Chinese beauty market and gain market share in recent months, with March being a particularly notable exception. Management's optimism about China for the rest of the year has given me a boost of optimism and encouragement. I believe the full momentum will be felt in 2H23, as such growth should be weighted towards 2H, suggesting sequential acceleration for China.

Similar to mainland China, March saw a significant increase in revenue on Hainan, with traffic increasing by around 20%. It's comforting to know that LRLCF maintains tight control over prices. It employs a team in Shanghai that keeps a close eye on retail and market prices across mainland China and Hong Kong, with a particular focus on Hainan. Based on historical performance, I believe pricing should continue to improve as it has raised prices by over 30% in the past three years.

Dermatological Beauty

The 1Q23 results are impressive, particularly in the Dermatological division, which has exceeded the growth rate of the worldwide dermocosmetics market. The division experienced a remarkable 30.6% growth, with robust performance in all regions and a notable acceleration in Europe and Emerging Market. La Roche-Posay's Anthelios UVMune sun care product was the primary contributor to the division's growth this quarter. Elsewhere, CeraVe's 44% growth also has me feeling very optimistic, especially since the company recently surpassed Neutrogena as the best-selling skincare brand in the United States across all distribution channels, as per management comments.

Valuation

The concern with LRLCF, in my opinion, is its valuation, which is currently at a high of 35x forward PE. The question here is what the normalized multiple should be for LRLCF. I evaluate valuation by comparing its forward PE to the S&P500, which has historically averaged 1.6x over the last ten years. The ratio is currently at 1.9x, close to its all-time high of 2.1x in 2021. I believe the ratio should be in the 1.7x+ range because the LRLCF business has structurally improved over the years, and if we look at it over the last five years, the average is around 1.8x, indicating that the current multiple is not excessive. The inverse of this argument is that interest rates are much higher today, and as a result, the equity risk premium is higher as well, implying that valuation should be lower. As a result, I believe the normalized ratio should be between 1.6x and 1.8x, or 1.7x, implying a forward multiple of 31x forward PE (with a 10%+ downside if it reverts immediately) - which is not a dealbreaker in my opinion given the expected earnings growth rate.

Conclusion

LRLCF's 1Q23 results have exceeded consensus estimates with a 13% organic sales growth. Although China's recovery story is still ongoing, LRLCF has outperformed the Chinese beauty market and gained market share in recent months, particularly in March. The Dermatological division has also had impressive growth, exceeding the growth rate of the worldwide dermocosmetics market. While the concern with L'Oreal is its current high valuation, which is currently at a high of 35x forward PE, I believe the downside in terms of valuation is only around 10+%, which seems alright given the rate of growth.

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