Luxottica Is Destined to Win in 2014

Very recently, Luxottica Group (NYSE: LUX  ) hit a new record, reaching the outstanding figure of EUR 7.3 billion in net sales for 2013, up 7.5% year over year. This company, the world's largest manufacturer of sunglasses and prescription eyewear, and also the largest eyewear retailer, has the strongest fundamentals I have seen in a very long time. Here's why I think its future looks even brighter.

Fundamental facts
Since 1961, Luxottica's focus has been on designing, manufacturing, and distributing mid- to premium-priced prescription eyewear frames and sunglasses. After all this time, the company has reached a scale in lens manufacturing, a know-how of frame technologies, and a distribution network impossible to find anywhere else in this industry.

Italian manufacturing has always been associated with design, quality, and flexibility. Well, Luxottica took these characteristics to a whole new level, and now it has the world's widest range of manufacturing capabilities in frame styles and lenses. This is hard to miss when luxury brand companies are wondering whether to self-source or to choose to license eyewear to competitors. And even if they manufacture elsewhere, distribution is still key, which is where Luxottica has a significant scale advantage and an unmatched distribution network. The company holds 7,000+ retail stores and 143 wholesale distributors in more than 130 countries. This is an impressive penetration, and it helps Luxottica get to the clients directly, wherever they are.

Another competitive advantage the company has developed over the years is a high level of efficiency in inventory assortment. You have to be aware that in this business, the number of combinations of lenses, lens treatments, frames, and sizes makes inventory control, planning, and distribution a very complex task. No one does it better than Luxottica at this scale, as it has continuously improved its lead times, assuring better market responsiveness.

Brands that matter
Luxottica owns an impressive portfolio of house brands such as Ray-Ban, Oakley, REVO, and Oliver Peoples, and holds designer-licensed lines such as Chanel, Polo Ralph Lauren, Prada, Burberry, Tiffany, Coach, and Armani. As you probably know, these brands are all premium-priced, and they enable Luxottica to maintain mid-60% gross margins.

Regarding retail in North America, the company owns vision-care plans provider EyeMed, along with LensCrafters and Sunglass Hut, and through Pearle Vision, SearsTarget Optical, and Ilori gets its products to the public. Now, Luxottica-manufactured eyewear accounts for approximately 80% of Sunglass Hut's total revenue, up from just 14% when the chain was acquired in 2001.

New markets
Luxottica is experiencing great results worldwide, but in emerging markets, the performance is especially outstanding. China, Brazil, and Turkey lead an average growth of more than 20% a year in the period. These markets will assure future growth for the company, as their populations continue to increase their spending in fashion and luxury items. Nonetheless, net sales in Europe grew 11% last year, while in the U.S. that number was 3.5% because of a drop in Oakley purchases by the U.S. military.

OK, but are there any risks?
Since six of its manufacturing facilities and its corporate headquarters are located in Italy, the company faces concerns from the country's local economic and political environment, including tax increases and worker discontent. Italy has also been facing a political turmoil lately, which led to the resignation of its Prime Minister Enrico Letta. However, this issue should not have a significant impact on Luxottica.

Regarding competition, it's important to follow France-based ophthalmic optics company Essilor International (NASDAQOTH: ESLOY  ) . This company has performed a series of acquisitions since November last year, when it bought a 50% stake in Xiamen Yarui Optical Company. Last January, it acquired majority stakes in two prescription laboratories; R. D. Cherry and Plunkett Optical, as well as in Frame Displays, a company that provides display furniture and accessories for optical stores. This month, it acquired all outstanding shares of the high-performance sunglasses company Costa. Essilor is clearly taking expansion seriously, and all of these operations will dispute Luxottica's territory, but not its leadership.

Looking ahead
2014 looks to be an excellent year for the company, as the global economy is expected to grow more than last year. According to Altagamma's True Luxury Global Consumer Insight report, in the next six years the global luxury market will grow from EUR 730 billion to EUR 880 billion, and the number of luxury consumers will go from 380 million to 440 million in 2020. So, we can expect a growing market to address.

In big developing economies such as China and Brazil, increases in consumption and more frequent access to doctors should boost sunglasses and prescription markets. In addition, other markets present opportunities, since they are in earlier stages of consumer consumption development. A good example of this is India, where the predominantly bright weather conditions will create a greater long-run need for sunglasses. In order to be prepared, Luxottica continues to look for small retail acquisitions in emerging markets, and Sunglass Hut will nearly double its store count to 4,000 locations in four to five years.

Final thoughts
There's no doubt this company has excellent fundamentals behind it. Economies of scale and favorable pricing from suppliers give Luxottica a terrific cost advantage, while its ability to develop and deliver new frames and designs act as an advantage for service and for capital efficiency. Plus, Luxottica's scale, brand portfolio, and logistics enable it to offer products and glasses combinations that competitors can't. Add to all this an enlarged footprint covering world markets, and you've got yourself a winner.

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