Is This Leading Fragrance Company a Buy?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Coty (NYSE: COTY) recently became a publicly traded company, raising less than $1 billion. The company has a long operating history, dating back more than a century ago when it was founded by a French perfumer. Normally, I do not like to participate in IPOs due to the fact that in majority of the IPO cases, the IPO prices are not cheap at all. However, as Coty has a leading position in the global perfume market, it’s important for us to take a look at it and determine its attractiveness.

Highly leveraged and not cheap

The company is operating in three main business segments: Fragrances, Color Cosmetics, and Skin & Body Care, under several famous brands including Adidas, Calvin Klein, Davidoff, Marc Jacobs, and Playboy, distributing to more than 130 countries around the world. According to Coty, it holds the number two position in the global fragrance market and number six in color cosmetics.

Around 53.2% of its total revenue, or $2.45 billion, was generated from the Fragrances segment while the Color Cosmetics and Skin & Body Care contributed $1.43 billion and $730 million, respectively, in 2012 revenue. The Fragrances segment is also the main profit contributor with more than $340 million in operating income while Skin & Body Care generated operating losses.

What I do not like much about Coty is its highly leveraged balance sheet. As of March 2013, it had $869 million in equity, $609.4 million in cash, and more than $2.46 billion in both long and short-term debt. It also had nearly $246 million in pension and other post-employment benefits.

At $17.50 per share, Coty is worth around $6.7 billion on the market. The market does not value Coty cheaply at all at 12.5 times its EV/EBITDA. EV/EBITDA stands for Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization. It reflects the relationship between the firm’s market value (after adjusting cash and debt) and the cash flow position of that firm.

Coty’s bid for Avon to increase its international presence

Coty has been increasing its presence in emerging markets such as China and Brazil. The plan for international reach might be the reason behind its $10.7 billion bid for Avon Products (NYSE: AVP). Interestingly, legendary investor Warren Buffett supported the bid with Berkshire Hathaway financing it. At that time, Coty was also interested in Avon’s R&D and distribution capabilities. However, because of no response from Avon, Coty withdrew the bid.

After the bid was withdrawn, Avon dropped to less than $14 share at the end of 2012, and then bounce back to $22.90 per share at the time of writing. Under its new CEO, Sheri McCoy, Avon has been going through a major cost-cutting program in order to bring its profit margin to historical levels. In a period of two to four years, Avon might earn around $1.50 to $1.75 per share. Avon is trading at around $22.90 per share with a total market cap of $9.9 billion. Avon has a bit lower valuation than Coty at 12.2 times its EV/EBITDA.

Estee Lauder is the most expensive

Another peer, Estee Lauder (NYSE: EL)has a higher valuation than the other two companies. It is trading at $68.40 per share with a total market cap of $26.5 billion. The market values Estee Lauder at more than 14.4 times EV/EBITDA. When talking about the global prestige beauty industry, everybody would mention Estee Lauder, with 30 brands in around 150 countries and territories, employing around 38,500 employees globally.

Estee Lauder is trying to grow its business in many regions of the world, especially in the emerging markets. It considers China to be the biggest long-term opportunity. Currently, China accounts for 5% of its global net sales, having three-year CAGR of 33% with 14 brands. For the full year 2013, the company expects to have around 6% growth in its EPS to $2.56-$2.61 per share.

My Foolish take

Coty seems to be a decent stock for investors due to its global leading position in both fragrances and color cosmetics, and its reasonable valuation. However, with an EV multiple of 12.5, it is certainly not cheap. So do Avon and Estee Lauder. I would prefer to wait for a cheaper price before initiating long positions in all three companies. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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