EUR 850.00 For Business Accounts Only

Morningstar | EssilorLuxottica's Guidance Disappoints as Synergies Take Time; Shares Attractive

We are maintaining our fair value estimate and wide moat rating for EssilorLuxottica as the company reported full-year revenue in line with our forecasts and slightly lower operating margin than we forecast. We expect to adjust our near-term forecasts to reflect delayed synergy realization. This will have a low- to mid-single-digit negative impact on our fair value estimate. Although the benefits from the merger are taking longer to play out and there is weakness in some parts of the business, we continue to believe that EssilorLuxottica is well positioned to benefit from the structural growth drivers of the global eyewear market and that increasing near-term market pessimism creates an opportunity for patient investors to build a position in this wide-moat name at an attractive price.

The company remained committed to its EUR 420 million-600 million synergy target net of reinvestment needs at the operating level within five years. Our expectations are for EUR 470 million in realized net synergies by 2022. However, guidance for 2019 came as a disappointment, with 3.5%-5% revenue growth (versus 3.2% in 2018 for the pro forma combined entity) and adjusted operating profit growth of 0.8-1.2 times sales growth. Guidance includes synergies from the merger, but management didn’t specify the amount. This compares with our expectation of over 7% revenue growth including synergies. We also expected margin improvement as cost synergies start to benefit the company; however, those are either slow to come through or being reinvested in growth. Although EssilorLuxottica remains committed to the announced synergies, it looks as if it will take longer to achieve them. We view higher insourcing of Essilor’s lenses in Luxottica’s retail channel and indirect procurement improvement as one of the first easier-to-implement synergies.

We believe that the market is increasingly concerned about the governance of the combined company and the ability to execute on synergy targets without one accountable person in place in the complex management structure; the integration committee is headed by two senior executives from Essilor and Luxottica who report directly to the executive chairman and vice chairman of the group. The CEO search process for the combined group has started this year and is expected to be finalized by the end of 2020. The key consideration is a record of integrating companies with different cultures.

In the fourth quarter, Essilor’s like-for-like revenue accelerated to 5.7% growth, bringing total like-for-like revenue growth to 4.6% (versus management’s guidance for growth around 4%). Luxottica’s performance also saw improvement in the quarter in wholesale division with negative 1.1% for the year at constant exchange rates (versus negative 2.4% for the first nine months) and some slowdown in the retail division with 3% annual constant currency growth (versus 3.5% in the first nine months). Luxottica’s wholesale results in the year were affected by revision of commercial policies in Europe and wholesale rationalization in China. Among retail concepts, Sunglass Hut outperformed while Lenscrafters returned to slightly positive like-for-like sales growth in the second half of the year.

Despite gross margin improvement driven by favorable product mix with more innovation at Essilor, operating margin declined to 16.5%, driven down by increased selling and marketing expenses to support e-commerce, Transitions products, and the prescription business in the United States. Luxottica suffered from a negative exchange rate effect, which weighed on profitability.