L’Oréal (hereafter ‘OREP’ or ‘Oreal’) is one of the largest cosmetics and beauty products companies in the world, and thus enjoys a dominant position on the market. With total revenue of approximately 25 billion Euro per year, the Oreal definitely is one of the giants in its sector. The company’s main listing is on Euronext Paris, where it’s listed with OREP as its ticker symbol. The current market capitalization is approximately 99 billion Euro.
Growth throughout all divisions!
The total revenue increased once again and whilst the top line growth was less outspoken than in 2015, a 2.5% revenue increase is actually pretty decent, especially as the cost of sales remained under control as well.
However, the company did increase its spending on R&D (up more than 10% in 2 years) and promotion (up almost 15% in two years). These efforts seem to be paying off, as the operating profit increased by approximately 3%, to 4.54B EUR, resulting in an operational profit of almost exactly 4B EUR. That’s slightly lower compared to 2015, but we expect the ‘other expenses’ to contain some one-time items which had a negative impact on the 2016 results.
Source: press release
The higher one-time expenses combined with a higher average tax rate were the main culprits of a lower net income (-6%) and EPS (also -6%).
That being said, the cash flows remained quite robust (and that’s exactly what we would expect from a company with a dominant market position). The adjusted operating cash flow was 4.7B EUR, and after deducting the 1.4B EUR in capital expenditures, the adjusted free cash flow of L’Oréal was approximately 3.35B EUR. That’s a massive amount of cash, but as the company’s market capitalization is zeroing in on 100 billion Euro, it’s hard to argue the company is priced attractively (or even fair).
Source: press release
How is L’Oréal spending its cash? And where will the additional value come from?
In 2015, the company didn’t repurchase any stock at all, as it focused on reducing its net debt by repaying in excess of 1.8B EUR of short-term debt to keep the balance sheet in a pristine shape. This situation changed in 2016, as the company has restarted its share buyback program and has spent almost half a billion on a share buyback program.
This buyback program was funded by new debt (as the company also reported an impact of approximately 1.2B EUR related to consolidation activities). Surprisingly, this wasn’t even necessary as L’Oréal added cash to the balance sheet (with the cash and cash equivalents position increasing to 1.75B EUR, resulting in a net cash position of approximately 400M EUR.
Source: annual report
The board of directors will now once again hike the dividend, and the L’Oréal shareholders can now expect the AGM to approve a dividend of 3.3 EUR per share, which is an increase of almost 6.5% compared to the dividend of 3.1 EUR last year. Based on the current share price, the dividend yield will be approximately 2% (and keep in mind France has a high dividend withholding tax rate of 30% so you might want to figure out if you could apply a double taxation treaty to reduce the tax pressure).
This means the payout ratio will increase as well, and the majority of the free cash flow will now be used to fund the dividend. Another share buyback program of half a billion euro has been announced again, but it’s unlikely this will move the needle as this repurchase authorization represents just half a percent of the total amount of outstanding shares.
L’Oréal is a quality company, but you’re paying a very high price to gain exposure to it. Even though the company’s 2016 was quite positive, a free cash flow yield of less than 3.5% just isn’t good enough to convince anyone to take a position in the company at the current share price level.
Should the share price come down to the 125-140 EUR level during a market pullback, an investment in L’Oréal could become very appealing, but the risk/reward ratio just isn’t good right now.
Disclosure: the author has no position in L’Oréal