Coty Inc. (COTY) Earnings Call Transcript & Summary

Good day, everyone. I'm Steph Wissink, Senior Research Analyst and Managing Director at Jefferies. Thank you so much for joining us for our virtual Nantucket conference. We wish we were on the island, but we're going to have to wait 1 more year, and we'll see you there next year. It's my pleasure this morning to be sharing the screen with 2 esteemed executives from Coty. You'll see, Laurent Mercier, the company's CFO; and Gordon Von Bretten, company's CTO. They've prepared a presentation. They're going to walk us through, and you can find this investor presentation on their website as well. So with that, Laurent, I'm going to turn it over to you.

Thank you, Steph. Hello, everybody. It is my pleasure indeed to share with you our Coty Investor Presentation. So let me start first with our Coty investment thesis. Coty, we have one of the most beautiful and comprehensive brand portfolio in the industry, and Coty is the only group at this table to operate 2 complementary brand portfolio. We are rapidly executing on all key strategic growth pillars, with green shoots in every strategic pillar, with strong cadence of portfolio milestones planned through calendar year '21. Our gross margin and cost reductions will fuel our growth plans. We have clear opportunity to drive increased profitability through gross margin expansion and cost reduction while still investing behind our focus brands. We have also multiple levers to deleverage, opportunities to improve free cash flow and leverage through EBITDA growth, working capital enhancement and asset monetization, including stake in Wella. Let me share now with you our Coty overview. Who are we today? Coty is a global leader in fragrance and color cosmetic. We have strong positions in key markets with a diverse brand portfolio. Coty is #1 in fragrance, #4 in color cosmetics, and we delivered net revenue in calendar year '20 of $4.2 billion. Looking at markets, Coty is #2 in prestige fragrance in U.S. and #2 in mass cosmetics. In U.K., #2 in prestige fragrance, #1 in mass cosmetics. And in Germany, #1 in prestige fragrance, #4 in mass cosmetics. Looking at brands. In prestige, our brands are Gucci, Hugo Boss, Calvin Klein, Burberry and Kylie, among others. And in color cosmetics, CoverGirl, Rimmel, Max Factor, but also adidas and Sally Hansen. Looking to next slide. This portfolio of iconic brands is across key price tiers. Starting with mass: CoverGirl, Sally Hansen and Max Factor, but also David Beckham, adidas, Bourjois and Rimmel. In premium, iconic brands, such as Marc Jacobs, Kim Kardashian skin care, Hugo Boss, Kylie, Calvin Klein, Davidoff, Lancaster, philosophy and Lacoste. And in prestige, Bottega Veneta, Gucci, Burberry and Chloé. Moving to next slide. I would like now to share with you strategy that our CEO, Sue Nabi, has designed with the leadership team and also to show you some recent milestones. Our strategic priorities are 6: Number one, stabilize consumer beauty makeup brands and mass fragrance; number two, accelerate luxury fragrance and become a key player in prestige makeup; number three, build skincare portfolio across both divisions; number four, build e-commerce and direct-to-consumer expertise and capabilities; number five, expand in China on luxury and select consumer beauty brands; and number six priority, Coty to become a beauty leader in sustainability. Let me share now with you some concrete example and concrete cases. We have currently BOSS Bottled experience platform and live influencer content. So this is currently on with the Euro soccer cup with 5 soccer players, 13 influencers, 150 posts and stories, 36 million impression and 3 million engagements. And this is going on, of course, in June and in July as the competition is going on. Second, I want also to share with you our strong prestige launch calendar for H1 fiscal year '22. First, on Gucci. Miley Cyrus is announced as a face of Gucci Flora Gorgeous Gardena Eau de Parfum, which will be available from July 30. We are -- on Burberry and Calvin Klein, we have also new male fragrance pillars in H1 fiscal year '22. And on Kylie, we have refreshed cosmetic product portfolio and integrated direct-to-consumer website. Moving on to also these key milestones. We want also to share with you what we are currently launching. We have already started in Sanya with Lancaster, and we recently opened a new store in Sanya Island. And let's take 1 minute just to share with you a short movie of what it looks like. [Presentation]

Thank you. So as you can see, I mean, this launch is very successful with more than 1,000 units sold in the first few days, with top 2 SKUs for skin and sun care hybrid. So very, very promising results and fully part of our key strategic imperatives, as I mentioned, on skincare, China and also e-commerce. So now let's move to financials. So in Q3, we have delivered a strong adjusted EBITDA of $183 million, increasing more than $180 million year-on-year. This brings to EBITDA margin up to 17.8%, which is 18 points above last year. Despite sales decline, we were able to have significant year-on-year profit growth, thanks to year-to-date, achieved over $270 million of savings. And we are on track to reach fiscal year '21 target of $300 million of cost savings and fiscal year '23 target of $600 million. And Gordon will share with you more detail about this savings plan later on. If we go to next slide, you will see that fiscal year '21 is a baseline for Coty sales and profit acceleration. We are confirming our near-term targets fiscal year '21. We are on track to end fiscal year '21 with net revenues of $4.5 billion to $4.6 billion. We are confirming our fiscal year '21 adjusted EBITDA target of $750 million, reflecting over 300 basis points of margin improvement from fiscal year '19 through strong profit protection efforts. And we are committed to exiting calendar '21 with a leverage ratio moving towards 5x. Looking more in detail on net revenue and EBITDA margin. This graph do show that, from '19 to '21, our net revenue has been reduced from $6.3 billion to $4.5 billion to $4.6 billion. This is the addition of 3 main components. The first one is scope effect with the exit of Younique. Number two is active reduction of low-quality sales of about $0.3 billion. And last is the COVID impact on core business over the last year. Despite this net revenue decline, as you can see, we were able to increase our EBITDA margin significantly of about 300 basis points from '19 to '21. Moving to next slide. Our Luxury business is to drive future revenue and profit growth. Skincare will move from 6% of our net revenue this fiscal year '21 estimation to above 10% in fiscal year '25. Prestige cosmetic from 3% this year to high single-digit percentage in fiscal year '25. And China will grow from 3% of our net revenue this fiscal year to over 10% in fiscal year '25. So let me now hand over to Gordon Von Bretten, our Chief Transformation Officer, who will give you now more detail and will drive you through our Coty transformation journey.

Great. Thank you very much, Laurent. So maybe let's move on to the next page, please. And thank you very much for taking the time to listen to us today. I'd like to spend the next 15 minutes to talk about the transformation program here at Coty. And we've named this program, and you may have read that somewhere already, All-in to Win because we feel that we are certainly all 100% committed to making this work. But before I maybe share the setup of the program, let me just tell you a little bit where we are coming from and where we would like to take the group, and that's what the slide is trying to do here. So let's start maybe talking about strategy. And specifically, Coty came from a time, many years, really, of a lack of a clear, distinct corporate strategy, first of all; but also the brand strategies had lost their focus. So the brands have become diluted, they didn't really know what they stood for anymore. And now I can say, after several months of work and certainly the strong impact from Sue, you can see that we now -- our corporate strategy has very clear growth drivers. Laurent has presented them the #6 of -- the 6 core priorities we have. And also, the brands are beginning to be reset. You see some early results with CoverGirl, which is now very much repositioned in a very different way than it was before. And I attribute a lot of these changes to the fact that we now have a leadership team that predominantly comes from the beauty space and really brings that expertise and knowledge of the market, which previous generations of CEOs of the company's maybe didn't bring to the table. Secondly, around IP and innovation. The company really has a wealth of IP, and the technology knowledge here is incredible. But in the last years, we really didn't fully benefit from that. Many products have become me-too. And going forward, and it started already, we're really going to build on what we have and invest behind additional innovation. But think about things like light repair technology that Lancaster is extremely strong in. Or think about regenerative medicine -- or formulas, I should say, rather that are medicine-inspired that Lancaster also brings to the table, but that haven't been fully exploited. And last example maybe could be, CoverGirl is known for long wear. Long wear, of course, applied in the past to make up. But going forward, this can be very much applied to skincare and other product segments as more people layer skincare in their routines and so on. So we think we have a lot of material here to work with, and we're actively working on it. In terms of channels, you know, and it's no secret, that Coty was pretty late to the e-commerce game. We're making great improvements on that. You see it when you look at our numbers in terms of what percentage of the business now is commerce-driven. So really, really promising. And certainly a lot of investment also from our side behind it, led by the new CDO, Jean-Denis Mariani, who joined 6 months ago. Operationally, the company is still burdened a bit by an underutilized network, both manufacturing-wise and distribution-wise. You've seen that some streamlining in the network happening. But certainly, as we continue to grow and as we continue to in-source some of our core technologies, we will be able to do with this underutilization, which will really have an impact to the cost base. And since we're talking about cost base, to sum up the last 2 points on the slide here around overhead. So we definitely had a very, very heavy overhead structure when we started the program a year ago in terms of headcount, but also nonpersonnel spending. We've really done a lot of work streamlining that. We've changed processes, make them much simpler. And have a lighter organization and have really stopped some of this very heavy external spending. So when you look across the page here, it's really quite staggering how many changes we're making in all the aspects we're covering. So I mentioned to Steph before we went live here, it really is a textbook turnaround with all the different elements. But I really have to say we're very much on track and we're excited by the opportunity. So maybe let's move to the next page, which really shows the setup of the All-in to Win program. And there are really 5 major work streams. The first one is called funding the journey, which started really a year ago when we started the program. And that focuses heavily on fixed costs, as I just mentioned. The second one that we're working on very diligently right now is to reset our gross margin. And this focuses on gross to net and pricing but also very much on the COGS arena. And I'm going to show you a slide on that in a second. Thirdly, the third major stream, is delivering sustainable, profitable growth. And this ties back to the 6 priority growth areas that Laurent has put up just a minute ago. The fourth stream, we've named Cash Olympics to tease out the competitive spirit in our people a little bit. And here, the focus really is to reduce -- to generate free cash flow, to free up cash, to ultimately reduce debt and improve our leverage ratios and so on. And the last stream is a softer one which deals with accelerating the culture and promoting the culture inside of Coty, but also very much embracing and accelerating ESG, which includes things like diversity and inclusion, sustainability and so on. And so why are we doing it? There are several factors here. Of course, we want to reinvest in the business into growth, we want to drive benefit to the bottom line, we want to make sure we make funds available for deleveraging and for getting our leverage ratios in line and so on, okay? So with that, maybe let's move on to the next one. Next page. As you may have seen already in prior presentations, our target was to deliver $300 million in fiscal year '21. This was an upsized target. Initially, we started the program saying we will deliver $200 million. And then we saw we were having really quite a bit of impact, and we upped it to $300 million. And we're very much on track to deliver. So we are $100 million ahead of schedule. Most of that is pulled ahead from the next fiscal year, but that's okay. Of course, it's better to have it now than in a year from now. And in terms of the breakout, let's just go through where it's coming from. So the vast majority at this stage is coming from fixed costs, and more than half of that is coming from headcount within that. But that is -- the basis for these headcount savings are really streamlined processes and a lot less overhead. So we reduced above-market, as we call them, positions in commercial, in marketing. So these are people not really working in the field, but at a regional or a central level, which we felt were too top-heavy. And certainly, we're reducing heavily our support functions, finance, HR and so on, to a much more appropriate level. Then you see 14% is coming from COGS. This includes E&O, which is excess and obsolescence. So basically, the amount of product that needs to be scrapped each year. And of course, the root cause for that is over-forecasting and inappropriate forecasting. So we've really turned the forecasting process upside down. We've changed it from monthly to weekly. We've changed it from being very centrally driven to being a combination of central and regional and local market input. And we're really seeing the results come through in terms of reduced excess and obsolescence. And of course, COGS wouldn't be COGS without a push on material cost, which procurement is working heavily on. And then we have quite a bit of projects going on in productivity, on the supply chain side and the manufacturing side -- sorry, logistics side and manufacturing side. Next is structural A&CP. We call it structural on purpose, not to confuse it with cuts in media, which we don't want to do. Structural really relates to renegotiations with our key agencies. It also has to do with standardizing marketing materials, point-of-sale materials and so on. And that's where the 17% of the savings are coming from. And lastly, trade investments. So we've really worked on gross to net. A lot of this here has to do with returns and markdowns. Of course, as you forecast better, you don't have to markdown as much, you don't get as many returns. And then we've also worked on temporary price reductions to reduce those to some degree. So that's the breakdown for this fiscal year. If we go to the next page, please, it gives you the 3-year view. So it will show again $300 million in fiscal year '21, an incremental $100 million next year and then finally another $200 million in fiscal year '23. Now you may say, "$100 million next year? That doesn't sound like a lot." But really, it is because, a, we pulled a lot of the savings that were meant to happen into the last fiscal year. And secondly, and this is very important, the methodology we employ when we calculate savings is really a P&L view. So we look every month, what's our spending versus the spending in the corresponding month the prior year. So these are really fully P&L-relevant rather than project savings. And oftentimes, in these kind of programs, you will be shown project savings which are then not materializing in the P&L. And another key thing for next year, and you see that on the right-hand side, we fully -- these are net savings. So we fully kind of netted any headwinds and other effects from that number. So the first one to mention is we're reinvesting quite heavily into our growth pillars, China, digital, skincare and so on. And we're basically adding positions. We're adding OpEx to the -- to our P&L, but that's fully netted here already. Material cost inflation. We're all aware material costs are increasing. So we see raw materials skyrocketing at least for the moment, and that is fully priced in here. And thirdly, we've brought bonuses back. There were no bonuses in fiscal year '20. But in order to be a competitive employer, we reinstated bonuses and some merit increases, and that's also included here. So if you see the $100 million net, we're really delivering over $200 million growth to lend the $100 million, if that makes sense. And then we're already working quite heavily on fiscal year '24. A lot of the structural changes in supply chain, for example, will show their benefit more in fiscal year '24. So there's additional upside in the following fiscal year beyond that. So with that, maybe let's go to the next one. This is a slide on the C1 or gross margin attack program that we've launched. And you can see here, there are 4 major elements of it. There's a commercial attack plan, which includes E&O, I've mentioned, but also trade investment pricing and a reduction -- further reduction in value distribution, which is not accretive to gross margin, as you might imagine. Then there's supply chain side, manufacturing, distribution, logistics and so on. There's the portfolio side. So it's about mix, platforming, active portfolio management. And last, but not least, there's material cost, which is a combination of commercial discussions with our suppliers, but also technical changes to some of our formulas and packaging materials. What's not shown here but will have an impact on gross margin, of course, is volume absorption. So as we return to growth, we will be able to spread our fixed cost base, overhead, across a different volume base. And that will really have an impact on gross margin as well. All right. So I'm trying to think -- I think that's it on this page. We will go to the next one, please. We wanted to do a little bit of a deep dive here on one of the specific topics we're working on. And this one is around portfolio optimization. And there are really 3 elements to this. Let's start with the one on the left, tail-end SKU rationalization. So basically, this is a program we started very early in the actual All-in to Win program, so about a year ago. And we found that out of our SKUs, 35%, which is a staggering number, only accounts for 3% of net sales. And it did that with very low [ C1 ] or gross margin as well. So we've decided, we made a quick decision to basically cut this 35% of SKUs that are not accretive and have very low net sales attributed to them. And now you might think, well, did we cut 3% of net sales? No, we didn't do that. Basically, these net sales, or these SKUs, are being replaced with other SKUs from the global catalog, and those have much better performance in the field. So we're estimating that by cutting 3% of net sales, we're seeing between 6% to 12% actually uptick on that baseline in terms of net revenue. The middle column here is around platforming, I think we've mentioned that before. You may have heard that in previous presentations. And there are really 2 elements. One is to define common chassis for formulas and common packaging materials that can be combined in different ways. And so obviously, Coty was known to be very, very fragmented in terms of SKUs and brands and materials. And as an example, we've shown you here foundations below. And you can see the number of bottles shapes, number of caps, the number of pumps going down to much lower numbers in the future. So that's number one. And the second key thing, and this is even more exciting, is that as we have winning invitations -- sorry, innovations in certain brands, take CoverGirl for example, with their Clean Fresh, we will try to cascade this down into other brands to make sure we very quickly replicate successes from one brand into other brands. And then on the right-hand side, last but not least, assortment management. So we found out, when we looked at planograms, obviously in the stores, that certain SKUs do much better than others. And we're now very actively optimizing planograms, a, by trying to double-face where that's possible; and b, by just replacing certain SKUs from our global catalog with others that have higher margin and better rotation. So let's move to the next one. Next one, that's the last slide really of the program itself, is around Cash Olympics. That's the program to take out or to free up cash in order to deleverage. And this is all towards our goal of getting to a 5x leverage ratio by the end of calendar year '21, which is coming closer. You see on the left-hand side are the key streams. It's the usual stuff you would expect. So it's inventory, it's receivables, it's payables, CapEx, tax, factoring, balance sheet reviews in the markets and so on. And basically, behind each of these streams, there is a team with a team leader and a cross-functional team oftentimes behind. And we have typical program management stuff in place, like drumbeats every 2 weeks, where we follow up with each team to make sure they meet the target that has been set. And on the right-hand side, maybe just a few examples. Maybe I'll talk to the first 2 in the interest of time. The first one here is around VaR, value -- these are basically -- let me define VaR. VaR is basically reach or inventory that extends beyond 12 months of what's required to fulfill the business. And so again, it's unfortunately typically a fact of over-forecasting. And at the moment, you have more than 12 months reach, you put it into VaR. And the logical consequence at some point after VaR, is that it will turn into excess and obsolescence, and has to be written off and destroyed. And that's something clearly we want to avoid for many reasons. So we're working in 2 different ways. A, we're improving our forecasting to make sure you don't have as much slipping into VaR to begin with. And secondly, we've tactically looked through the list of our products and we're finding ways to sell these products and take them back out of VaR. And the second example, maybe just the second box down around DSO, so accounts receivable. There's a market in Europe, and we can't disclose the market yet because it's not fully public. But there's a market, it's for the CB side, so consumer side of the business, where we're going from a direct approach to a distributor approach. And with that, we will get an improvement in DSO by 40 days, which is worth about $6 million in cash flow, okay? So with that, and I know I'm almost out of time. Let's go to the final page, please. I just want to recap what Laurent has shown earlier, our investment thesis. So let's start with the first one, Laurent has mentioned, and I fully concur. We really have an amazing portfolio of brands. And we've now defined very clear brand hierarchy. And within the brands, we've really defined what each brand stands for. And you may have seen our previous presentation, Sue discussed how CoverGirl was repositioned in very short amount of time, but we see in the green shoots in terms of performance. And that's what we want to do for some of the other brands. The plans are fully locked, and we will communicate it when we're ready to do so. The second point is we're really rapidly executing on all of the key growth pillars. You've seen the video of Lancaster, which is an early example of our break into skincare, and we're very pleased with the early results. CoverGirl, you've seen the share growth in the U.S. that we're seeing, so also quite favorable. So these are all good examples of how the growth pillars are beginning to deliver. The third one is around cost. I've talked about that extensively. And really, we are laser-focused on that. When you think of the cost reduction target of $600 million, half of that is really fully in the bank already, and we have 2 years in addition to deliver the other half, which is great news. And of course, why are we doing that? We're doing it because we want to reinvest in the business, in A&CP. You've also seen some of the announcements of some of the very high profile spokespeople we're being able to afford now with the money we're freeing up. And we're really putting money, resources, effort behind these new growth pillars, which is coming from a cost-reduction program. And of course, the other side is we want to bring some of that money down to the bottom line, and you've already seen it in terms of how the EBITDA has been improving. And then very lastly, and Laurent mentioned it already, we have multiple levers to deleverage the business, which we want to do. So we can continue to grow the EBITDA. We will create additional free cash flow. And there are certain ways to monetize some of our assets, and all of those are fantastic ways to basically deleverage the business. So sorry, I'm a little bit over, but I hope it was useful. I just want to say maybe to close. We are, as a management team, but also as the associates of the company, we're super energized by this transformation and by the success we see in the market. We said jokingly the other day, we're here writing corporate history, to some degree, of how a business that was really underperforming, within a matter of a year or 2, can be turned into a star. And we believe this is fully possible. So super excited, and thank you very much for the opportunity to speak to you today. And I'll hand it back over to Steph.

Yes. Thank you, Laurent and Gordon. Very, very informative. And we appreciate the incremental details on some of the projects you're working out. We know this is hard and really deliberate work. So thank you very much for the time and the insights. If you do want to speak with Coty, please let us know, I'm happy to get you in touch with their IR team. And we'll leave it there for today. But gentlemen, thank you very much. And everyone, have a wonderful day.

Thank you so much.