TheChek News Flow

Will Multiple Contraction Consume EPS Accretion in a Buyback Scenario?

* We remain Neutral on L'Oréal, even if it buys back the Nestlé stake (although we don’t think it will)

— Whilst there has been much debate about the potential mechanics of L’Oréal buying back Nestlé’s 29% stake, we think subsequent valuation multiples would be just as important. Although we expect Nestlé to maintain the status quo, if we are wrong we see gradual post deal P/E multiple contraction (down to ~20x), effectively offsetting the mechanical earnings accretion (of ~15-20%), which broadly supports the current share price, but does not provide any basis for significant upside.

* Questioning the supports of L'Oréal's rich multiple — We think L’Oréal has

commanded a premium trading multiple for i) the potentially longevity of growth for

HPC companies versus other staples categories (given lower levels of penetration

in Emerging Markets), ii) the perception that L’Oréal is a premium growth business

and iii) balance sheet optionality. Whilst we tend to agree with the first point, we

disagree with the second and think a transaction would consume the third.

* Good, but not exceptional growth — We think the days of L’Oréal sustainably

delivering 6-8% organic sales growth are gone. We expect the company to deliver

~5% growth on an ongoing basis, which is strong, but broadly in line with other

leading global staples companies.

* Normalising the balance sheet — We model net cash of ~€3.0bn (~0.6x EBITDA)

in 2013, rising to ~€4.5bn (~0.9x EBITDA) in 2014. On a pro-forma basis, assuming

a Sanofi plus debt funded buyback of the Nestlé stake, 2013/14 net debt/EBITDA

would increase to ~2.3x/1.9x, at the more geared end of the peer group.

* Results on 10 February — L’Oréal’s full year results after the close on Monday are

likely to provide further evidence of the relative resilience of HPC and L’Oréal’s

good execution within that group. We expect 5.0% organic growth for the quarter

and 4.9% for the year. Combined with 35bps of margin expansion, we expect full

year EPS of €5.05 vs. consensus of €5.09.