EUR 850.00 For Business Accounts Only

Morningstar | Raising Coty's Uncertainty Rating to High to Reflect Wider Range of Outcomes as Turnaround Continues. See Updated Analyst Note from 14 Dec 2018

We are raising our uncertainty rating for no-moat Coty to high from medium, as we think its ability to revitalize its product portfolio and integrate the brands acquired from Procter & Gamble could lead to outcomes that stray from our valuation to a greater extent than in our prior outlook. From our vantage point, the material impact that supply chain disruptions in the first quarter had on both organic sales (8% decline) and gross margin (contracting 70 basis points to 60%) evidences the sensitivity of its performance to these efforts. This also aligns with our view that Coty lacks the brand strength or entrenched retail relationships needed to secure a competitive edge, as these disruptions also resulted in heightened promotional pressures from retailers and shelf space losses.

We don't think the firm's path to turn around its business (particularly the consumer beauty segment, which accounts for more than 40% of sales and posted a 14% decline in comparable sales in the first quarter) will be a smooth one. Accordingly, we wouldn't be surprised to see increased volatility in sales, and model a wider range of five-year compound growth rates, ranging from a 3% increase in our bull case to a low-single-digit decline in our bear case. Similarly, we surmise the extent to which Coty relies on promotion (which it has done historically) or invests behind its brand set (in the form of marketing and research and development) to support top-line improvement could lead to greater variance in profitability.

Despite this revision, we're holding steady on our $12.70 fair value estimate for the firm, which incorporates sales growth around 1% and operating margin below 9% on average over the next five years. At current levels, we see an attractive entry point for patient long-term investors.