Coty Inc. (COTY) Earnings Call Transcript & Summary

Good morning, good afternoon. This is Robert Ottenstein from Evercore ISI. I'm very delighted to start our conference off today with one of our favorite stocks and management teams headed with Sue Nabi, CEO of Coty; and Laurent Mercier, the CFO.

So Sue, a lot of ground to cover, so why don't we get right into it at a kind of very high level? As the year has progressed, what are you seeing now in your markets in the U.S. and Europe in April and May?

So Rob, thank you very much for having us. So again, that's a very good question. Indeed, beauty is a category that does well when people socialize. And again, as you know, with -- as we lapped the last -- the past two summers of lockdowns or different restrictions on socializing that we have seen in the past in many markets, people are now more free to get out, and we see this as a benefit to the overall beauty category now and going forward. So if I try to break down this in categories, the Prestige fragrance category is the one that has been booming the most. In the U.S., the sales of this category continue to be significantly above prepandemic levels, and we believe this has rebased more or less higher driven by increased usage from, remember, males, Gen Zs, Hispanic consumers as well as a very strong premiumization trend. In Europe, we see also people getting back in stores and online, and we see this category back to prepandemic levels. And in Travel Retail, we are seeing a tremendous -- I have to say, tremendous growth year-on-year as consumers are eager to finally travel and take summer holidays, particularly in Europe and in Asia Pacific. On our other core category, which, as you know it, is mass cosmetics, we've been growing our market share globally, and this has been driven by our key brands be it CoverGirl, be it Rimmel, Max Factor or Sally Hansen, to name a few. We recently, as you know it, repositioned Bourjois, which is doing very well in its key market, which is France, while we are on track for the repositioning of adidas later this summer. After this, we also have some key white spaces, opportunities that I've been sharing with you now since a few quarters that should further support our growth, including, of course, skincare, Prestige cosmetics and, of course, China. So overall, I would say that we remain positive on the category, and I believe -- we believe Coty is very well positioned to thrive. Remember, we have guided to low teens like-for-like sales growth in the fourth quarter, and the business trends we are seeing so far support this view.

Terrific. So Sue, one of the questions we're getting from investors who look at the macro data and the energy prices is like, once we get at -- once we get past this euphoria of -- coming out of the lockdown, going out and socializing and then, all of a sudden, people starting to look at their pocketbooks after paying pretty high gasoline prices, food prices, there's concern, obviously. So how do you see your business developing and the markets developing in the second half of the year perhaps or going forward once the initial euphoria lifts?

Yes. So before going forward, let me maybe reframe this into what we have seen in the past. And again, the data that we have about, for example, past recessions shows the overall beauty market generally outperforming overall GDP trends. This is the first thing that everyone needs to know and to remember. In the '28/'29 recession, both mass and premium beauty were similarly impacted. More or less, the market was flattish on a global basis, while in developed markets, mass was down low to mid-single digits and Prestige was still growing mid to single high digits. Importantly, beauty is a much more emotional category than other consumer segment. This is very important to remember. And this is something that people are putting on their face or spraying on themselves to feel confident, to look better and to feel better. So for me and for us, this means that even in a more constrained economic environment, when consumers, particularly in low- to mid-income tiers, I have to say when they have to make choices, I think that they are unlikely to significantly trade down on beauty products as they still want product that work. And at the same time, if you think about higher-income consumers, they continue to be in a much better financial shape, and they are continuing to spend and to premiumize. All of these, you can see in the robust demand for luxury goods globally, and this is clearly benefiting some of our luxury brands. Think of Gucci, Burberry, or Chloé.

Great. Great. One of the things that when we look at the U.S. market and kind of step back, looking at the channels that is very evident is that a lot of the mass merchandisers, Target, for instance, are starting to really emphasize and focus on Prestige beauty. What -- how do you see that affecting the market overall?

So again, we see this as a testament to the strength and, I would say, the attractiveness of our industry, the beauty industry. But also, as a testament of the ongoing premiumization of the market in recent years, we have seen some of the stores that serve the prestige markets such as department stores, these stores were closing unproductive doors but, at the same time, seeing strong momentum in their leading doors, particularly for beauty products. So overall, we do think an increase in point of sale is a positive. Some of these concepts are still very new, so there is a lot to learn, as you can imagine. And of course, the right level of involvement for us and which brands, all this can vary and evolve over time.

Great. Great. You mentioned in your opening statements or actually, to my first question, globally, you're gaining share on the consumer side. Can you kind of talk about that in a little bit more detail? And from a fundamental basis going forward, what gives you the most confidence that your consumer business is on track for sustained improvement and especially if you could touch on CoverGirl?

Of course, that's a very important question. Again, there are several factors that make us confident that we have the right portfolio and the right capabilities to continue to win in mass beauty. First, our in-market position, which is a very important element. We have a leading position in many key markets, as you can see it on the slide on the screen. So in the U.S., our cosmetics brands are in the top 3. In the U.K., our cosmetics brands are in the top 4, including Rimmel being the #1 brand of this market. In Germany, our cosmetic brands are in the top 8. And in Brazil, we have a strongly positioned portfolio of local brands, as you can see it on the slide again. So first thing. Second thing, the strong heritage of our brands, which have been in place for decades or even over a century for some of them. This is very well aligned with the current consumer preferences, where being a trusted brand is the #1 driver of consumer brand selection. Now to move on. In addition, I would add to these elements that we have also very strong IP and technical know-how that I've been talking about recently in key beauty trends. And again, you can imagine that having know-how in long hair or in skinification or in bold makeup are clearly things on which we are going to build our next innovations. Now specific to CoverGirl, which has been impacted, as I said it, during last earnings call by supply constraints in lash blast clean mascara and, more recently, Simply Ageless, which are two of its biggest franchises, we expect the supply situation to stabilize by this summer, which should allow CoverGirl to return to its recent share gains. It's clear, in fact, if you look to CoverGirl's brand equity and product offering, that this brand continues to appeal to consumers because excluding, in fact, the issues we have on lash blast supply and constraint, the famous Magnificent 8 franchises, which account more or less for 70% of CoverGirl brand sales, continue to perform in line to ahead of the cosmetics category, and this week after week. In the meantime, we are, as you know, strengthening, continuously strengthening the foundations of this brand by attracting the key consumers demographics with our activation strategy. As you can see it on the slide that's on the screen right now, not only has CoverGirl overall household penetration increased by more or less 150 basis points year-on-year, but, as you can see, Clean line, Simply Ageless line, Exhibitionist line are all driving penetration and over-indexing with Gen Z and with Hispanic consumers, which is something very, very new for the brand. In the meantime, we are, of course, focused in activating our step 2 brand transformation strategy. Remember, we started with clean beauty first. And now we are into cool beauty. And we have a very strong attack plan on mascara to drive what I call the coolness factor of the brand because you need the two to attract these Gen Zs and Hispanic users. You've already seen that with the recent CoverGirl Exhibitionist mascara launch, which is playing incredibly well specifically online, it's driving the overall Exhibitionist franchise to over -- a growth of over 30% in the last months, which is 4x the category growth. So clearly there, we are starting to see a very strong momentum. And you will see in the coming months similar Gen Z-focused, social media-driven mascara launches from the rest of the portfolio, especially from Rimmel.

Great. Very impressive. So earlier today, it was almost like it was planned. It wasn't. We had a presentation for Macy's, and they were saying that fragrances was their #1 traffic driver to bring in younger consumers. Now fragrances are obviously your sweet spot, 60%, roughly, of the business. And there really seems to be a global renaissance, right? It's not just in the U.S., it's in China as well. Can you talk about how your business is doing now? The renaissance has been going on for, I guess, about a year almost. And maybe an update on your strategy. Has it evolved at all during this time?

Yes, absolutely. That's -- I think the word renaissance is really accurate. So again, we see four key trends that are behind the boom in fragrance demand: very strong momentum in the U.S. and in China, as you just said it; the simultaneous growth of both e-com and brick-and-mortar demand; the global premiumization trend in this area is very, very obvious; and last but not least, and I'll answer into more details, the critical role of social media in fueling this demand. So in the U.S., you have seen the population's appreciation for fragrance increasing over the last few years. Fragrances had indeed transitioned from primarily being gifting items and something that people would wear during socializing moments to personal mood-boosting items that are critical to an everyday routine. And this makes a huge change. There have been growing usage and adoption among men, Gen Z, Hispanic consumers. Gen Zs proportion of the fragrance market has increased by 3% in the last year and the one for millennials by 5%. So this is clearly something that's changing very strongly. From a channel perspective, related to pre-COVID levels in 2019, global fragrances sales have doubled online and are also up high single digits in brick-and-mortar, speaking to the importance of both online and offline to drive the consumption of this category. Last, premiumization, not -- but not least, premiumization has been also a key trend in fragrances where we see consumers across the U.S. but also Europe and China all trading up from premium plus to sometimes ultra-premium. And the final, I would say, element that's very, very new is the one of consumption driven by social media and particularly by TikTok. And again, if you look at the #perfumetiktok, it has close to 2 billion views today, and the engaging content made by TikTok creators, finding new and very, very unique ways to describe fragrances is indeed driving real sellout results. And I have a very interesting example that's a very recent one to share with you. You can see it, I think, on the slide. And this is about one of our fragrances called Burberry Her. You can see that there had been a clear acceleration of TikTok videos focused on Burberry Her fragrance franchise. You see it at the top of the slide. And this spike in TikTok content is almost 1:1 correlated with the brand market share in the U.S., and you see the brand market share rising like crazy in red at the bottom of the slide. And today, the Burberry Her franchise has reached the #3 spot in March in the U.S. market, which is insane.

That's extraordinary. And just as real quick follow-up, one of the big questions we get on fragrances is, is this just kind of a short-term trend? Or is it something more sustainable? It would seem to me that if you're going from just a gifting occasion to mood boosting, then that's more sustainable. Is that how you look at it?

Absolutely. It's exactly what we are seeing. And again, these new consumers that are making the rise in demand are really into premiumization. They are into more premium fragrances. They're also moving from eau de toilette to eau de parfum. Eau de toilette is the less concentrated version. Eau de parfum is the most concentrated. So all these trends are all converging in the same direction, which explains this momentum we are seeing that I think is more than the momentum. I do believe it's a structural change for the years to come.

Great. And just so kind of we level set with everybody, as you look at your portfolio and the market, how do you think of the different price tiers for fragrances, kind of what they are? And what would your major brands be in each of those price tiers? And how do you think about the price -- overall pricing architecture?

Yes, that's also a very important question because people don't realize the -- Coty's portfolio and the strengths of our fragrance portfolio. And again, we are very happy with the strength of this portfolio. I do believe that there are few companies out there that have a portfolio of fragrances brand that cover each of the relevant price tiers, as you can see it on the slide, from entry premium at the bottom to premium in the middle, premium plus to ultra-premium. This is clearly uniqueness of Coty as a prestige fragrance company. So in any evolution of the market, we do have the brands that cater to consumer needs. At the ultra-premium and collection part of the market at the top of the slide, which continues, by the way, to be the fastest-growing globally, we have Gucci Alchemist's Garden collection; we have Chloé Atelier des Fleurs, which, by the way, is the fastest growing amongst our fragrance brand in China and in Asia Travel Retail; as well as the Burberry Signatures collection. At the premium plus level, as you can see, we have the core franchises of Gucci. Think of the recent Flora success, Chloé Signature, Burberry Hero for men and others. At the premium level, we have Hugo Boss -- and by the way, Hugo Boss is fully benefiting from the successful fashion brand repositioning in recent months as well -- as the very successful Marc Jacobs fragrance portfolio. And finally, we have, as you can see it at the bottom of the slide, very strong regional heroes. Think of Jil Sander, Joop! and Davidoff. Importantly, outside of covering the different price tiers, each of our brands have also very distinct equities and brand positionings which allow us to have an appeal to a very large variety of consumers' preferences.

That's great. So while we're talking about price tiers, the other question, right, that we are getting across our firm in this environment is any sense of trade down in which consumers may stay in a category but are starting to trade down because they feel pinched. So is that something that you're starting to see in any of your regions or categories?

We have not seen any signs of trade down in our key markets, Rob, to be very transparent with you. All of the data points we are seeing and hearing in markets suggest that consumers are broadly maintaining, in fact, their current price range or sometimes trading up rather than trading down. Let me take a few examples. In Consumer Beauty, when we look at average selling prices in key markets, think U.S., Germany or U.K., the market prices for overall cosmetics, including pricing increases and any discounts, all these prices have trended up by low to mid-single digits year-on-year, with Coty average price moving higher as well as we continue, as you know it, to premiumize our makeup portfolio through premium ranges. Think of COVERGIRL Clean Fresh, Simply Ageless or, more recently, Rimmel Kind & Free. It's very important also to understand that price increase visibility is relatively low for less frequently shopped categories. And this is a very important element. For instance, do you think a 5% increase on mascara will get noticed if you buy only a mascara once or twice a year? Probably not. So lower-income consumers are, of course, clearly being pressured by what is the rising inflation. However, the good news for Coty as a company is that if in fact consumers do start looking for more value-oriented options, our Consumer Beauty brands are able to offer, I would say, Prestige-like technologies at a more affordable price. On the Prestige side, the middle- to high-income consumers, well, they are continuing to be very -- in a very good shape, in fact, financially with significant savings built up and willingness to spend. We continue to see this. And these consumers account for the majority of spend in key categories like the beauty category, of course. As you can see it on this slide, the Prestige fragrances, specifically ultra-premium and premium plus brands and franchises, are outperforming low premium brands, and this in all key markets be it U.K., Germany, Italy or France. So it's important to remember again, as I said it a few minutes ago, that the Prestige portfolio of Coty skews towards premium plus brands like Gucci, like Burberry, like Chloé. And therefore, these products are purchased by higher-income consumers that are not as pressured economically, and they are generally less price sensitive. And here, again, I would like to share with you another example. If you think about the fact that our average fragrance price is roughly $70, if you take a 5% price increase, this adds only $3 to $4 to the price which will honestly not really impact these consumers' decision to buy something that costs $70 or $74. And again, as I said it several times, but it's very important, we are premiumizing our portfolio even further as our premium plus brands and ultra-premium lines, think of Chloé Atelier des Fleurs, Gucci Alchemist's Garden or Burberry Signatures, all these are continuing to increase as a percentage of the mix of the Prestige fragrance portfolio of Coty.

Great. Thank you. So let's -- just going over to China now. We're hearing that we're -- it's opening up a little bit. What are the trends that you're seeing in China, the underlying trends? How is that market looking? And do you feel well positioned for the 618 shopping holiday?

So again, on June 1, we moved from the hard lockdown that impacted something like 1/3 of the Chinese population to the reopening starting with Shanghai. Again, the sentiment that we are seeing is that people are willing to spend and enjoying getting back out, as you can imagine. In 2020, I remember that it took around close to 3 months for China to recover. Today, we do not question if China will recover but more so if the speed will be the same. In Mainland China, [indiscernible], we see traffic back in store. We estimate more or less 50% level. You can see this on the slide photos from the past weekend of some of our key beauty counters that have reopened, including in Shanghai, with consumers, again, engaging with beauty brands and trying on product, which is great, great news. E-commerce delivery has resumed in Shanghai, and we anticipate a competitive 618. On Hainan, we do estimate that the flow of tourism from Shanghai will start around the middle of this month, middle of June. Specifically referring to your question about the 618 festival, it's important to remind everyone that the focus for Coty and for our brands is on activating our brands and launches in a very disciplined way, avoiding the heavy promotional activity which often occurs during these key events, which in the end erodes certainly the equity and the pricing power of the brand, and we are all talking about pricing power today. So you can see on this slide a great example of something recent that our teams has been doing in a very smart way during the early 618 activation period. We launched indeed the Burberry Matte Cushion Foundation (sic) [ Burberry Matte Glow Cushion Foundation ] last week, and this was in anticipation of the 618 holiday period. We executed the launch through a live streaming event with a key celebrity but with no major promotions. And the results were honestly very, very strong, but they were even exceptional with over 30,000 views -- viewers joining the show and over $100,000 worth of sellout in 1 hour, pushing Burberry to the #1 store live streaming ranking. So it's possible to do this in a great way with our promotions.

Wow. That's amazing. Let's -- moving on to another topical item that was just announced, SKKN BY KIM was launched -- announced last week. You talked a little bit about your plans for distribution of the brand. What does the portfolio look like? And what, if anything, is in your guidance for the fourth quarter and next year from this?

Yes. So again, we are super excited -- yes, I'm very excited to be launching SKKN BY KIM on June 21. As you can see it on the slide, in just the initial days post announcement, the SKKN Instagram new account has already reached almost 160,000 followers, which is a really very, very strong start. The initial collection comprises of 9 high-performance product priced between $43 and $95, which put it squarely in the premium skincare price tier. The plan right now is to lead with direct-to-consumer, with DTC. And again, when it comes to the sales, we do not comment, as you know, it, on revenue expectations from specific brands, but it's important to note that the revenue contribution from SKKN in Q4 will be fairly limited as the line launches right at the end of the quarter, on the 21st of June, and we cannot recognize revenues until the consumers receive their products at home. But again, we are super excited by the potential for this skincare line as one of the growth contributors in fiscal '23, which, we -- you'll remember, is the skincare year for Coty.

Yes. Great. Let's move over to Laurent and go into some of the more financial-oriented questions. So after the last earnings call, we got a lot of questions on inflation and how that's going to -- if that's going to offset some of your cost savings. So can you talk a little bit more detail on your cost savings? Is it more in the COGS line? Is it more SG&A? And maybe tying into that, how you're thinking about your overall marketing spending and whether you're going to have to do additional cost cutting given the fact that inflation is probably greater than any of us thought it would have been 3 months ago, 6 months ago.

Sure, sure. Thank you, Robert. So indeed, and as I explained a few times during our earnings call, so most of the savings in fiscal '21 were related to fixed cost. So people and non-people. So this was really the step -- the Phase #1 of the program. So -- however, this year and in fiscal '23, the savings are shifting more towards gross margin-related drivers. So this includes COGS savings from procurement, improved manufacturing utilization rates as we close the plant in Germany, consolidated distribution footprint and improved planning and E&O but also trade investment. So while inflation is going to impact different parts of the P&L, we remain fully committed to offset inflationary headwinds through pricing actions, premiumization and portfolio mix, as we explained, as well as the ongoing savings initiatives. So that's really the overview. And probably, if I continue to deep dive, as you mentioned about cost savings, All-in to Win program, so definitely, as you know, this program, we announced a couple of years ago with well-defined project. And over time, we have fine-tuned the program and made some adjustment, but our plans remain absolutely fully on track.

Great. Great. And can you just remind us where your gross margins are today, where do you think they can go and what the key drivers for that will be?

Yes, absolutely. And maybe, Robert, to complete, there was also your question definitely -- how we are monitoring definitely also our A&CP in this environment. So what's really important is that in this All-in to Win program is that we also look to capture additional efficiencies, for example, in our central support function. But also, we continue to invest and build capabilities in some of our growth pillars like China, skincare, R&D, digital. And definitely, this is where we are focusing on. And on media allocation, we remain very focused on the highest-ROI assets. So now back to your questions on gross margins today and where we think we can really improve. So we have guided to mid-60s level by '25. And as you know, year-to-date, we are running over the 64% level. We have numerous levers to drive this gross margin. So the first area is on top line, pricing and gross to net. We have said we will be taking some more pricing. Right now the plan is mid-single-digit increase by the end of summer. And while we do this at a very granular level, we do have a centralized team. So we have a pricing office in Coty that started to work with each of the market more than 6 months ago to determine what pricing could be taken. And the other area is on the gross-to-net side, which is a big opportunity. We started working on this more than 12 months ago. So this represents the cost savings we have delivered this year, and we will have further room to cut this next year. Manufacturing is another opportunity for us. We are very focused on driving continuous improvement in our facilities and driving productivity. We have been bringing in some people who specialize in this with backgrounds in Six Sigma and lean manufacturing, and we are seeing our cost per unit go down. So net-net, the strong progress we have made this year on gross margin makes us very confident in reaching our mid-60s gross margin target by fiscal '25, and we do not believe this will represent a cap for the business.

Great. Great. And then just to kind of sum things all up on the financial side, you came out with some very ambitious targets that, frankly, a lot of investors kind of came back to us and said, geez, they look like real stretch targets. And are they setting themselves up to fail? So 6% to 8% sales growth, 9% to 11% EBITDA growth through fiscal 2025. Given the fact that the -- there's concerns over obviously not just inflation but potentially a recession, how are you feeling about those targets? And aligned with that, how do you -- are -- you still believe that your financial leverage target of getting below 2 turns is still realistic by fiscal 2025?

So our medium-term growth algorithm is a realistic view built through detailed building blocks by category and region. So this outlook has a balanced approach of risk and ops with building blocks that we view as reasonable. So let me give you more details. Specifically, we are assuming Prestige fragrance, which account roughly half of our business, will grow in line with the market at a mid-single-digit CAGR. Of course, internally, we are targeting to outpace the market as we can also see a scenario where the market growth is higher than this mid-single-digit level given the momentum to date, but we want to set reasonable and credible external expectations. We are assuming our core Consumer Beauty business, which accounts for roughly 40% of our business, grows in line with the market at a low, single-digit CAGR. Again, our internal ambitions are for share gains, and our brands have been gaining share in recent months, as you saw. So the balance of the 6% to 8% total revenue growth target is being driven by areas where Coty is currently small and under-indexed versus leading peers and which presents significant white space opportunities, namely skincare and Prestige cosmetics. On skincare, the high teens to mid-20s CAGR is premised on accelerating our existing skincare brands Lancaster, philosophy, Kylie Skin, and adding in contributions from projects that are already underway, including the recent launch of CoverGirl skincare, the launch of SKKN BY KIM skincare debuting June 21, as we have just presented, and the recent license agreement with Orveda. Even with this targeted growth, skincare will still account for only 10% of revenues in fiscal '25, well below the skincare exposure for L'Oréal and Estée. On Prestige cosmetics, the 25% to 30% CAGR is premised on accelerating our existing brands, Gucci cosmetics, Burberry cosmetics and Kylie cosmetics, and through the continued expansion in both SKU assortment and omnichannel distribution, particularly as all three brands are highly desired around the world. More recently, as you know, we have announced that we are exiting Russia, which represented 3% of sales and a mid-single-digit percentage of EBITDA. The underlying medium-term growth algorithm still holds, but we do need to adjust for the Russia exit. We are very pleased with the progress we have made on reducing our leverage. We came in a little ahead of our calendar '21 target of 5x and ended Q3 with leverage of about 4.7x. We intend to exit calendar year with leverage towards 4x and remain fully committed to deleveraging 2x exiting calendar '25, which will, of course, include the divestiture of our remaining Wella stake, where the underlying value has continued to grow. And while we believe reaching this much more attractive leverage level by calendar '25 is one of the key ways to deliver value for all stakeholders, we are quite conscious that our shares have become particularly attractive right now due to the recent stock market volatility and technical factors. I firmly believe that our ability to deliver sustained strong free cash flow generation, combined with the eventual cash contribution from our expected divestiture of Wella, will allow us to deliver on our disciplined deleveraging commitments and simultaneously unlock shareholder value. So Robert, as you can see, as you can understand from all these elements in total, even as we track the dynamic macro environment, we remain confident about the path ahead.

That's great. So we've run out of time, unfortunately. Thank you very much, Sue. Thank you, Laurent. This has been great.

Much appreciated.

Thank you, Robert.