COTY INC.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

A global beauty company with a portfolio of well-known brands across fragrance, color cosmetics, and skin & body care categories.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Coty Inc. operates as a global beauty company, offering a wide range of products across several key categories. These include:

Prestige Brands: High-end fragrances, color cosmetics, and skincare products sold primarily in department stores, perfumeries, and travel retail. This segment is more sensitive to fluctuations in the economic cycle.
Consumer Beauty Brands: Mass-market fragrances, color cosmetics, skincare, and body care products sold in drug stores, mass merchandisers, and supermarkets. This segment has a more loyal customer base due to generally cheaper products, but is more sensitive to promotions and discounting.

Coty’s portfolio features a mix of iconic global brands and some regional favorites:

Fragrances: Burberry, Gucci, Calvin Klein, Marc Jacobs, Hugo Boss, Davidoff, and Chloe.
Color Cosmetics: CoverGirl, Rimmel, and Bourjois.
Skin and Body Care: Adidas, and other localized brands.

The company utilizes a multi-channel distribution strategy including retail sales, e-commerce, and direct-to-consumer initiatives.

Coty’s recent earnings results revealed that despite overall revenue growth of 9% (including 3% underlying growth), operating margin has decreased to 10.4% from 13.8%. However, management has repeatedly reaffirmed that they are on track to achieve 14-15% margins by fiscal year 2025 through focusing on productivity savings and revenue growth.

Industry Trends and Competitive Landscape

The global beauty market is characterized by:

High competition: Intense rivalry from established players and new entrants, resulting in pressure on pricing and market share.
Fragmented market structure: A combination of large multinational corporations alongside smaller independent brands and niche specialists.
Rapid changes in consumer preferences: This requires constant innovation and adaptation to shifting trends in beauty.
Increasing digital influence: Growing role of e-commerce and social media in brand awareness and product discovery.

Coty faces challenges from multiple angles. In makeup and fragrance, it fights against well established brands, and new, trendy, and social media driven brands. In body and skin, it has to compete with fast growing, new companies and also established corporations.

The beauty industry generally has a high brand loyalty which is a double edge sword. Companies with brands in the prestige or consumer market are able to capitalize, but if they lose brand trust and popularity, profits could drop rapidly.

What Makes Coty Different

Coty differentiates itself through:

A portfolio of established brands: A large collection of well-known brands, including numerous heritage fragrance labels, gives Coty a level of established recognition and trust with consumers.
Extensive distribution network: Strong global reach and multi-channel distribution, allowing access to both established and emerging markets.
Strategic partnerships: Collaborations with brand owners and licensing agreements. However, these often have a limited life and could be costly to maintain, or lose the right to.
Focus on emerging markets: Expansion in developing economies, where growth prospects are often higher, yet these economies can be less stable.
Emphasis on a focused approach: Coty has been divesting operations and assets, and concentrating on core brands and segments, which, in the long-term, could reduce the drag of underperforming products, but also limits diversification.

Recent Concerns and Management Response

Lower than expected earnings and growth: Coty has been hit by rising inflation, supply chain disruptions, slow economic growth, and more recently, weaker Chinese demand, which all affected growth for the past few years, as well as their 2023 financial results. Management, however, reiterates long term growth and profitability goals.
Increased Promotional Activity: High levels of promotion and price discounting to encourage consumer spending, may be impacting margins and overall profitablity. However, management says that they are focusing on more targeted discounts in the future, which should result in increased pricing power and reduced discounting.
Cost of Acquisitions: Although the company has done some interesting acquisitions to bolster their portfolio of products, the company has stated that they did not contribute significantly to the bottom line so far, this has cast doubt over whether these acquisitions are value accretive. Management argues that it is about long-term growth over just one period.
High Debt: The company still has quite a lot of debt, although the management has improved its balance sheet substantially over the past couple of years.

Financial Analysis

Coty’s financials reflect a company undergoing significant transformation.

Revenues: Coty’s revenue shows some signs of improvement, increasing by 9% from 2022 to 2023. This is also driven by pricing, which has affected volume for some products.
Profitability: Operating margin has decreased from 13.8% to 10.4%. Although revenue has been increasing, costs are also increasing, impacting profit margin. Net income was -$65.9 million in 2023.

While net sales increased, reported earnings decreased as a result of rising costs and less favorable market trends, which could be problematic.

ROIC and WACC: ROIC is currently around 12% while the WACC is approximately 8%. In their annual reports, management has consistently stated the desire to make ROIC higher, which should increase long-term intrinsic value. However, they do not provide information about their specific ROIC or WACC calculation in the reports.

Overall, Coty is moving toward better profitability as the costs of Covid, Russia, and inflation subside, but will need to continue improving its ROIC.

Balance Sheet: Total debt to equity is almost 4, while the net debt is roughly $4.4 billion. It is clear the business is leveraged, and the amount of debt may be a drag on the company’s overall value, especially with rising interest rates. While they have enough liquidity to operate in the short term, more work is needed to reduce their debt. However, management has made significant reductions to the company’s debt over the past years, through deleveraging, which has been effective so far.

Moat Analysis (2/5)

Coty’s moat is rated as a 2 out of 5 or a narrow moat due to the presence of a few structural competitive advantages. However, they face significant risks that could erode the moats and prevent them from having sustainable economic profits.

Intangible Assets (Brands): Coty possesses valuable brands with strong recognition. However, as the retail market has become more competitive, the company’s brand pricing power is now less than ever, because of discounts and increased availability of competition from new, trendy companies.
Switching Costs: Some of the products have moderate switching costs for loyal users, particularly within the professional lines that are used in salon, but that does not provide a wide-reaching moat. There is little stopping consumers from choosing a similar product that is cheaper or a trendy new product.
Network Effects: Coty doesn’t really have any network effect, which further weakens the companies’ competitive advantages.
Cost Advantages: Coty cannot be said to have a significant cost advantage. Although management has been trying to improve efficiency, they are unlikely to be the lowest cost provider, as they operate a broad range of categories.

Legitimate Risks

Macroeconomic Factors: Inflation, supply chain disruption, and slower GDP growth are impacting revenue, margins and profitability. These can also impact the purchasing power of the end consumer.
Intense competition: The beauty market is very crowded, so competition is intense and growing.
Changing Consumer Trends: Beauty trends are volatile and influenced by social media. The change in customer preferences can make old brands go out of fashion quickly.
Licensing Agreements: Coty’s business relies heavily on licensing deals that allow them the right to sell perfumes and cosmetics under a brand name. These are often expensive, and the terms of contract limit the time periods, which could damage the value of the company.
Economic Downturn: Consumer discretionary spending is highly influenced by the health of the economy. Coty’s business could be greatly impacted by a severe downturn.
Debt levels: A high level of debt, while not as bad as previous years, remains a risk factor to Coty. High debt levels could hinder future growth opportunities or force Coty to be more reactive instead of proactive.
Inability to recapture profitability: The company might not be able to achieve the 14-15% margins they aim for by 2025.

Business Resilience

Brand Strength: Many of Coty’s brands are well known and have some level of reputation and consumer loyalty. Therefore, they can recover from setbacks better than smaller companies with no brands, which enhances resilience.
Global diversification: Although Coty is highly present in the U.S. market, they do operate globally, and therefore could sustain shocks better by having geographically diversified revenues.
Shift to luxury: Focusing more on prestige can help the business capture pricing power. If they manage to successfully transition to higher margin business that should help the company in the long run.
Transformation plan: Restructuring activities by management are aimed at improving overall efficiency and margins, which should make the business better prepared for the future.

The risks are real and Coty has several challenges. However, they do have some key strengths that would help them navigate these challenges and remain successful.

Understandability (2/5)

Coty’s business model is relatively complex and therefore ranks a 2 out of 5 in terms of understandability. While the general idea of selling beauty products seems straightforward, the company operates with numerous brands, licenses, different distribution channels, geographic regions, and target markets. A full understanding would require in-depth knowledge of their financials and accounting principles, as well as an understanding of the beauty market itself.

Balance Sheet Health (3/5) Coty’s balance sheet is somewhat improved, which warrants a rating of 3 out of 5. The amount of debt is still concerning, but cash is fairly stable, while the company has been actively reducing its debt. Given the high leverage though, there are concerns about interest payments, and any unexpected business downturn could severely affect its balance sheet.