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Morningstar | Coty’ Efforts to Revitalize Its Brand Set Should Support Top-Line Recovery Longer Term

In October 2016, Coty acquired Procter & Gamble’s specialty beauty business, which doubled its revenue base and made it the foremost player in the global fragrance market. This acquisition was a watershed moment for the firm, in our view, as it also bolstered its presence in the color cosmetics and haircare categories and should provide substantial benefits to Coty’s bottom line over the long term. However, even with these assets, we think Coty has fallen short of securing an economic moat, as we see little to suggest that it has developed the brand intangible assets and entrenched retail relationships needed to establish a competitive edge.While Coty owns several well-known brands, such as CoverGirl, Sally Hansen, and Marc Jacobs fragrances, we believe it lacks the capacity to exert pricing power, as evidenced by our estimate of flat price/mix over the past five years. Further, the margins on its products tend to erode with maturity, suggesting that the firm relies on discounting to drive volume in its legacy offerings and has possibly struggled to develop new products that resonate with evolving consumer preferences. We also don’t think Coty’s material exposure to the fragrance category (37% of revenue) confers it with defensible brand assets, as this category is characterized by substantial competition, and the popularity of a fragrance is often linked to its underlying designer or celebrity.Still, we expect Coty’s cost structure to improve as the company integrates the higher-margin assets acquired from P&G, which should free up resources to reinforce the investments behind its brands and restore growth in its underlying business. The firm plans to achieve $750 million in cost synergies (about 9% of fiscal 2018 cost of goods sold and operating expenses, excluding amortization) by fiscal 2020 through improvements in its manufacturing processes, procurement, and supply chain, which we view as achievable and should allow for bottom-line improvement. Moreover, the firm's divestiture of 14 noncore brands in fiscal 2018 should afford it the opportunity to focus on its faster-growing and higher-margin fare.