L'Oreal Continues to Face Depressed Markets

Stock price: €69.5 ($103.11)
Conclusion: Future growth in developed markets remains an issue. Current stock price looks full (P/E 21x 2009 and 19.6x 2010), in line with our DCF based valuation estimate.

Q3 sales: Sales up 0.8% like for like (-0.7% reported), adjusted for SAP, sales almost flat. 9 months down 1.9% like for like, up 0.7% reported to €13bn.

L’Oreal continues to face depressed markets in the salon business and in the prestige segment which account for almost 40% of sales. As a result, revenue growth in Q3 continues to be lower than the performance achieved by most competitors in Q3, notably Beiersdorf (BDRFF.PK) (+2.2%), Unilever (UL) (+4.6% personal care) or Procter (PG) (+2% overall and in beauty).

However, the consumer division returned to growth (+4% adjusted for SAP impact) thanks to +14% sales in the Rest of the World. Such a trend looks good in comparison to Unilever, considering that the rest of the world accounts for a much lower proportion of sales. The comparison with Nivea in Q3 looks also favorable for L’Oreal.

Growth in developed markets remains an issue, as we estimate that revenue in the mass market division decreased by 1.2% in Q3.

Outlook for Q4 and next year?

On the one hand, L’Oreal will benefit from the end of destocking, easier comparison base and increased innovation. On the other hand, CEO does not see any recovery in developed market. All in all, we expect Q4 to increase sales by 2.6% and the whole year to remain negative.

For next year, a return to 4% growth would require to keep a high single digit growth momentum in the Rest of the World and to return to low single digit growth in developed market, which we feel is a realistic assumption. However, most of it will be offset by a negative forex impact based on current rates.

What should be the normalised medium term growth rate of L’Oreal? We feel that a return to +7+8% will be difficult to achieve given the increased competition in emerging markets, the switch towards value driven products…and also the size of L’Oreal. Growth of +5+6% in sales would require around +3+4% in developed market, which is already a demanding target.

The bottom line should benefit from positive leverage, but marketing spending will further grow, holding back margin expansion. Consequently, long term EPS growth could average +7+9% vs. double digits in the past.

L’Oreal does not look cheap versus Procter or Unilever, however valuation is in line with our DCF model. A rerating would require a return to +7+8% long term revenue growth which today looks unprobable.