Fixing mass, a multinational’s tale
Excessive margin hopes for 2016. Cosmetics multinationals have become more
vulnerable, and investing into rebuilding barriers to entry for leading brands has to
be prioritized over short term margin expansion. We believe that scale has stopped
being a relevant competitive advantage for cosmetics multinationals, as accessing
consumers has become cheaper for new entrants via digital. Consequently, brand
proliferation is creating a disruptive environment for the big (and sometimes
underinvested) mainstream brands. In that context, we believe that input cost deflation
or the success of various flagship cost stories in Consumer have created too high
margin expectations for companies like L’Oréal, which need in 2016 to reinvest most of
their cost tailwinds, and not just go for the short term margin boost, in order to
perpetuate their business model and rebuild barriers to entry. We downgrade to Equal
Weight with a new price target of EUR164 on margin concerns, in a transition year
where EPS growth will likely be below peers such as Unilever (our Top Pick).
The cost of fixing mass. Our analysis suggests that L’Oréal weakness revolves around
its mass business, while the company keeps growing c1.5x faster than its markets in
the rest of its portfolio. Mass market is in our view the segment where margins were the
most reliant on big umbrella brands sold in "traditional" channels and pushed via mass
advertising, which explains why technological changes have been the most disruptive
for this division’s barriers to entry. The vulnerability of the mainstream segment is not
specific to cosmetics (dairy or frozen food are also vulnerable), but we fear that in the
case of L’Oreal, margin expectations do not factor in the need to reinvest most of the
cost tailwinds into (big) brand support and digital (already started).
Valuation status inconsistent with a transition year. We expect margin expansion to
remain limited due to brands & channel investments in Consumer, and forecast a 3.5%
EPS growth for 2016, below peers and not helpful given valuation. That said, we feel the
company is doing the right thing, but fear the return on these investments being made
may only pay off in 2017. In the meantime, we will watch for a gradual improvement in
Consumer trends, and L’Oréal’s balance sheet offers optionality in terms of cash return.
We favour Unilever over cosmetics for the year. We fear L’Oréal Q1 sales may not
show any acceleration in Consumer yet, while H1 margin may still be marked by heavy
investments. We favour Unilever for its specific barriers to entry in EM and cost actions,
over cosmetics pure players facing pressure on their mass business.