L’Oréal Earnings Preview: Long Term Prospects Remain Bright Despite Currency Headwinds

L’Oréal SA (PINK:LRLCY) will be reporting its first half 2013 financial results on August 29. The beauty product giant reported subdued sales numbers on July 16, considering the currency headwinds in the industry. From the sales data reported, like-for-like sales grew 5.7% y-o-y compared to 5.9% in H1 2012. Taking into account the effects of currency fluctuations, reported revenue growth fell from 10.2% in H1 2012 to 4.9% in H1 2013.

Net sales for the group in H1 2012 stood at approximately $14.54 billion, compared to $14.24 billion in H1 2011. Gross margins in H1 2012 declined 49 bps over H1 2011 to 71%, partly due to the consolidation of Clarisonic into the L’Oréal group. Operating and net income margins on the other hand registered marginal gains of 14 bps and 5 bps to 16.91% and 14.51% respectively. Total operating expenses for the first half of 2012 were $7.87 billion compared to $7.8 billion in H1 2011.

Although the total operating expenses as percentage of net sales were flat, the company started to invest more into digital marketing campaigns than traditional marketing ones. Digital marketing expenses represented 9.5% of advertising expenses in 2012, compared to 8% in 2011 and 5% in 2010, and the company guides further investments into digital marketing in the future. The company has a debt amounting to $327 million as of December 31, 2012, with debt maturing within a year amounting to about $300 million. This reduces any interest payment obligations for the company in H1 2013.

We expect further dilutive effects on gross margins in the first half of 2013 following the acquisition of Kenya’s Interconsumer Products Limited (ICP) in April 2013. However, operating margins are expected to remain consistent with the historical trend with decreasing interest expense.

View our detailed analysis for L’Oreal here

Temporary Weakness Prompts Investments Into New Markets

In addition to decelerating top line growth due to currency headwinds, L’Oréal is facing weaker volume growth excepting Europe. A recovery in the Eurozone economies witnessed lower unemployment and lower inflationary prices. The strengthening of currencies in the region combined with lower-priced products saw like-for-like sales in Western and Eastern Europe grow 1.7% and 13.5%, respectively, in H1 2013, compared to 0.8% and 3.1% in H1 2012.

However, strength in European markets was offset by persistent weakness in the North American economy and a slowdown in the new markets. Weak currencies dented growth in the Asia-Pacific region of the new markets with reported revenues growing at 5.1% y-o-y compared to 21.9% a year ago. Similar weakness was observed in the Middle East and Africa region with sales growth slowing down to 12.3% compared to 18.2%.

In 2012, new markets contributed the largest share of 40% to the total sales. The company has been introducing newer products to tap into the potential for beauty products in these markets and expects sales to grow at a double-digit pace. The management guides that performance in markets like China, India, Indonesia and Turkey has been strong in 2012, and Russia is starting to regain lost ground.

Investments being made into newer manufacturing facilities in these regions to increase products that are locally relevant to the consumer would improve categorical market shares for the company. A reduction in associated costs such as production and export costs would help in improving margins in the long run.

Globalizing Major Products and Rolling Out New Products To Support Sales Growth

In 2013, L’Oréal is expected to globalize various products in different categories such as skin care, hair care, make-up etc. L’Oréal Advanced Hair Care has been launched in the North American markets in January 2013. Additionally, various hair care and skin care products are in the pipeline for 2013. An anti-spot treatment cream and a BB cream from Garnier are scheduled to be globalized in 2013.

Additionally, L’Oréal is investing heavily into new technology development for hair care, make-up, and skin care products. ODS Technology for long lasting color protection from Garnier has been incorporated into its latest product, Olia, which registered strong performance. The company’s investment in January 2013 into the Research and Innovation (R&I) facility in Mumbai is expected to study the Indian hair and skin specificities, as well as beauty routines and expectations of Indian consumers. The new R&I facility is the sixth R&D hub globally for the Group, and includes both a Product Development Center in Mumbai and an Advanced Research Center in Bangalore.

With increasingly relevant products in the offing, we expect sales’ volumes from L’Oréal to pick up as macroeconomic environments worldwide become increasingly conducive. We will be revising our $28 price estimate for L’Oréal after it files its financial results on August 29.

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