Coty Inc. (COTY) Earnings Call Transcript & Summary

Good morning, and welcome to day 2 of the Bank of America Consumer and Retail Conference in sunny Miami. My name is Anna Lizzul, lead analyst at Bank of America on Coty, and I am pleased to be joined by Chief Financial Officer, Laurent Mercier. Laurent joined Coty in 2017 as CFO of the luxury division and then became Coty's CFO of EMEA in January 2020. Thanks so much for being here today. Laurent will be doing a 20-minute presentation followed by a 20-minute fireside chat. And with that, I'll turn it over to Laurent.

Thank you, Anna, for this introduction, and hello, everyone. I'm very happy to be here today to share an overview of Coty and our strategy and share some incremental updates since our presentation at CAGNY a few weeks ago. In the past 2.5 years, we've made tremendous progress setting a clear strategy, executing on our growth pillars and significantly improving our financial position. Most importantly, there is a significant untapped potential ahead for Coty. Let me start by sharing with you an overview of Coty. We are not only an established player in beauty, but we are also increasingly a beauty powerhouse. We are one of the few companies operating with 2 divisions that reach consumers across price points. This is a critical element in our business diversification strategy. Our Prestige division accounts for more than 60% of our sales and is nicely profitable with EBITDA margins over 20%. Our Consumer Beauty division accounts for roughly 40% of sales and has a solid EBITDA margin of 12%. And our margins in both divisions continue to grow. Our portfolio is diversified across categories. In the last year, Prestige Fragrances accounted for over 50% of the mix. Mass Cosmetics is the second largest category with roughly 25% of the mix. Skincare and Prestige Cosmetics are still fairly small with each at a mid-single-digit percentage of the mix and these are the areas we plan to meaningfully grow in the coming years. And Body Care, Mass Fragrance are each high single digit. We also diversified geographically. North America is roughly 1/3 of our revenues. Western Europe is less than 30%. We are still small in China, Asia Pacific and Latin America, but we see a lot of opportunity to grow meaningfully in each of these markets, particularly China. And Travel Retail is about 7% of sales in fiscal '22 and continuing to grow fiscal year-to-date. You can see here our beautiful portfolio of brands, and how they truly reach consumers across all price points. Starting with mass brands like CoverGirl and Rimmel with many products priced below $10, all the way up to the ultra-premium part of the market with brands like Orveda, Chloé Atelier des Fleurs and soon Lancaster Ligne Princière priced between $150 and $400. Coty has made very substantial financial progress in the last 2 years. We have significantly improved our P&L and balance sheet with more improvement to come. Let's start with the P&L. We've grown our core revenues at a CAGR of 10% to 11% on a like-for-like basis. This, of course, excludes ForEx and also adjusted for exit from Russia. We have grown adjusted EBITDA at a CAGR of 12% to 13% in the last 2 years despite significant ForEx headwinds to profit this year, and adjusted EPS has increased by 7x in the last 2 years. Fueling a strong profit growth has been very strong margin expansion. Gross margins have increased by roughly 400 basis points in the last 2 years. We are on track to end fiscal '23 with gross margins of roughly 64%. On adjusted operating margin, we are also on track to increase by roughly 400 basis points. We expect to end fiscal '23 with adjusted operating margin of approximately 13%. At the same time, we've significantly improved the health of our balance sheet. We lowered leverage by 2.7 turns in the last 2.5 years and we ended calendar year '22 with leverage at around 4x and well on track to end calendar year '23 with leverage towards 3x. This deleveraging has been enabled by both tactical asset monetization and strong free cash flow. In fact, we generated over $500 million of free cash flow last year, and we are on track to generate over $400 million this year. Turning to current trends. As we are now roughly 2 weeks away from the end of Q3, we wanted to share an update on how the business is trending. In fact, our core like-for-like revenue growth adjusted for exit from Russia is tracking at 10% growth for Q3. This is a nice acceleration from the 7% core like-for-like sales growth in Q2. We are seeing this growth acceleration in both divisions. In Prestige, the acceleration is driven by continued strong consumer demand, a steady improvement in our Prestige Fragrance service levels and restocking by our customers as they exited the holidays with very lean inventory. In Consumer Beauty, the acceleration is driven by continued strong category momentum and the contribution from key brand launches this quarter, including the CoverGirl Clean eyeshadow and Yummy gloss, Max Factor Miracle Pure Foundation and serum and the broader rollout of the new adidas active skin & mind line. As we shared at CAGNY, while our top line trends are ahead of initial expectations, we are investing incremental profit into our critical skincare strategic initiatives like Lancaster Ligne Princière and the new Burberry and Gucci Foundation we are launching in China as we speak. Based on the results we reported in the first half and our view on Q3, I want to take the opportunity to provide some color on the quarterly phasing of the P&L. As mentioned, we now see Q3 core like-for-like revenues up 10%, following 9% core like-for-like growth in the first half. As a result, we are raising our fiscal year '23 core like-for-like revenue growth outlook to the upper end of our 6% to 8% core like-for-like guidance. For Q3, we are also seeing slightly more moderate ForEx impact on the top line, now expected to be at the low single-digit headwind from our previous estimate of a mid-single-digit headwind. At the gross margin level, the seasonality of our business with big fragrance sales during the holidays means that gross margin in the second half of the fiscal year typically declined by 200 to 300 basis points from the first half. We, therefore, expect Q3 gross margin roughly at 63% and Q4 gross margin of roughly in the range of 62% to 63%. The Q3 gross margin appears to show a decline year-on-year, but this is due to the following: first, as we discussed at the time, in Q3 of last year, the Wella TSA exit benefited our P&L and cash flow, including a roughly 100 basis point benefit to gross margin. Second, with various material contracts repricing entering calendar year '23, the COGS inflation has stepped up to 200 to 250 basis points of sales from below 200 basis points in first half. And third, the pricing we are taking now is only coming through at the end of the quarter, so the full benefit will only be felt in Q4. Importantly, there is no change to our fiscal '23 gross margin outlook for modest expansion year-on-year to approximately 64%. And there is no change to our fiscal year '23 EBITDA outlook of $955 million to $965 million. With a strong financial improvement in the last 2 years, let me turn to the path ahead. In light of the strong and resilient beauty market and the significant untapped growth potential for Coty, we continue to expect a very attractive growth algorithm for the company. Turning to the P&L growth algorithm. Our outlook remains largely consistent with the algorithm we shared in November 2021. We continue to see like-for-like sales CAGR of 6% to 8% in the next 3 years, though we now anticipate to be at the upper end of this range. We continue to expect gross margins in the mid-60s, 9% to 11% EBITDA CAGR and mid-20s EPS CAGR, supported by lower interest expense as we deliver and lower share count. From a free cash flow standpoint, all of this translate into strong cash generation and steady deleveraging. We continue to expect free cash flow over $400 million this year, driving our deleverage towards 3x end of calendar year '23. By fiscal '26, we expect adjusted EBITDA in the $1.2 billion to $1.3 billion range, free cash flow over $500 million, leverage of around 2x exiting calendar year '25. Finally, this brings me to the framework for our capital structure and anticipated capital returns. First, we exited calendar year '22 with net debt below $3.9 billion and leverage of around 4x. Over the next 3 years, we expect to generate a minimum of $400 million in free cash flow annually or over $1.2 billion cumulatively. We also continue to target the divestiture of our Wella stake by calendar year '25 with proceeds of over $1 billion. Together, this brings cash inflow of over $2.2 billion over the next 3 years. Assuming 3 quarters to deleveraging and a quarter to capital returns, this should drive a very attractive capital returns in calendar year '25, including net debt below $2.5 billion, leverage around 2x, capital returns of around $500 million, including the $400 million of share buyback we have announced via equity swaps with banks. With that, I'm happy to join Anna for some Q&A.

Great. Thank you so much, Laurent, for that excellent presentation and for being here today. Coty has been a turnaround story for the last several years, and I wanted to remark on the improvement in Coty's stock, particularly since I initiated coverage in September 2022. The stock has increased by about 40%. Can you talk a bit about what has fueled Coty's outperformance over the last several months?

Thank you, Anna. Indeed, we are very pleased with the stock performance over the last few months and indeed, overall outperforming the market. So there are a few key drivers explaining this performance. Number one is that we continue our deleveraging agenda. This -- I usually repeat deleveraging is the #1 imperative for the company. Indeed, we delivered our 4x leverage ratio by end of calendar '22. We confirm now moving towards 3x end of calendar '23 and reaching 2x, okay, by end of calendar '25. So this is absolutely critical. And we have, as you understood, all the elements to drive this deleveraging agenda. Number two is consistency of our financial delivery. Now it's 10 quarters in a row where we are delivering -- over delivering versus guidance. So it shows the robustness of our model. And concretely, we raised -- we increased our EPS guidance we announced in our last earnings call. And we have just announced that indeed, we are also increasing. Now we confirm that we will be at the upper end of our full year net revenue guidance of 6% to 8%. So you see consistency and our model is delivering. Number three, which is absolutely critical, is definitely the strength of the category. So we are -- as I explained, we are really -- I mean, beauty category is booming. We are seeing and it continues and it's sustainable strong appetite for beauty products. And again, our portfolio is matching exactly these consumer needs. So that's very, very, very positive. So definitely, so when we continue on these elements, it shows that we have the right portfolio. The strength of Coty's are balanced portfolio. This is really essential balanced portfolio in terms of divisions, but also in terms of geography, okay, and also in terms of brands. Just to give an example. So when you see Prestige Fragrance, so indeed, we are seeing penetration is increasing, category is increasing. And definitely -- and on top of this, as you saw, we announced that we renewed our license contract with Hugo Boss. So it means that now our top license average duration is about 10 years. Okay? So we are very well established. And on Consumer Beauty, we are gaining market share quarter after quarter. What's important to notice is that in this portfolio, both divisions, we are seeing also some premiumization in this portfolio, and we are taking advantage of these elements. So all these key drivers are consistent, so indeed have attracted long-term investors. And this is something that we are -- where we are seeing continued progress quarter after quarter and indeed is explaining also the good performance over the last month. Still there is still a discount, I mean, versus our peer. So still very strong potential ahead of us.

You announced today that you're seeing fiscal Q3 sales at about 10% growth like-for-like, which is an acceleration from the 7% growth you saw in fiscal Q2. Can you talk a bit about the drivers of that and which categories where you're seeing outperformance?

So definitely, we are seeing, I mean, a strong performance on both divisions. So again, it confirms that beauty category is very resilient and is very robust and across the whole portfolio. So this is the case for Consumer Beauty. We are seeing really on Color Cosmetic and Mass Fragrance, and this is also the case on Prestige. What we are seeing is, as I said, really also some premiumization. Let me give you a concrete example on -- we have a key icon. We are building a key icon, which is Burberry Hero. The usual launch mechanism you have in fragrance that you start year 1 to launch Eau de Toilette. And the second year, you're launching Eau de Parfum, which is more concentrated product and more premium. And usually, Eau de Parfum is, let's say, 20% or 30% of Eau de Toilette. That's a normal data we get in the past. What we are seeing this year is that, in fact, Eau de Parfum is the same size as Eau de Toilette. So it shows that there is a strong appetite from consumers to get more valorized product and definitely, these are products also which have much higher margin, okay? Price is about 40% to 50% higher. So definitely, there is this strong demand. At the same time, we shared in Q2 that we had some challenges on supply chain and components. So step by step, we are improving our service level. And definitely, this is also supporting that now our supply chain can match this high demand. So that's very positive momentum. And that's why, indeed, it gives us full confidence to now raise our full year algorithm and to be at the upper end of our guidance, 6% to 8%.

And Coty has seen relatively stable COGS inflation around 2% of sales while you've been able to take pricing up with another pricing round in fiscal Q1, you took pricing up about mid-single digit in fiscal Q3. And you've stated plans to evaluate another price increase in fiscal '24. How are you planning to balance pricing versus market share growth in the categories in which you operate? And why do you think there is more room to take pricing in this environment?

Yes. Thank you, that's a very important question. And we started to work on this. I can tell you more than 2 years ago, okay? So we knew at that time that inflation will come. So we made already a conscious choice that we built a dedicated pricing office. So we have a small team in the organization and they are very granular level of understanding of pricing, competition, retailers, channels, markets. So it means that, indeed, the price increase we have implemented last year and that we do now end of Q3, we do it in a very detailed manner. So that's the recipe of success. You cannot make it as a global price increase, you need to go -- to go in the details. So this is what we are doing. Now we are also supporting this approach that we have a specific program, which is strategic revenue management and it's really again to go deep in the value analysis. So between us, so the producer, the retailer and the consumer so that we make sure that the way we share this value is done, of course, in a profitable manner, that is done in a fair manner. So revenue management data, we are reviewing promotional policy. We are reviewing trade terms. We are reviewing the mix. And by doing this, it's really our way to mitigate inflation, but sometimes indeed to avoid to have too aggressive price increase. So these are very detailed and operational work. Third element is that pricing we are doing, in fact, is in line with what our peers are doing, okay? So there is no market share implication. And last but not least, which is very important, and we have some data. We have some study is that there is very low elasticity in the beauty sector. Of course, there is a limit. But definitely, pricing. We are seeing lower elasticity because, again, there is a strong appetite for the product. And of course, we are making sure that we are offering the top-quality products to our consumers. So we continue -- we do it in very agile and with a high level of method because at the same time, we are seeing that inflation is still there. There is, as we are seeing in Q3, a lag effect. Also, we are seeing our suppliers even impacting inflation that they get from their own suppliers. So we remain very, very active on the stream.

And turning to gross margins. Gross margins have improved around 400 basis points over the 2 years at Coty, which have benefited from the continued premiumization of the portfolio. The strategic pillars that Coty has previously outlined are all margin accretive as well. As you expand into higher price, higher margin products and higher-margin regions, such as China, how do you see gross margin evolving from here?

Absolutely. So you're absolutely right to notice that indeed over the last 2 years, our gross margin improved by 400 basis points. So this was again in our transformation agenda. It was a key focus. We have to improve our gross margin because this is what's giving us the fuel to support the strategic initiatives. How did we do that? We have very concrete initiatives on fragrance. We closed one Prestige factory, and this is benefiting to our reduction of cost of goods, thanks to fixed cost absorption. We had a specific program to simplify our portfolio. We have too many SKUs in Consumer Beauty and also in Fragrance. So we reduced number of SKUs in Consumer Beauty by 30% and in Prestige by 15%. And by doing that, in fact, we are seeing that the net revenue by SKU has increased. Because, in fact, you bring the product which has the best productivity. So it's a very healthy mechanism, and we continue to do this work. Third element, which also gave some strong improvement is what we are calling E&O. E&O is excess and obsolescence because we understood that we are -- we were building some inventories, but some of these inventories were low rotation SKUs. So we reviewed in depth improved our forecast accuracy significantly so that now we make sure that inventory we are building are really with high rotation SKUs, and we have very limited inventory of low-rotating SKUs, and by consequence, reducing, I mean, the hurt on our P&L. So these are very, very concrete example. So we continue this work definitely in this context of inflation or where we are doing pricing. So you're absolutely right to highlight that mix is now a big driver of our gross margin expansion. Strategic initiatives we are putting in place. Skin Care, China, niche fragrance, what I was referring our premiumization of Fragrance, but also in Consumer Beauty. All these initiatives are margin-accretive and definitely will continue to bring us gross margin in the mid-60s indeed in the coming years. So this is -- we continue this journey. And definitely, as we improve the mix, okay, step by step, we should be very comparable to our peers.

Great. And Coty has also been very diligent on identifying and executing on cost savings across the business. You've delivered over $500 million in cost savings and expect another $265 million in savings over the next 2.5 years. Where do you see the greatest benefits in the P&L?

Absolutely. So indeed, as I was referring, I mean, the work we have been doing over the 2.5 years, and I mentioned on specific streams that we had this transformation umbrella. What we are calling all in to win program and [ Gordon from Bratton leadership ]. So definitely, the first step of this transformation was focused on SG&A. So we made very drastic actions, which were needed to optimize people cost and to optimize nonpeople costs. So this was the first stream and we continue -- we keep this discipline, okay? So it's believed that there is no way back we keep these disciplines. There are some tools, methodology, and this is embedded in depth in the organization. The second part of the work, as we just mentioned about gross margin, was focused on cost of goods. Okay? So I mentioned what we did on the factories, what we did on E&O and also on warehousing. We had also in this transformation stream, specific work on value analysis. We -- I said we simplify the number of SKUs, but we also standardized the number of SKUs. I usually give the examples that we are roughly in our Fragrance portfolio 70 different types of caps. And this was history. Now we have a specific stream that we can reduce drastically. Of course, we keep the specificity of the product, we keep high value for the consumers. But this is where we are making savings. Now we continue this work, and this is, okay, what's coming. So we expand this productivity approach to all the streams. So we have, as I shared, a specific program on strategic revenue management. So it's really to optimize our gross to net part and, again, creating value for all the stakeholders. We are doing also productivity on A&CP. A&CP is a big amount. Of course, we invest in A&CP, but there are also a lot of ways to improve and to bring productivity in A&CP. So to make it short, the next step on transformation and these savings is really that now we are really in an end-to-end approach, okay? So we took all the, I will say, P&L line, but now is really a value-creation approach with some trade-offs and really supporting the business. So -- and again, we are perfectly on track, and we have a pipeline of initiatives, which are very exciting.

And one of the other long-term goals for the business is building out Skin Care, which you're doing in the next few weeks with Lancaster in China. You're launching the premium plus Skin care line there. In which channels are you rolling out the product initially? And what are some of the goals you have for this rollout and what would allow you to categorize this rollout as a success?

Absolutely. So indeed, that's a very good and very important question in our strategy. We made very clear in November 2021 in our strategic pillars that Skin Care is definitely a great opportunity for Coty. So what are we doing concretely? Number one, we are revamping Lancaster. Lancaster is a fantastic brand. We have, I mean, a great technology. As you know, we have an R&D center in Monaco. We have a factory in Monaco and we have top-class product and Lancaster is benefiting from R&D. So we are revamping the brand, and we are launching, as we speak, Ligne Princière, which is a great innovation we are launching in China, okay? So is Skin Care China go together, no surprise. And this is definitely where we are focusing on building the capabilities and really making this revamp of Lancaster. Second is philosophy. Philosophy is so an outstanding brand in U.S. The awareness is amazing. And we're also reworking and this is coming in the coming months, with new communication assets, a new website and new transversal serum. So there is all these elements. And in fiscal '24, we will be accelerating Orveda, which is a new brand in our portfolio, which is very high end and with very high research and benefit to the consumers. So with all these elements, the ambition is to double Skin Care in the coming years. To be concrete on your point, we are definitely focusing on quality of execution, okay? So that's really, again, the recipe of success. So we are very selective and choiceful about the doors we are opening to make sure that these are the right doors, these are the best doors, focusing on productivity. These are definitely and we are tracking all these KPIs. This is related also to quality of our beauty advisers. As you know, Skin Care is, I mean, proximity and in-store excellence is absolutely key. So the teams are focused. We have great implementation, and this is what we are going to attract. So then we will track, of course, consumer loyalty, consumer repurchase and we need to make sure that if we have to adjust some details and so on, we will do it. So it's really a question of detailed work. And last element, which is very, very important. It's also a business where [ PR Buzz ] is absolutely critical. So this is -- now we have also a team who's doing an excellent work on this. And we are seeing some concrete tangible element. So last week, for example, we were honored to have the Prince Albert II of Monaco visiting our labs and factory in Monaco. And now we have a partnership with the Royal family of Monaco on Lancaster. So it shows also this brings a lot of credibility and this is something that for the Chinese consumers mean a lot. So it's really credibility and shows really, okay, how this is high-end premium and very loyal consumers. So same on Orveda, we are partnering with some French fashion designer. This was the case during the fashion week and there is more to come. So you are seeing that we are really doing all this in very detailed and serious manner. And last but not least, as I mentioned, we have some Hero products. And these Hero products, Lancaster Ligne Princière, Philosophies, that we are going to launch Orveda. These products are top quality products. The formula are the best -- we have the best formula. So now we are within this execution mode. And this is, of course, the strategic move for Coty.

And in Consumer Beauty, you've talked about expanding more into certain categories that are popular with Gen Z as well as reaching more consumers via social media. Where do you see the biggest opportunities on other Gen Z subcategories? And how are you planning to leverage social media in your overall marketing initiatives?

Absolutely. So Consumer Beauty, first of all, as you see, there was a strong -- again, back to the strategic imperative, there was #1, which was stabilized Consumer Beauty. In fact, we did better than stabilizing because we are gaining market share, okay? So now is over the last quarters, consecutively, we are gaining market share quarter after quarter. So it shows that, okay, the work we are doing is the right one. There is a strong -- we have a very strong footprint in the clean and vegan territory. And this is what we are stretching. CoverGirl in U.S. started as a clean beauty brand. So this is really what we are doing, and it resonates a lot with Gen Z. So this is definitely what we are doing with CoverGirl and the current innovations we are launching with Yummy Gloss and so on are definitely in this territory. This is the case with Rimmel. We launched last year with a kind and free also on other initiatives like Sally Hansen Good. Kind. Pure., which is a line of nail polish. So this clean and vegan territory is really our legitimacy definitely and resonates really well with Gen Z. In addition, of course, we are fine-tuning, reviewing our communication strategy and also to attract this Gen Z and we are attracting Gen Z. TikTok, of course, is an important lever. And now we started in U.K., and now we are rolling out in all markets where we have in-house TikTok team, so really creating some traction with the Gen Z community of brand creators. So definitely, we are seeing very strong traction. So attracting Gen Z, at the same time, keeping and even increasing penetration from other consumers.

And I wanted to touch on leverage. In the past, Coty has been hampered by high leverage, but you have been diligent about deleveraging. Can you talk about Coty's goals to deleverage? And what is fueling your ability to take down leverage?

Absolutely. So I usually repeat and I repeat again, deleveraging is the #1 imperative of the companies. So we were very clear from the beginning. And back to your first question, we confirmed definitely our ability to deleverage the company. So there's 4x end of calendar '22 and now moving towards 3x end of calendar '23. So I would say the model is perfectly on track, perfectly in control. Number one is that now we are generating cash flow, okay? That's sustainable cash flow $500 million last year, we delivered more than $400 million this year, and cash flow, of course, combination of our EBITDA, working capital. We made tremendous progress on working capital and the working capital cycle now is a virtuous cycle, okay? So this is very positive. We keep our CapEx in control, okay? We are allocating where there is a strong ROI. And now we have very limited one-off cash items. So the model is perfectly in place with good focus. And this share now when you take $400 million free cash flow at a minimum per year. On top of this, as you know, we have 1 -- at least $1 billion value from Wella stake. So this is a book value. So that's why I'm insisting it's $1 billion at a minimum. So all these ingredients, cash flow generation plus Wella asset monetization, so bring us to this 2x leverage ratio by end of calendar '25 and gives us also the ammunition to start capital return to our shareholders, okay? We estimate roughly $500 million. So we are perfectly on track. We keep strong focus on deleveraging and will be perfectly in place indeed in fiscal '25.

Great. And as you look ahead, is Coty open to acquiring stakes in other brands? You currently have partnerships such as SKKN BY KIM and are there any other categories in what you're looking to expand your partnerships?

So definitely, as I shared, I mean, we have very strong partnerships. So average of our key license is about 10 years. So this is -- and these are indeed very, very strong partnerships. That's number one. Number two, as I shared, we have a great portfolio. We have great brands. We have -- and this is the case in Consumer Beauty, in Prestige, in Skin Care, as I shared. So we are really focusing, and I gave a few examples on quality of execution of our existing portfolio. And number three, I made very clear that the big focus is, first, we reached this 2x leverage ratio, which is fiscal '25. So it means that by that time, there is no M&A, okay, on our agenda.

Great. Well, thank you so much for your time, Laurent. We really appreciate you being here.

Thank you, Anna. Welcome.