L'Oréal is the largest beauty company that has been in business for more than a century. As a global market leader, it operates in a resilient and growing sector that has weathered depressions, recessions, world wars, and pandemics. This indicates that L'Oréal possesses the characteristics of a long-term compounder. The question at hand is whether now is the opportune time to invest in L'Oréal. This analysis aims to address that question.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in L'Oréal. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of L'Oréal either. Thus, I have no personal stake in L'Oréal. If you want to purchase shares (or fractional shares) of L'Oréal, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started with investing with as little as $100.
The Business
L'Oréal manufactures and sells cosmetic products for women and men, and is the largest beauty company in the world. The company was founded in Clichy, France in 1909. L'Oréal sells its products in more than 150 countries worldwide and owns 37 global brands. L'Oréal has four divisions: Consumer Products (approximately 37% of sales), Luxe (approximately 36% of sales), Dermatological Beauty (approximately 16% of sales), and Professional Products (approximately 11% of sales). L'Oréal operates in six categories: Skincare and sun protection (approximately 40% of sales), Makeup (approximately 20% of sales), Haircare (approximately 15% of sales), Fragrances (approximately 13% of sales), Hair coloring (approximately 8% of sales), and others, such as hygiene products (approximately 4% of sales). Its largest market is Europe, followed by North America, North Asia, SAPMENA – SSA (Southeast Asia, Middle East, and Africa), and Latin America. L'Oréal owns 37 global brands, and some of the most well-known are L'Oréal, Garnier, Maybelline, Lancôme, Yves Saint Laurent, Biotherm, La Roche-Posay, Vichy, CeraVe, Helena Rubinstein, and Kérastase. L'Oréal is solely focused on beauty, and this singular focus represents a major competitive advantage for L’Oréal as they have more than one hundred years of cosmetic expertise, talented specialists, and an in-depth knowledge of consumers. Thus, I believe that L'Oréal has a moat through its extensive experience in the industry and its numerous global brands.
Management
Nicolas Hieronimus is the CEO of L'Oréal, having joined the company in 1987 and being appointed as CEO in 2021. He is a graduate of one of France's top business schools, ESSEC, where he earned a degree in marketing. Hieronimus brings tremendous experience to his role, having held various significant positions within L'Oréal over the years. In 1993, he became the Marketing Director for Laboratoires Garnier, where he successfully created the Fructis haircare range. By 1998, he advanced to the role of General Manager of the Garnier Maybelline Division in the UK. In 2000, he was named General Manager of L'Oréal Paris France and later the International General Manager for L'Oréal Paris, where he repositioned the brand as "accessible luxury" and developed key skincare lines such as Dermo Expertise, Solar Expertise, and Men Expert. In 2005, Nicolas Hieronimus took on the role of General Manager of L'Oréal Mexico. Three years later, in 2008, he became the General Manager of the L'Oréal Professional Products Division, enhancing its global leadership, particularly through the launch of Inoa hair color. In January 2011, he was appointed President of L'Oréal Luxe, a position he held until the end of 2018. In addition to this role, he took on a new position as President of Selective Divisions (Luxury, Active Cosmetics, Professional Products) on July 1, 2013, and was named Deputy CEO in charge of Divisions on May 1, 2017. Nicolas Hieronimus has been described as a great leader, consistently improving L'Oréal's strategic direction and its focus on new opportunities. His vast experience within the company and the industry makes him well-suited to lead L'Oréal into the future. I believe that Nicolas Hieronimus' extensive background and proven track record at L'Oréal position him as the right person to guide the company forward.
The Numbers
The first metric to investigate is the return on invested capital (ROIC). Our criterion requires a 10-year history with all figures exceeding 10% annually. L'Oréal has consistently delivered a ROIC above 10% over the past decade, demonstrating the company's quality and operational efficiency. Notably, from 2014 to 2020, ROIC remained stable, never exceeding 14% or dropping below 12%. L'Oréal delivered its lowest ROIC during the pandemic but still managed to maintain a ROIC above 12% in this challenging year, which speaks to the quality of the company. Since 2021, when Nicolas Hieronimus became CEO, L'Oréal has achieved a higher ROIC, exceeding 15% in all three years and reaching 17% in the past two years. This development is particularly encouraging, considering the macroeconomic challenges during this period, especially in 2023.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. I don't have the growth rate from 2013 as Finbox only provides data for the past ten years. L'Oréal has managed to grow its equity in all years except for a significant drop in 2021. However, since 2021, L'Oréal has resumed its equity growth trajectory, achieving its third-highest equity level in the past ten years by 2023. The company appears to be on the right path to reach a new all-time high equity in the near future. These numbers are encouraging and indicate strong financial health and resilience.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that L'Oréal has managed to deliver positive free cash flow every year over the past decade. Free cash flow has increased year over year in most years, which is an encouraging sign of financial health. Although L'Oréal's free cash flow decreased significantly in 2022, the company achieved its highest free cash flow ever in 2023, which is very encouraging. The levered free cash flow margin is currently lower than its previous peaks, largely due to macroeconomic factors that have impacted most companies over the past two years. However, it is a positive sign that L'Oréal managed to increase its levered free cash flow margin from 2022 to 2023. The free cash flow yield is currently lower than the ten-year average, indicating that L'Oréal shares are trading at a high valuation. This aspect will be revisited later in the analysis.
Debt
Another important aspect to consider is debt. It is crucial to assess whether a business has a manageable level of debt that can be repaid within a period of three years, which is determined by dividing the total long-term debt by earnings. Upon analyzing L'Oréal's financials, it is evident that the company has no debt. Therefore, debt is not a concern when considering an investment in L'Oréal.
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Risks
Based on my findings so far, I believe that L'Oréal is an intriguing company. However, no investment is without risk, and L'Oréal also faces its fair share of challenges. One risk is Macroeconomic Factors. The general level of consumer spending is influenced by a number of macroeconomic factors, including overall economic conditions, inflation, interest rates, energy costs, and consumer confidence, all of which are beyond L'Oréal's control. Consumer purchases of discretionary items, such as beauty products, tend to decline during recessionary periods when disposable income is lower, which may impact L'Oréal's sales. Consequently, a slowdown in the global economy could negatively impact the company's financial performance. Furthermore, due to its international presence, L'Oréal is naturally exposed to currency fluctuations. Changes in exchange rates between the main currencies can affect L'Oréal's results when non-euro subsidiaries’ accounts are converted into euros. Management reported that foreign exchange had a negative impact of minus 5% in 2023 as the euro strengthened throughout the year.
The China Risk: Management has noted that the Mainland China market was flat, with the anticipated recovery in 2023 failing to materialize as consumer confidence remained subdued. Additionally, L'Oréal experienced a disappointing 11.11 event due to weak consumer sentiment and signs of festival fatigue among shoppers. Furthermore, L'Oréal has faced a decline in Asia travel retail, which accounted for around one-third of the decline in L'Oréal's sales in its North Asia market. This decline is partly attributable to China's crackdown on "Daigou" activities. Daigou refers to individuals outside of China who purchase goods on behalf of someone living in China. These sellers have been buying L'Oréal products in Hainan's duty-free shops to sell them at lower prices in China. The crackdown on Daigou activities has significantly reduced these transactions, leading L'Oréal to reduce inventories. These factors highlight the risks associated with L'Oréal's operations in China and the broader North Asia market. The company's performance in this region is sensitive to consumer confidence and regulatory changes, which can impact sales and inventory management.
Competition. A significant long-term risk for L'Oréal is competition in the highly competitive beauty industry. Some of L'Oréal's largest competitors include Moët Hennessy Louis Vuitton, Procter & Gamble, Estée Lauder, and Unilever. Additionally, new competitors, such as e.l.f. Beauty, continue to gain market share each year. Furthermore, L'Oréal must anticipate and respond to changes in consumer expectations, particularly in the areas of natural beauty, health, personalized services, connected products, and environmental commitments. Failure to innovate and adapt product offerings to meet these evolving consumer preferences could negatively impact L'Oréal's sales and growth.
Reasons to invest
There are numerous reasons to consider investing in L'Oréal, one is that L'Oréal is operating in the growing beauty industry. One compelling reason to consider investing in L'Oréal is its operation within the growing beauty industry. Despite numerous economic and geopolitical challenges, the global beauty market grew by over 8% in 2023. L'Oréal outpaced this growth, expanding at 1,4 times the market rate. Management has expressed confidence that L'Oréal will continue to grow faster than the market in the future. The global beauty market is now worth more than €280 billion as of 2023. This market has demonstrated resilience, adaptability, and prosperity, even amidst geopolitical and economic upheavals. The beauty market is expected to continue growing, driven by ongoing economic, technological, demographic, and sociological changes. These include a significant appetite for beauty among younger generations globally. Management has emphasized their confidence in the continued growth of the global beauty market. They attribute this to consumers' desire to feel good about themselves, with beauty products offering a relatively affordable means of achieving this. Management refers to this as the "dopamine effect of beauty," where the use of beauty products provides feelings of pleasure and satisfaction. This effect is particularly relevant in a time when the world faces numerous economic and geopolitical challenges.
Emerging Markets. Another compelling reason to consider investing in L'Oréal is the company's strong performance and potential in emerging markets. Management has noted that these markets continue to demonstrate significant growth, with sales increasing by 24% in 2023 and contributing to 15% of L'Oréal's total sales. Management has described this as a once-in-a-lifetime opportunity, as L'Oréal is just beginning to tap into the potential of these regions. Emerging markets are expected to be home to over 1 billion consumers within L'Oréal's target demographic by 2030. The growth in these markets is driven by increasing population sizes and rising affluence. For instance, India and Indonesia alone are projected to add 250 million people to the global middle class by 2030. These emerging market consumers are rapidly becoming beauty-savvy, seeking more sophisticated beauty routines. L'Oréal believes that the growth in emerging markets will be a significant driver for the company in the coming years, providing a substantial engine for future growth.
Acquisitions: Another compelling reason to consider investing in L'Oréal is its strategic approach to acquisitions. A key component of L'Oréal's business model is acquiring early-stage brands with the potential to become global players. L'Oréal integrates these brands into its distribution and visibility channels while retaining the brands' unique identities. A notable example is Kiehl's, which L'Oréal acquired in 2000 when the brand had annual sales of $40 million. By 2016, Kiehl's had crossed the $1 billion revenue mark. The latest acquisition is Aesop, purchased by L'Oréal in August 2023. Management has expressed their ambition to make Aesop another billion-dollar brand. This goal will be achieved through leveraging L'Oréal's extensive distribution network and expanding Aesop into new categories. Management noted that Aesop is already strong in luxury, body care, and body wash but has significant growth potential in skincare and fragrances, areas where L'Oréal has considerable expertise. This strategy suggests that Aesop could become another successful acquisition, and similar opportunities are likely to arise in the future.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 12,72, which is from 2023. I have selected a projected future EPS growth rate of 8%. Management expects EPS to grow by 8% moving forward. Additionally, I have selected a projected future P/E ratio of 16, which is twice the growth rate. This decision is based on L'Oréal's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be €108,38. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy L'Oréal at a price of €54,30 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 8.395, and capital expenditures were 1.644. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 1.151 in our calculations. The tax provision was 1.999. We have 534,7 outstanding shares. Hence, the calculation will be as follows: (8.395 – 1.151 + 1.999) / 354,7 x 10 = €172,86 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With L'Oréal's Free Cash Flow Per Share at €12,63 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is €145,09.
Conclusion
I believe that L'Oréal is an intriguing company with strong management. The company has consistently delivered a high return on invested capital (ROIC), indicating its quality and operational efficiency. Notably, ROIC has increased under the current CEO. Free cash flow is at an all-time high, although the levered free cash flow margin has declined due to macroeconomic factors. Macroeconomic Challenges: L'Oréal is currently facing several macroeconomic challenges, including adverse foreign exchange rates and lower consumer confidence. Consumer confidence in China, one of L'Oréal's largest markets, remains subdued, and the anticipated rebound in 2023 did not materialize. The decrease in Asia travel retail, exacerbated by the crackdown on Daigou, has led L'Oréal to reduce inventory. While management believes these challenges are short-term, the future development of the Asia travel retail market post-Daigou crackdown remains uncertain. Competitive Sector: L'Oréal operates in a highly competitive sector, which necessitates continual innovation. Competition will always pose a risk for a company like L'Oréal. Nonetheless, L'Oréal remains the largest company in a growing and resilient industry, which is expected to continue expanding for decades. This makes L'Oréal a very appealing investment. Emerging Markets: Management believes that L'Oréal is in the midst of a once-in-a-lifetime opportunity in emerging markets, which could serve as a long-term growth catalyst. Currently, emerging markets account for only 15% of sales, indicating significant room for growth. Acquisitions: Historically, L'Oréal has excelled at acquisitions, as exemplified by the success of Kiehl's. If L'Oréal continues to acquire early-stage brands and grow them into billion-euro entities, these acquisitions will deliver tremendous value to the company and its shareholders. Overall, I find L'Oréal to be a compelling investment. I will not hesitate to buy shares if they reach the intrinsic value of the Ten Cap price at €344.
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