2023-07-31 04:43:31 ET
Summary
- Despite challenges in North America and North Asia, L’Oreal showed strong performance with 13.7% organic growth in 2Q23, driven by Europe.
- I expect L’Oreal's growth and margins to recover from the current macroeconomic climate, with a return to normalcy.
- I believe L’Oreal's valuation is well-supported at a premium to peers due to its position as the largest player in the industry and higher expected growth rates.
Summary
Following my coverage on L’Oreal ( LRLCF ), which I recommended a buy rating due to my expectation that L’Oreal will continue to grow despite some FX headwinds in the coming quarters. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for L’Oreal as I expect growth and margins to recover from here towards normalcy. The valuation should be well supported at a premium to peers, as I expect investors to favor the largest player in the industry.
Investment thesis
While North America and North Asia both performed poorly, Europe was the driving force behind L'Oréal's 13.7% organic growth in 2Q23. North America saw growth of 9.7% while North Asia saw growth of 5.9% (impacted by decline in Travel Retail). Management restated its FY outlook, saying it expects to expand top line and profit again this year while outperforming the market. Overall 1H23 organic sales increased by 13.3%, which was above the estimated 10% growth in the beauty market and resulted in increased market share across all categories, but especially in Consumer Products. In addition, the group's gross margin improved in H1 by 120bps to 74.3%. EBIT margin only grew by 30bps to 20.7% in 1H23 despite a €890 million rise to 32.5% of net sales in marketing.
“We estimate that the Beauty market grew by close to 10% in the first half. So we outperformed again, which is obviously fantastic news” 2Q23 earnings, L’Oreal CEO
Although management hinted to challenges in 2H23, including Hainan performance, pricing comparisons, and FX headwinds, I found yesterday's call to be positive. It was encouraging to hear that management hasn't noticed any signs of waning consumer demand or downtrading, and I anticipate that the marketing dollars spent this quarter (and likely the next) will help propel results in 2H23. I believe that whether or not L'Oreal meets consensus profit estimates depends heavily on whether or if EBIT margin grows more rapidly than it did in 1H23. If it does, then either the efficiency with which marketing dollars are being spent has improved or gross profit growth has outpaced marketing expansion. Investors will benefit in any case, which will likely drive near-term momentum in the stock price as profitability inflects to historical rate.
However, the Chinese government's crackdown on Daigou since May is a negative takeaway, and I anticipate that it will continue to put pressure on sales in the Travel Retail sector. China's growth was also weaker than predicted, despite the fact that it was meant to be picking up speed.
In my opinion, the 2Q23 result was positive because the problems in China and North Asia will eventually go away once the macroeconomy improves and regulatory strain decreases. In fact, I felt more positive as L’Oreal company was able to deliver despite the weakness in Asia.
Valuation
Own calculation
I believe the fair value for L’Oreal based on my model is $465.32. My model assumptions are that: L’Oreal will regain its historical growth pace of high single-digit growth and net margin. Assuming we have seen the worst of the current macroeconomic climate, growth from here should trend towards normalcy. The US inflation rate has seen significant progress toward the Fed’s target of 2%, and while China's growth is slower than expected, it is still recovering positively with the government being very vocal about driving stimulus to spur a recovery in the economy.
Peers include: Unilever, Reckitt Benckiser Group, Beiersdorf, Essity Aktiebolag, Haleon, PZ Cussons, Henkel AG & Co., and Ontex Group. The median forward PE multiple peers are trading at is 19x, and the expected 1Y growth rate is 2% (L'Oreal's expected 1Y forward growth rate is 6%).
Previously, I compared L'Oreal's valuation to S&P, which suggests that L'Oreal's valuation at >30x forward PE was not excessive. For this post, I compare L'Oreal's valuation to other cosmetic and beauty players in Europe, which also suggests that L’Oreal is not trading at a crazy high multiple. L’Oreal has historically traded at a premium of 65% over peers. Suppose L’Oreal reverts back to 65% (forward PE will be 19x * 1.65 = 31x), which would make the share fair valued. However, I believe L'Oreal's valuation will sustain a premium in the current investing climate as it is the largest player in the industry, with higher expected growth rates. I believe investors will favor L’Oreal over the other players, which will support valuation.
Conclusion
I maintain my buy rating for L’Oreal as I anticipate the company's growth and margins to recover and return to normal levels. Despite challenges in North America and North Asia, L’Oreal's strong performance in Europe and increased market share in all categories, particularly Consumer Products, showcase its resilience and potential. While challenges like the Chinese government's crackdown on Daigou remain, I believe they will eventually subside as the macroeconomy improves. With L’Oreal being the largest player in the industry and having higher expected growth rates compared to peers, investors are likely to favor it, supporting its valuation. Based on my model, I believe the fair value for L’Oreal is $465.32. Overall, I see L’Oreal as a favorable investment choice over its industry peers.
For further details see:
L'Oreal: Reiterate Buy, Expect Investors To Favor It Over Peers