EUR 850.00 For Business Accounts Only

Morningstar | Strong Demand in Asia Pacific Fuels Further Top-Line Growth for L'Oréal; Shares Not a Bargain

Wide-moat L'Oréal posted 6% like-for-like sales growth in the second quarter, as the positive impact of premiumization trends, particularly in emerging markets, continued to lift demand for high-end cosmetics. These results largely mirrored trends seen in the first quarter; as such, we aren't expecting a significant change to our EUR 172 fair value estimate, which calls for mid-single-digit revenue growth and above 19% operating margin on average over our forecast period (versus 18% in 2017). The active cosmetics (9% of sales during the quarter) and Luxe (32%) businesses continued to drive sales, each posting like-for-like growth around 13% during the second quarter, on top of 13% and 15% growth, respectively, in the prior-year period. We expect 6%-7% growth in each of these segments longer term, contributing nearly half of revenue by the end of our forecast period. From a geographic perspective, comparable sales in the Asia-Pacific region grew a striking 23%, driving 15% growth in developing markets in the aggregate, as Chinese consumer demand for luxury fare remained robust.

Gross margin in the first half expand 130 basis points to 73%, tracking slightly above our annual expectation of 72%, but we note that margins tend to moderate in the back half of the year. Operating margin in the first half expanded 30 basis points to 19.2%, as a portion of the company's gross margin savings were reinvested in advertising and promotion (up 80 basis points over the prior-year period to 30% of sales). From our vantage point, this was a prudent decision, as we contend L'Oréal's investments behind its brands, through both advertising and research and development, will allow it to support its brand intangible assets and defend its competitive edge longer term. In this context, we forecast combined expenditures on advertising and research and development averaging roughly a third of sales over our forecast period, comparable to the rate over the previous five years.

While comparable sales in the professional products (up 1.4%) and consumer products (up 2.3%) segments remained lukewarm, we were pleased to see solid operating margin expansion in both businesses. Professional products' operating margin expanded 80 basis points to 19% and consumer products' operating margin expanded 100 basis points to nearly 21%. Management cited continued challenges in the French consumer environment as a headwind to its mass-market consumer business, with comparable sales in Western Europe declining 2%, but we posit continued innovation and new product launches should help restore growth longer term. Still, we expect higher-end brands (like those in the active cosmetics and Luxe segments) and developing markets to be more significant contributors to Loreal's overall prospects.