Little Potential in L'Oreal

Stock Price : € 60.8 ($85.96 USD)
Conclusion: unchanged, fully priced before H1 results release.

H1 sales down 3.2% like for like (-2.1% Q2), up 1.4% reported (+2.6% Q2). H1 results will be released August 27th. No guidance given for the year.

L’Oreal continues to struggle in markets which are still down. The slight improvement visible in Q2 comes from the luxury products division sales which continued to contract, but at a slower pace than in Q1 (-8% vs -17%). Consumer products (+1%) and professional products (-4.8%) performed in line with Q1, while active cosmetics slowed down. The second half should benefit from the end of destocking coupled with easier comparison. We expect full year sales to be down 2% versus 3.2% in H1.

Visibility looks poor on the margin front. H1 should be impacted by negative volume growth, negative geographic mix, higher marketing expenses, the consolidation of YSL, tough comparison base, partly offset by lower raw material prices and media rates. Comparison will get easier in H2. All in all, margins could contract by 110bps to 14.5%, net earnings fall by 6-7% in 2009.

L’Oreal is adapting its product line to changing consumer behaviour. The group is switching from a premium based offer to more affordable products in order to enlarge its consumer base. However, the place is crowded and L’Oreal will have to compete directly against Unilever (UL), P&G (PG) or Nivea. It remains to be seen, whether the group can adapt its cost structure in order to preserve the margins.

The stock looks fully priced, trading at 18.2x and 16.2x our 2009 and 2010 estimates. We prefer to invest in Reckitt (RBGPF.PK) which offers faster growth in household product at a lower multiple. Our long term DCF valuation points to €68 ($96 USD) per share.

Although the Bettencourt family has always reiterated its commitment to L’Oreal, we feel that a durable slowdown could suggest other medium term scenari such as take over by Nestlé.

Disclosure: No position