Coty (COTY) has positioned itself for a tremendous recovery. New management, deleveraging the company and moves into Gen-Z preferred businesses have provided the keys for a comeback. The first sign of this turnaround was clear during the Q1FY21 quarterly earnings call. Both the top and bottom line came in ahead of estimates due to cost reductions and strength in the business. The company posted revenues of $1.12B and a profit of 122M. It is the first profitable quarter for Coty in over a year. Posting a profit during the pandemic surprised investors. As a result, the stock jumped 22%. It is the first step in a potential multi-year path of recovery. At the current share price of $4.79, investors should give Coty a second look and consider buying low.
Coty is an American multinational beauty company founded by François Coty. With stakes in Burberry, Gucci, Covergirl, Adidas, Calvin Klein etc. the company has quite the assortment of luxury beauty products. The portfolio is split into three categories as shown below. Coty Luxury, Coty Consumer Beauty and Coty Professional Beauty.
The beauty industry is heavily intertwined with customer loyalty and new trends. Coty has unfortunately been missing the mark for several years. This has led to decreasing revenue dropping from a peak of $9.4B in FY17 to $4.71B in FY19. The ship has been very difficult to turn around with CEOs going in and out of the company at a record pace. The share price has suffered in accordance, falling from $30.40 in 2016 to a current share price of $4.79.
The latest change was announced in July of this year. Sue Nabi became CEO with Peter Harf taking the role of executive chairman. Sue Nabi comes with tremendous experience as she served as the worldwide president of L’Oreal for 20 years.
The new leadership is heavily influenced by KKR Capstone, a private equity company with close to $150B in assets under management. KKR closed a $4.3B deal for Coty’s Wella division and is adding Johannes Huth to the board with another experienced investor joining the board in the near future. The plan is to deleverage Coty’s balance sheet and sell certain divisions of Coty’s portfolio to significantly improve the capital structure. Along with that, Coty is growing e-commerce sales rapidly and getting into Gen-Z focused businesses such as Kylie Cosmetics and KKW Beauty. The latter two provide tremendous growth opportunities.
A successful implementation of the new financial plan could make Coty very attractive at the current share price. It might have more potential left than investors think. The new Covid-vaccine by Pfizer is a tailwind as well with the ability to revive travel and mall sales.
Better than expected Q1FY21
Coty’s share price rose more than 22% on November 6th after posting much better results than expected. Both the top and bottom line came ahead of estimates. The positive results were mainly created by e-commerce momentum, innovative product launches and tremendous cost reductions. Revenue was $1.12B and net income $122.60M. Coty has not achieved a positive bottom line since Q1FY19 where it posted a profit of $56.30M. Peter Harf and Sue Nabi are confident and are “convinced more than ever that Coty is looking at a bright future”. Posting a profit during the pandemic was very much unexpected by analysts and show that the cost reductions and focus on a simplified portfolio is starting to work.
Source: Coty Earnings presentation
With the recent sale of the Wella division, Coty has taken a significant step in the right direction. Wella is Coty’s professional hair product division. The $4.3B deal allows Coty to focus on a much more simplified portfolio of brands. Reducing complexity is important in the search of profitability. KKR will take control of 60% of Wella while Coty keeps a 40% stake. The result is $2.5B in proceeds reducing the net debt from $7.86B to $5.36B post-closing. With additional expected positive cashflow in the next quarter, the net debt will be reduced to $5.0B according to management. Net debt to EBITDA is expected to drop to 5x by end of FY21. Finally, the 40% stake in Wella is valued at $1.3B which reduces the economic net debt to $4.0B.
Source: COTY Earnings Q1FY21
Fixed cost reductions
In Q1FY21, fixed costs decreased by 17% YoY. A headcount reduction and savings in business services led to $80M of savings. These savings are expected to grow even further. Management estimates they can reduce fixed costs by more than $200M in FY21 and $600M by FY23. This is very positive as it will lead to positive cash flow and a further reduction in net debt improving the balance sheet of the company.
Kylie Skin and KKW Beauty
Coty’s new trajectory has led to significant stakes in both Kylie Cosmetics and KKW Beauty. Kylie Jenner and Kim Kardashian have enormous reach on social media with 200M and 191.7M followers respectively. Coty acquired 51% of Kylie Cosmetics for 51% and a 20% stake in KKW Beauty for a reported $200M. Sales for both brands have been skyrocketing since their inception. Social media influencers promoting their own brands have proven to be a very effective model. Kylie Cosmetics has annual revenue of $177M. Kylie Skincare sales tripled YoY with over 50% of orders coming from returning customers. This is the brand/ influencer loyalty Coty has been looking for. With the addition of e-commerce sales for Kylie Cosmetics in Germany, France and Australia, the company is looking at a continued growth trajectory for several years. KKW Beauty is posting very strong sales as well, reportedly in the range of $100M per year. KKW Skincare is currently being developed with an expected release of products in FY22.
Source: Kylie Jenner Instagram reach
The vaccine candidate provided by Pfizer and BioNTech on Monday has shown very promising results in the phase 3 trial. The vaccine currently has a 90% efficacy, much higher than analysts were originally expecting which has led to stay-at-home stocks to rebound rapidly. This vaccine is important for Cody as it can potentially revive the travel sales in duty-free shops and shopping malls. The vaccine comes at the right time for Coty who just posted better results than expected in Q1FY21. A return to normal will make Coty’s comeback complete.
The main risk for Coty is a prolonged lockdown in either Europe or the US. Beauty sales suffer tremendously during these times as non-essential stores are closed. However, the Pfizer vaccine and a potential Moderna vaccine reduce this risk tremendously. The rapid rise of e-commerce sales for Coty is another factor mitigating this risk. Buying a beat-up stock at lows before a positive turnaround creates a risk-reward ratio that seems to be worth it. Coty is not done yet. Soon, the balance sheet will look better than pre-Covid times while the share price is under $5 compared to $12.18 in February.
The recovery for Coty has started and is well underway as Q1 results proved. Now is the time to add shares at a very attractive price while Coty’s business goes back to growth. A reignited interest in the brand with strong marketing and focus will lead to the continued recovery of the share price, potentially back to pre-covid levels in the coming quarters.
Disclosure: I am/we are long COTY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.