This Beauty Company Has Blemishes

Coty (NYSE: COTY  ) distributes beauty products in over 130 countries, targeting both prestige and mass markets. It offers fragrance products such as Calvin Klein, Davidoff, Playboy, Beyoncé, Guess?, Lady Gaga Fame, Roberto Cavalli, and JLo; color cosmetic products such as Rimmel and Sally Hansen; as well as skin and body care products Lancaster, philosophy, and TJoy. However, despite all those big names, recent trends might dissuade you from investing in Coty and lead you to an investment in one of its peers instead. 

Geographic trends
Coty is seeing a trend that many companies are experiencing throughout various industries -- weakening domestic demand. Additionally, Coty is seeing volatility in China, Europe, and Japan. This should come as no surprise since China is attempting to control its growth under new leadership, much of Europe has chosen an aggressive austerity route, and Japan has opted for the stimulus route during a time of weak consumer demand.

Despite current economic trends throughout the world, Coty aims to expand its geographic footprint while diversifying its distribution channels in existing territories. As far as the latter is concerned, Coty will broaden its distribution in Brazil, Taiwan, and Thailand in fiscal year 2013, and Asia and India in 2014. 

All of this might lead to confusion about Coty's future potential, but this story will soon be simplified.

Recent results tell a story
In FY 2013, net revenue for fragrances increased 2%, and unit volume grew 8% year over year. If you only looked at these two numbers, then you would assume that everything looked great in fragrances, but there is a negative. The higher volume was for lower-priced products, and promotions were necessary in order to help drive sales, which negatively impacts Coty's margins. 

Katy Perry's existing fragrance portfolio, Lady Gaga Fame, and Roberto Cavalli have all helped drive sales in fragrances. But revenue from celebrity products tends to fade, which means Coty will continuously have to find new avenues to drive revenue growth. For instance, new launches represented 16% of new revenue in FY 2013, whereas net revenue from existing products declined 15%.

The color cosmetics segment enjoyed market share gains thanks to the development of the Rimmel brand, and entry-price level brands also saw strong demand.

Skin & body care suffered a 4% decline in net revenue, primarily due to weakness in Europe and fewer promotions.

The annual revenue chart below pretty much paints the picture for Coty (revenue in millions):

Net Revenue

2011

2012

2013

Fragrances

$2325.3

$2452.8

$2490.7

Color Cosmetics

$1143.2

$1430.6

$1468.5

Skin & Body Care

$617.6

$727.9

$689.9

Total

$4086.1

$4611.3

$4649.1

Growth is slowing in fragrances and color cosmetics, and skin & body care is headed in the wrong direction. The good news is that thanks to an effective supply chain savings program, net income improved to $168.0 million in FY 2013, versus ($324.4) million in FY 2012. .

To summarize, Coty is seeing strength in some areas and weakness in others. Therefore, potential exists for the company, but it doesn't look to be an ideal investment opportunity. Perhaps there's a better option in the space.

Coty vs. peers
Inter Parfums
(NASDAQ: IPAR  ) and L'Oreal (NASDAQOTH: LRLCY  ) are two of Coty's competitors. L'Oreal is by far the largest of the group, sporting a market cap of $103.38 billion, versus $904.48 million for Inter Parfums, and $6.02 billion for Coty.

L'Oreal offers many household brands, including its namesake brand, Maybelline, as well as Giorgio Armani, and Ralph Lauren. Inter Parfums also offers several popular brands, including Jimmy Choo and Paul Mitchell. Additionally, Inter Parfums designs, produces, and manufactures fragrances for many retailers, including Brooks Brothers, bebe Stores, Nine West, and Lane Bryant.

When you look at these three companies on a fundamental basis, it should immediately become apparent that Inter Parfums and L'Oreal are fiscally stronger than Coty:

 

Net Margin

ROE

Dividend Yield

Debt-to-Equity Ratio

Coty

(2.75%)

(7.07%)

1.30%

1.63

Inter Parfums

21.52%

45.32%

1.60%

0.00

L'Oreal

12.84%

14.60%

N/A

0.00

Inter Parfums is the best at turning revenue and investor dollars into profit, while also offering the highest yield and the best debt management. However, Inter Parfums doesn't offer the same type of broad reach, brand strength, and resiliency as L'Oreal. Coty lags both peers fundamentally. 

The bottom line
If you want to invest in beauty, Inter Parfums and L'Oreal are likely to offer better long-term investment opportunities than Coty. While Coty does have potential via new product launches, geographic expansion, and supply chain improvements, top-line growth is slowing, its fundamentals are subpar, and lower-priced products are more in demand than higher-priced products, which is concerning. 

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