Saturday, September 8, 2012

Because you're worth it

L'Oreal is the largest beauty company in the world, selling a variety of different brands.

Also owns a minority stake in Sanofi-Aventis - this is ignored here, all earnings are operational earnings.


Sales and Profitability

By sales, the company is the largest in the world, closely followed by the beauty divisions of P&G and Unilever.  The other players, such as Ester Lauder, Avon have less than half their revenue.

Notes on the categories:
  • For P&G we are looking at 'Beauty' category: this excludes 'Grooming' (men's personal care)
  • For Unilever, it is 'Personal Care': this includes all skin care, hair care,m deodorants and oral care.
Looking at profitability:

All operating margins above exclude taxes.  P&G and Unilever numbers are special: their margins exclude additional company-wide 'corporate' costs (so really, their margins should be reduced a little):
  • P&G 'corporate' costs are mentioned in the breakdown, but I could not understand the description.
  • Unilever's profit numbers also exclude corporate (2011: about 8% of operating profit).  However the profit numbers already include interest costs.
We can see that size matters.  The top 3 (Loreal, P&G, Unilever) consistently have a distinctly higher profit margin.  L'occitaine is still in its early growth phase, hence its high profit margin.

The beauty market is still quite fragmented.   Total size is estimated at 153bn Euros - all the players above together have less than 50% market share.  There must be a 'long tail' of smaller, localized or niche players.

It is a fiercely competitive market; L'Oreal is one of several large players and there are no barriers to entry for smaller players.

Marketing Costs

Since marketing is their largest cost, lets compare:

L'Oreal consistently spends one of the highest percentage of sales on marketing.

In dollar terms, it was the only company to increase marketing spend every year over the period shown.  Tom Russo often talks about a company's capacity to suffer: the ability to spend money for the long term, while ignoring short term drops in EPS.  Publicly listed companies often face pressure to cut costs.  L'Oreal is controlled by the Bettencourt family and Nestle, who each have a 30% stake, it seems to meet this criteria.  (Wonder why Tom Russo has no direct investment in L'Oreal?)


Industry Growth

Woldwide growth has been 3-5% in good times and 1% in bad times:

Looking at different regions:
  • Developed countries show low single digit growth in good times, offset by the same low single-digit declines in bad times.
  • Developing countries (AsiaPac, Eastern Europe and Latin America) show continual high growth (between 5-20%).  Don't know about bad times - was not able to get figures back from the Asian Financial Crisis.


L'Oreal's sales show mid to high digit growth in good years; -ve single digit growth in bad years:

How much of their costs are fixed vs variable?  From the 2009 contraction:

Their main costs are variable, especially A&P.  Low fixed costs (depreciation and R&D), high variable costs (A&P and others - that covers SGA and COGS - cannot break them down due to depreciation).


Balance sheet:

Compared to their 2011 earnings of 5bn Euros, the balance sheet looks fine.

Negligible liabilities. Debt, contingent liabilities and operating leases added up are far less than 1bn.

Pension fund is underfunded by 753m.   Conservatively invested: 50% bonds, 35% equities.  Acturial gains/losses are recognized as they occur, it seems that other losses (e.g.: poorer than expected returns) are not.  Their assumptions look reasonable:

History of Debt and acquisitions

The beauty industry is fast changing, and L'Oreal makes constant acquisitions.  How are their acquisitions funded, and what is the effect on their balance sheet?

Long-term debt and spending on acquisitions is below, with operational earnings for comparison:

  • LT debt has always been less than 1 years operational earnings, except in briefly in 09.
  • Acquisitions are always funded by debt, no new shares issued.
  • Sometimes they change their LT debt to ST debt, usually before paying it off.
  • They are conservative: Historically, L'Oreal does not carry large amounts of debt, and likes to pay it off within a few years after accumulating it.

Business Model

Low capex, low working capital, high marketing.

In the long term: develop brands so that customers come to retailers for them.  Occasionally acquire some of the new brands that pop up and give them support to expand.

In the short term: its a constant battle to push new ideas, new products, new advertising.  And to keep up with compeditors.

Independent Retailers

A recent trend is the rise of large, independent beauty retailers stocking multiple brands.  LVMH's Sephora is the largest:

Sephora is popular because they offer a large variety of products in a clean, bright environment, allowing customers to try them.  They are a possible threat to beauty brands, as they will try to push their house products first, LVMH brands second, then others third.

Sephora's sales are unknown: LVMH's Selective Retailing group made 6.4bn Euros sales in 2011, but this includes DFS plus a few other maybe say 4bn.  Compared to 19bn Euros sales of L'Oreal alone, or a total estimated market of 153bn Euros, Sephora is still a small player.  The beauty product retailing space is still fragmented, but if Sephora keep doubling the number stores every 6 years, they could gain some control over the market in the future, similar to how supermarkets can replace some products with their own brands (e.g.: Kraft cheese) and therefore control pricing.

Another US player is Ulta, supposedly more mass market, but trying to move upmarket.  They had roughly 1.4bn Euros sales in 2011, and 449 stores.

Retailers are not a threat yet, but may be later.


  • One of the strongest players in a growing industry.  Wide variety of brands from mass market to luxury.
  • Recurring income (unlike watches, cars for example).  Low capex.
  • Good play on emerging markets, can deploy capital to wherever the growth is.
  • As people grow from poor to middle class, they use more beauty products.  And after they get richer, they use more expensive beauty products.
Don't like:
  • Fiercely competitive industry, no barriers to entry.  Constant re-invention, pushing of new products (or of marketing passing itself off as re-invention).  Consumer tastes can be fickle.  The phrase "You're only as good as your last ad" comes to mind.
  • Possible threat of large retailers gaining control of products placement and pricing: Sephora/Ulta.  LVMH is a formidable competitor. Not a threat yet, but something to watch for.
I'll put L'Oreal on my watchlist to buy