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Steven Chen
Steven Chen
Articles (109)  | Author's Website |

Urbem’s 'Wonderful Business' Series: L’Oreal

Two layers of moats and six growth engines

Founded by young chemist Eugène Schueller in 1909, France-based L’Oréal (XPAR:OR) has been devoting itself entirely to the beauty business for more than a century now. The company has transformed from a small hair dye manufacturer in Paris to the number one cosmetic group in the world.

L’Oréal offers a wide variety of products, including skincare (32% of fiscal 2018’s sales), makeup (27%), hair care and coloring (27%) and fragrances (9%). The business is a truly global one, with a presence in 150 markets and 40 production sites worldwide. As of fiscal 2018, the Western Europe region accounted for 30% of the company’s total revenue, followed by the Asia-Pacific’s 28% and North America’s 27%.

As is shown below, L’Oréal generated a decent return on invested capital on a consistent basis for more than two decades.

The company underperformed its American rival, Estee Lauder (EL), which focuses on the prestige niche. It did produce higher returns than Coty (COTY), Shiseido (TSE:4911) or Henkel (XTER:HEN3) during most of the years.

We think that L’Oréal should be able to maintain its return on capital at the current level thanks to its portfolio of leading brands on a global scale.

For the beauty business, big brands tend to be winning brands, as consumers could be risk-averse and may want to shop for the products that are highly recognized. The company’s namesake brand, L’Oréal, was one of the top fast-moving consumer-goods brands according to Interbrand’s 2019 rankings of “Best Global Brands,” lagging behind only Pampers and Gillette (both owned by Procter & Gamble (PG)). The company also owns other well-recognized brands that are highly ranked by various sources, including Maybelline, Lancôme, Kiehl’s and Yves Saint Laurent.

With a comprehensive portfolio of 36 brands, L’Oréal distributes its product widely through different channels, such as hair salons, mass retail, department stores, pharmacies, travel retail and online platforms, to maximize coverage of each market and seize growth opportunities. This further widens the moat in our view. We observed that the operating margin has steadily improved from 10% in 2000 to over 18% in 2018, demonstrating a scale advantage.

The management is seeing six growth engines propelling the organic business expansion for recent years – the Asia Pacific, the luxury niche, the skincare segment, travel retail, the dermo-cosmetics category and e-commerce. All of these are double-digit-growth contributors that beat the benchmark for L’Oréal at the moment. For example, the company is increasing its sales in the Asia Pacific at an annual rate of 24%, compared to the market growth rate of 10% in the region; its skincare business is growing by 18%, compared to 8% in the market; the e-commerce has been growing at over 40% since 2018, compared to 25% in the market.

It appears that the megatrend of consumption upgrade and continuous market penetration, especially in the emerging markets, may drive secular growth for the foreseeable future. We are not sure whether the current growth rate should be sustainable in the long run. But with a competitive moat staying intact and prudent, disciplined capital allocation as the base case, all we know is that any growth is a meaningful, value-generative one for long-term shareholders.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

Steven can be reached at [email protected] or through LinkedIn.

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