L’oréal

The world’s largest cosmetics company has made a comeback in the portfolio. Since the 1980s, the company has grown 60 percent faster than the industry average. This is a testimony to the fact that part of the corporate culture is to always strive to outperform competitors. We see enormous growth potential, particularly in Asia. In addition, we hope that one of the company’s major shareholders will one day decide to sell its shares back to L’Oréal so that our proportional ownership can become even greater.

The roots of L’Oréal trace back to 1909 when a young chemist had a breakthrough with an innovative hair colour product that was sold to hair salons in Paris. The hair colour was to become the beginning of what later became a global manufacturer, marketer, and seller of beauty products. The brands of L’Oréal range from the most luxurious and expensive labels to regular, mass-market makeup, skin and hair care and perfumes, and from active cosmetics consisting of advanced dermatological products to products that are specifically targeting professional hairdressers.

This year, we have added L’Oréal – which we also owned previously – to our portfolio after a period of accelerating growth and no significant share price movements. We therefore currently own – combined with our ownership of Estée Lauder – two of the world’s largest cosmetics empires who combined have a global market share of approximately 20 percent. Thus, let there be no doubt that we consider this an attractive industry.

The beauty companies belong in a fairly stable and predictable industry due to the relatively low price points. Makeup and skin care products are not the first to be cut from average consumer budgets during turbulent times. The sale of beauty products has increased annually by around three percent on average for the industry throughout the last decade. L’Oréal’s revenue has grown even faster with more than four percent annually in the same period. Since the middle of the 1980s, L’Oréal has grown by 60 percent more than the industry average and has thus gained market share. This is a good indication of the company’s ability to create and market their products to consumers around the world. For the last several years, L’Oréal has had high and continually growing market shares around the world – both organically and through acquisitions – and for a number of years it has been the world’s largest cosmetics company when measured on sales, with a yearly revenue of approximately 26 billion euros.

L’Oréal’s luxury business is growing explosively

What we find most appealing about L’Oréal is the company’s growing luxury division, in which we see the same trends and opportunities as for our other beauty company, Estée Lauder. Today, the luxury beauty market represents around a quarter of the total beauty market – and while the general beauty market grew by between four and five percent in 2017, the luxury beauty market grew by around nine percent. L’Oréal’s luxury division grew even faster at around ten percent.

L’Oréal Luxe, which is the division for luxury products, is the fastest growing division of the company and represents more than 30 percent of the revenue today. The growth is mainly driven by the growing upper middle class, which is expected to be the fastest growing income class in the next 15 years – particularly in Asia, where this income class still represents a relatively small proportion of the total population. Makeup and skin care are the two most important categories in the luxury division. One of the most important sales channels is travel retail, e.g. sales through airport stores and other duty-free stores, where almost half of the sales to Chinese customers are made.

L’Oréal is much more than the brand L’Oréal itself – in fact, there are currently over 40 well-known brands belonging to the L’Oréal group. Everyday brands, representing almost half of L’Oréal’s sales, include well-known names such as Garnier, Maybelline, and Essie. L’Oréal’s luxury division includes more than 20 prestigious brands such as Lancôme, Yves Saint Laurent and Biotherm. Under the active cosmetics category, which represents eight percent of the company’s sales, you will find pharmacy brands such as Vichy and La Roche-Posey, whose most important ingredients are from thermal mineral water. Among the brands that are mainly marketed to professionals, we find names such as Kérastase and Redken, and this division represents almost 15 percent of sales. What all the brands have in common is that they are distributed via L’Oréal’s large and global distribution network.

Sales to developing countries currently represent more than 40 percent of L’Oréal’s total sales, and thus constitute a larger proportion of the revenue than Europe or the United States individually. L’Oréal’s market share in developing countries is estimated to be at around 10 percent, and the Asian markets represent particularly good growth opportunities for L’Oréal. The company’s sales in Asia account for a quarter of the total sales, and last year the company grew its sales in Asia by more than 15 percent. China was the main engine of this growth. Asian consumers are expected to have a larger consumption of makeup and skincare products than Western consumers. This is reflected by the fact that the Asian beauty industry is twice as big as in Western Europe. This will benefit L’Oréal as it is the market leader in Asia in both the luxury and mass market category.

A timeless slogan has defined what L’Oréal stands for

Because I’m worth it. This is a sentence that most of us have probably heard a few times – and you can almost visualize it; a beautiful woman with flowing and glowing hair. L’Oréal’s slogan has been used for more than 40 years – more recently in other versions such as Because you’re worth it or Because we’re worth it. With one of the largest marketing budgets in the world (amounting to almost 8 billion euros or almost 30 percent of the company’s sales), L’Oréal has spread the revolutionary message that focuses on women. L’Oréal has thus succeeded in creating a well-known brand associated with beautiful and successful women – exactly what you want your brand to be associated with when your primary goal is to sell beauty products.

Despite the high investments in marketing, L’Oréal has managed to increase its operating margins continually throughout the years. The company’s operating margin is 18 percent, and this is an improvement of almost two percentage points compared to 2010. Furthermore, the company has also had higher earnings levels than its competitors for several years, though competition has been catching up recently. Management remains focused on cutting costs, and the company should have significant economies of scale advantages. We therefore believe that there is still a lot of potential for improving operating margins.

An improvement of the operating margin should be expected to have a positive impact on the company’s return on invested capital, which is currently just under 40 percent. If goodwill from the company’s long history of acquisitions is included, the return is around 20 percent. A higher return on invested capital should – all other things being equal – have a positive impact on L’Oréal’s cash flows. These amount to almost four percent of the company’s market value.

Hoping for a major shareholder to sell its shares to L’Oréal

The management of L’Oréal consists of CEO Jean-Paul Agon who has headed the company since 2006 and been Chairman of the Board since 2011. The company announced in the fall last year that Christophe Babule will take over as CFO. Babule has been with L’Oréal for more than 30 years, and the past four years he has occupied the role as Administration and Financial Director for the Asia Pacific Zone. Babule will succeed Christian Mulliez, who has been group CFO since 2003. The previous group CEO, Sir Lindsay Owen-Jones, has been the main architect behind L’Oréal. He was CEO of the company from 1984 to 2006, but he remained an influential figure in the company up until 2013 by first acting as Chairman of the Board and later as Honorary Chairman.

Jean-Paul Agon has been with the company for over 30 years and has, together with the rest of the management, been very wise about capital allocation. The company’s dividend payments have increased at an annual rate of more than 14 percent over the last 20 years. Most recently, the dividends increased by 8,5 percent in 2018 to 3.85 euros per share, which is equivalent to L’Oréal paying almost 2 percent of its market capitalization in dividends. In 2017, L’Oréal also repurchased shares for 500 million euros, and – including dividends – L’Oréal has thus distributed more than 2 percent of the market cap to shareholders in 2017.

L’Oréal’s largest shareholder is the founding family, the Bettencourt Meyers, who has an ownership of 33 percent. The second largest owner is the food giant, Nestlé. However, back in 2014, L’Oréal bought back eight percent of Nestlé’s shares and subsequently cancelled the shares. Today, Nestlé owns approximately 23 percent.

As we see it, it can add value if L’Oréal buys back the remaining 23% from Nestlé and cancels the shares, as this will increase our proportional ownership in the cosmetics giant. While Nestlé’s management and board have historically expressed reluctance to sell, some of the owners have begun to advocate for the company selling its shares in L’Oréal. With no debt and with cash reserves amounting to approximately one and a half years of EBITDA, L’Oréal already has part of the financing needed if Nestlé should decide to sell its shares (worth around 25 billion euros) back to L’Oréal.