Fragrance maker Coty filed a registration statement amendment May 28 that sees it raising as much as $1.2 billion from its IPO. Coty tried to buy Avon Products (NYSE:AVP) for $10.7 billion in 2012 but was unsuccessful. With majority shareholder JAB Holdings getting busy in the coffee business it looks as though some profit taking is underway. Should investors be interested in owning Coty stock? I'll have a look.
Joh. A. Benckiser acquired Coty from Pfizer (NYSE:PFE) for $440 million in May 1992. It proceeded to go on a buying binge over the next 20 years; today Coty has annualized revenues of $4.79 billion with operating income of $558 million. JAB Holdings is selling 43.56 million shares in the IPO for approximately $762 million in gross proceeds. That's more than JAB paid for the entire company. Including the over-allotment, JAB will still own 69% of Coty's equity and 85% of its votes. The entire business, based on a $17.50 IPO price, has an enterprise value of $8.6 billion or 10.6 times EBITDA. If you assume the Reimann's put no additional funds into Coty's business (unlikely given the number of acquisitions) it's achieved an annualized total return of 15.2%. If you assume JAB put another $440 million into Coty's business, it's achieved an annualized total return over 21 years of 11.5%, which is 280 basis points (BPs) better than the SPDR S&P 500 (ARCA:SPY). It's solid if not spectacular.
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In the previous paragraph I estimated that Coty's enterprise value is 10.6 times EBITDA. In comparison its three peers--Estee Lauder (NYSE:EL), Elizabeth Arden (Nasdaq:RDEN) and L'Oreal (OTC:LRLCY)--average an enterprise value of 14.4 times EBITDA. At least from this perspective JAB Holdings is bringing the company to market at a fair valuation.
But of course there are countless ways to value a company. For instance, Coty's operating margin based on its annualized revenue and operating profit is 11.7%, 480 basis points less than L'Oreal, which has an enterprise value 17.3 times EBITDA. On every $100 of revenue, L'Oreal earns $4.80 more than Coty. When you consider that L'Oreal's annual revenues are $29 billion or six times Coty's, the additional profit per $100 in revenue adds up quickly. Profits, however, don't necessarily translate into free cash flow (FCF). While Coty doesn't make as much as L'Orleal per $100 of revenue, its free cash flow yield of 6%, which is based on its IPO market cap of $6.87 billion, is almost double L'Orleal's at 3.2%. Profits are important but cash flow pays the bills. In this regard Coty's valuation doesn't take into account its ability to generate cash, which is critical to the success of any business.
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Globally, Coty is number two in fragrances and number six in color cosmetics. Its 10 power brands, which include Chloé, OPI, Rimmel and Sally Hansen, generate 70% of its annual revenue. Its fragrances generate 53% of its overall revenue with color cosmetics another 31% and skin & body care the remaining 16%. Coty generates 23% of its revenue from emerging markets with the majority from developed markets like the U.S. Globally, the industry growth in the three segments where it competes was 3.7% and is expected to be in this range for the next four years.
Excluding acquisitions, its 10 power brands increased revenue in 2012 by 10%. In the past three years it's added a power brand in each of its three operating segments. Sally Hansen, which it acquired in fiscal 2008 for $800 million, has seen its revenues increase by 53% over the past five years. It's done an excellent job integrating acquisitions into its existing business. Acquisitions, combined with new product innovations, which account for approximately 17% of its annual revenue, are key drivers of growth. Clearly, it can generate additional revenue from emerging markets. By 2017 it expects that at least 33% of its business will come BRIC countries. In 2012, excluding foreign exchange and acquisitions, emerging markets saw revenues increase 14% year-over-year. The other area where it sees real opportunity for growth is in its skin & body care segment, which currently accounts for just one-sixth of its overall revenue. If it does make an acquisition in the next couple of years, I'd expect this segment to be its biggest priority.
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Coty faces some serious competition in all three segments in which it operates. Having said that, it's real obstacle to climbing higher in the food chain is its skin & body care segment, which took a $576 million impairment charge in fiscal 2012 on the reduction in carrying value of its TJoy and Philosophy brand assets it acquired in 2010. That's by far its biggest concern. Other than that it's doing just fine.
Would I buy its stock at $17.50? I definitely would and anywhere up to $20. For once I've found an IPO that's fairly priced.
At the time of writing, Will Ashworth did not own shares in any of the companies or funds mentioned in this article.