The origin of L’Oreal can be traced back to 1907 when Eugène Schueller developed and started selling a hair dye formula called Auréale.
Although L’Oreal started in the hair-color business, it soon expanded into other beauty products. Currently, it has a portfolio of over 500 brands and thousands of products in every sector of its business: body, skin and hair care, makeup, perfumes, hair color and dermatology. The company has an extensive distribution channel and its products are found everywhere — salons, perfumeries, supermarkets, outlets and pharmacies.
L’Oreal holds 10.41% of Sanofi-Aventis, Europe’s No. 1 drug company.
Name: L’Oreal Group
Price: €115.80 (Mar 5, 2013)
52wk Range: €85.85-€116.10
Market Cap: €69.8 Billion
Revenue: €20.3 Billion
Net Income: €2,868 Million
2 The Business
This is one of those businesses with a very wide moat. People care about what they are putting on themselves. Makeup for example is something you put on your face. It is a very important part of your appearance. If you go to a shop and you see a primer selling for $20 of an unknown brand and Maybelline selling for $30, then you will buy Maybelline. A customer goes through many considerations before buying a product. For example: Is it going to harm my skin, hair or face? Will it be comfortable and not leave my skin tight or dry? And so forth. An expensive brand implies quality product in a consumer's mind. This is the best kind of business.
The world’s cosmetic market was worth €153 billion in 2011. It has been growing in low single digits for the last 10 years at least.
Even in 2009, the sales grew by 1%. This shows the robustness of the business.
L’Oreal is the largest player in this market. With 27 international brands it takes the top spot with $25.89 billion in sales. P&G comes second, closely followed by Unilever.
The group describes its opportunities in its annual report of 2011.
Today, a consumer in France or the United States spends between 80 and 100 euros on cosmetics products a year, compared with 11 euros on average for a consumer in the New Markets excluding Japan. There are very clear differences between Brazil,
for example, where beauty aspirations are extremely strong (60 euros per person), and countries such as China, where the average eight-euro spend per person conceals a yawning gap between the major urban centres of Shanghai and Beijing and the rest of the country
For L’Oréal, the shift in the world market towards the emerging nations is a historic opportunity.
For although the L’Oréal flag is already flying on five continents, the group today makes its sales
with less than 15% of the world’s population. Only one American out of two and one German
out of three consumes the group’s products. And in the New Markets, penetration is lower.
In ten years’ time, the group should have as many customers in the Asia, Pacific zone as in Europe and the United States combined. It is this powerful momentum which underpins the group’s objective of conquering a billion new consumers.
Looking at the sales numbers for L’Oreal, you would not realize that there was an economic collapse in 2009. The sales have been climbing slowly and steadily year after year. During the last four years, the sales have grown at a compounded annual rate of 4.4%.
The sales are also quite diverse geographically.
The company has maintained a net profit margin of around 11%. The only exception was the year 2004 when the margin jumped to 24.95% but apart from this anomaly, it has been quite consistent.
3 The Management
The chairman and CEO of the company, Jean-Paul Agon, joined L’Oreal in 1978. He has worked his way up from product manager of cosmetic products. He has been the CEO of the company since 2006. He also played a role in the takeover of Body Shop in March 2006 at a price of £652.3 million.
Twelve out of the fourteen management members have larger than 20 years of experience in working for L’Oreal. Each one of them started in a much lower positions and have worked their way up to their current responsibilities.
4 Financial Situation
The company is in an excellent financial situation. It has €54.1 million in long-term debt as opposed to €1.46 billion in cash (June 30, 2012). With operating income of €3.39 billion, the financial situation of the company is extremely strong.
Historically, L’Oreal has been wary of long-term debt. Following is the chart of the LT debt of the company as percentage of the total assets. As we see, L’Oreal has been extremely careful in taking on debt.
L'Oreal paid nearly €800 million for Body Shop in 2006 and €1.15 billion for Yves Saint Laurent in 2008. The high level of debt during this period is because of these acquisitions.
5 Shareholder Returns
The share count of the company has gone down over the years and is slowly creeping up because of share-based compensations, capital increases and selling of the Treasury stock. In 2011 for example, the company spent €86.8 million on share-based compensation, and earned €123.5 million on capital increase and €208.2 million on sale of Treasury stocks. Although this is peanuts to the market cap of €70 billion, it is enough to increase the share count by a small amount.
The founding family of Ms. Bettencourt holds 30.8% of L’Oreal shares while Nestle owns another other 29.6%.
My only gripe with L’Oreal is its price. I do not see any way to justify a price of the stock. The company sells for €70 billion which is 33xFCF in 2011!
Even if we think of L’Oreal as a dividend stock, the yield of less than 1.7% before tax is not that great. Granted the dividend is increasing at a healthy rate, it is still a stretch to pay such a high price for the stock.
I assert that the fair value is below 15xFCF which is €52. Sadly, I do not think that I will be able to buy the shares so cheaply in the near future.
The major risks that L’Oreal might face are as follows.
- Competing with local and global players. Given its size, L’Oreal has to compete and is subject to constant pressure from competitors in every country in which it operates.
- Defending its trademark and brands. Counterfeiters sometimes use similar packaging and claims to use the reputation of L’Oreal to sell their fake products. This may have damaging effects on the brand and the company itself, apart from a loss in revenue. The company has to constantly monitor its markets to stop it from happening.
- Protecting its patents and molecules.
- Protecting its brand and image. In the increasingly globalized world where information is disseminated very quickly, it is imperative for a company to nip its mis-steps in the bud. It is hard to protect oneself against misuse of product or reprehensible individual conduct. But it is imperative to do it as well as possible to maintain the quality and the image of the brand.
- L'Oreal also has 8.8% of Sanofi-Aventis which at current prices is worth €8.5 billion. Also, the company has a net cash position of €500 million due to strong cash flow. A strong balance sheet might also act as a catalyst for the management to do stupid things but given the history of the management, such a situation doesn't seem likely.
L’Oreal is a wide-moat, financially strong and growing business. Nearly 31% of the company is held by the founding family and the management is seasoned with nearly 20 years of experience with L’Oreal. Furthermore, the management is shareholder friendly and has been able to hike the dividend at an average of 10% in the last five years.
The price, however, is too high. I would be okay with paying 12x earnings for such a great business. This puts the price at €78 a piece. On a FCF basis, the price would be still lower at 15xFCF which puts the price around €52. The current price of €115 is too rich.
9 Additional Information
Nestle and the founding family each hold nearly 30% of the company. They have an understanding that neither of them will buy or sell shares to decrease this proportion. This contract expires in 2014. Nestle was interested in acquiring L'Oreal but it seems that this is going to be difficult with a price tag of €70 billion. It is also possible that L'Oreal may use its strong balance sheet to buy back the holding of Nestle. Cancelling these shares will immediately push the earning per share higher. It is hard to say anything at the moment because Nestle has said that it will declare its intentions in 2014. Meanwhile, the shares are probably trading at a huge premium because of a chance that Nestle might try to acquire the company.
The charts and graphs have been either taken from the reports of L'Oreal or made by me using Google docs. I do not hold any shares of L'Oreal but will opportunistically buy if it hits my buy price.
About the author:I started investing in December 2009
and my first stock CreditSuisse (CS) tanked to almost half its
value. This nudged me to start learning about investing from the ground
up. I am a long term value investor and am planning to generate sustainable amount of money from investment income by the time I am 40 years old i.e., 2025.