Summary
- I expect LRLCF to report good results in 4Q22, driven by outperformance in the US and Europe, but China may be a drag.
- I believe consensus estimates for L'Oreal's FY23 organic growth of 5.9% is too low, considering the company's pricing power and potential share gain.
- Valuation gap vs. major peers like Estee Lauder and Shiseido has widened.
Overview
L’Oreal ( LRLCF ) is expected to report earnings next week, and my post here is to talk about my expectation about this 4Q22 print. Overall, I expect good results from outperformance in the US and Europe while China might be a drag. That said, I believe consensus estimates are underplaying the recovery impact from China – where investors might already be looking past it – as such, net-net it might turn out alright after all. Business-wise, I believe LRLCF can keep beating its US competitors thanks to its powerful brand equity and marketing prowess. I'm still confident in LRLCF's ability to grow at a faster rate than the US beauty market in 2023.
Earnings expectation
In 4Q22, I expect organic growth in the mid-to-high single digits, which is in line with consensus. However, I think LRLCF's Active Cosmetics segment will outperform the market due to the positive impact of its performance in the United States and Europe where LRLCF should gain share. On the flip side, I continue to be wary of Luxe's performance because I believe that nearly half of it is connected to Asia /China and they were impacted by lockdown throughout Q4.
Particularly in light of the statement by Estee Lauder ( EL ) that their decline in China is in the single digits, while the overall decline in China is double digits. Moreover, EL management anticipates a decrease in stock in China due to destocking. In addition, commentaries from Amore Pacific (refer to FY22 presentation slide) also warned of sluggish demand and uncertain trading conditions in China and Travel Retail in 4Q22.
That said, I think consensus estimate of 5.9% organic growth for FY23 is too low, especially when taking into account LRLCF's pricing power and potential share gain in the US and Europe (based on my expectations). They also don't seem to give the reopening of China's economy much credit for its potential to boost LRLCF's performance.
Things to look out for
There is reason for concern, even though I think the consensus is wrong to downplay the effects of China's reopening. Truth be told, after seeing the EL results, I started to be more cautious about LRLCF's performance in China. In particular, I fear that LRLCF could experience a similar situation — a de-stocking problem which would push out the reopening effects until the latter part of this next year. Outside of China, I also find it concerning that U.S. department stores (like Nordstrom (JWN)) are implementing further markdowns to clear excess inventory. This would lend credence to the concept of destocking and might also imply a slower 1H23. Consequently, operating deleverage should have an effect on the bottom line as a result of this (lower gross margin on fixed cost).
But overall, I think there's a good chance the market starts pricing in a strong impact from China's reopening, and looks past this weakness near term (once we get nearer to 2H23) - especially since LVMH mentioned they are seeing start of recovery in China.
Valuation
I think the 14% gain in LRLCF's share price so far this year is impressive. That said, despite the recent share price rally, if we look at relative valuation, the LRLCF discount relative to EL has also widened over time. The same can be seen when compared with Shiseido as well. Thus, I think there is still a possibility for another rally once investors start to see recovery momentum, which would help close valuation gap in the near term.
Risk
Key market performance
In my opinion, the stock price would fall if trading conditions in major markets deteriorated. Additional lockdowns or travel restrictions are examples of what might bring this about.
Conclusion
In conclusion, despite some uncertainty in the performance of LRLCF's Luxe segment in Asia due to the impact of lockdowns, something to look forward to is the LRLCF Active Cosmetics segment, which I expect to outperform, driven by positive performance in the US and Europe. On consensus, their estimate of 5.9% organic growth for FY23 seems low and does not fully account for LRLCF's pricing power and potential share gain. The risk here is if trading conditions in major markets deteriorate, such as from additional lockdowns or travel restrictions.
For further details see:
L'Oréal: Expecting Good Q4 2022 Results