L’Occitane International: Earnings Recovery Will Take A Longer Time (OTCMKTS:LCCTF)

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I maintain a Neutral rating on Hong Kong-listed international beauty products company L’Occitane International S.A. (OTCPK:LCCTF) (OTC:LCCTY) [973:HK].

This is an update of my prior article on L’Occitane International published on July 7, 2020. L’Occitane International’s share price has declined by -4% from HK$13.72 as of July 6, 2020 to HK$13.20 as of August 31, 2020, since my last update. L’Occitane International trades at 33.8 times consensus forward FY 2021 (YE March) P/E, and it offers a consensus forward FY 2021 dividend yield of 1.1%.

L’Occitane International’s net sales decreased by -22.2% YoY to EUR274.2 million in 1Q 2021 which is in line with market expectations, thanks to the good performance of the company’s online sales channels and Asian markets. However, L’Occitane International’s earnings recovery could take a longer than expected period of time, as evidenced by its relatively low FY 2021 operating margin guidance of 5%-7%. Also, the performance of the recently acquired ELEMIS brand in the next few years determines if L’Occitane International achieve its medium-term revenue target of EUR2.5 billion, as the company’s other mature brands have a natural growth ceiling.

Taking into account the above-mentioned factors, I see a Neutral rating for L’Occitane International as fair.

Readers have the option of trading in L’Occitane International shares listed either on the Over-The-Counter Bulletin Board (OTCBB) as ADRs with the tickers LCCTF and LCCTY or on the Hong Kong Stock Exchange with the ticker 973:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Hong Kong Stock Exchange is one of the major stock exchanges that is internationally recognized and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $800,000, and market capitalization is above $2.4 billion, which is comparable to the majority of stocks traded on the US stock exchanges.

Institutional investors which own L’Occitane International shares listed in Hong Kong include HSBC Global Asset Management, The Vanguard Group, Pictet Asset Management, and Norges Bank Investment Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers or Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.

Online Sales Channels And Asian Markets Shine In 1Q 2021

On July 21, 2020, L’Occitane International provided a quarterly update on its financial performance in the first quarter of FY 2021 (YE March) or the period between April 1, 2020 and June 30, 2020. Similar to most Hong Kong-listed companies, L’Occitane International reports financials on a semi-annual basis, and it only releases sales data in the first and third quarter of the fiscal year.

L’Occitane International’s net sales decreased by -22.2% YoY from EUR352.5 million in 1Q 2020 to EUR274.2 million in 1Q 2021, which was in line with market expectations. I had noted in my prior article on L’Occitane International published on July 7, 2020 that the company disclosed earlier that net sales declined by -20%-30% YoY for the April-May 2020 period. L’Occitane International’s online sales channels and Asian markets performed well in 1Q 2020.

With lock-down and social distancing measures implemented in various parts of the world, L’Occitane International had to rely on its online sales channels, rather than its brick-and-mortar stores, to drive top line growth. In the company’s 1Q 2021 update announcement, L’Occitane International notes that online sales channels include “own e-commerce, marketplace, digital direct selling and web partner channels.” Net sales from online sales channels increased by +95.8% YoY in 1Q 2021, and its sales contribution as a proportion of total net sales expanded from 20.9% in 1Q 2020 to 52.6% in 1Q 2021. In contrast, L’Occitane International’s same-store sales growth was a negative -24.9% in 1Q 2021, as compared to +2.0% for 1Q 2020.

In terms of performance by geographical markets, strength in most of L’Occitane International’s Asian markets helped to partially offset weakness in its other markets in Japan, Europe and the Americas. In 1Q 2021, L’Occitane International’s businesses in South Korea, Mainland China and Taiwan delivered impressive sales growth rates of +27.4%, +24.9% and +11.5% YoY, respectively on a constant currency basis. On the other hand, the company’s businesses in Japan, France, Russia, and Brazil posted negative same-store sales growth of -28%, -34%, -37%, and -62%, respectively. The disparity in performance between the different markets for L’Occitane International is a reflection of how well the individual markets have managed to contain the spread of Covid-19.

With respect to brands, LimeLife was L’Occitane International’s only brand that achieved positive YoY sales growth (+51.6%) in 1Q 2021, which was largely attributable to the fact that LimeLife operated on an online-only business model. In comparison, L’Occitane International’s ELEMIS, L’Occitane en Provence and other brands (e.g. Melvita, Erborian, and L’Occitane au Brésil) delivered negative sales growth of -4.0%, -25.7% and -35.3%, respectively in the first quarter of fiscal year 2021. ELEMIS is discussed in greater detail in a subsequent section of this article.

Operating Profit Margin Guidance For FY 2021 Was Disappointing

L’Occitane International guided for a 5%-10% YoY decline in revenue and an operating profit margin of 5%-7% for FY 2021, as part of its 1Q 2021 presentation for investors.

While the revenue guidance was roughly in line with market expectations, the company’s operating profit margin guidance was disappointing, especially in contrast with its medium-term (FY 2024) operating profit margin target of 15% and its FY 2020 operating margin of 11.4%.

L’Occitane International closed 52 stores (total of 1,556 self-operated retail stores as of June 30, 2020) on a permanent basis in 1Q 2021, but it seems that the company is unable to realize sufficient cost savings from store closures or rent negotiations on expiring leases going forward to maintain a double-digit operating profit margin. In other words, L’Occitane International’s earnings recovery could take a longer than expected period of time.

One possible factor that could contribute to lower-than-expected cost savings in FY 2021 is that L’Occitane International wants to maintain a certain level of marketing spend to support the growth of the ELEMIS brand, as discussed in the next section.

Growth Potential Of ELEMIS

As highlighted earlier, the ELEMIS brand performed relatively well in 1Q 2021, with a relatively mild -4.0% YoY net sales contraction in the most recent quarter.

At the company’s earlier FY 2020 earnings call on June 29, 2020, L’Occitane International disclosed that it set a target of achieving a mid-to-high single-digit revenue growth for the ELEMIS brand in FY 2021, and emphasized that the brand has “big growth potential.” ELEMIS is the UK’s largest independent skincare brand, which L’Occitane International acquired a year ago.

The key growth driver for the ELEMIS brand is geographical expansion in Asia, where the brand has a relatively low penetration rate. L’Occitane International has collaborated with Sephora to distribute ELEMIS-branded products at 120 point-of-sales in Mainland China starting in July 2020.

Other Asian markets of interest for the ELEMIS brand include the Emirates and Southeast Asia. Apart from physical sales channels, L’Occitane International also plans to expand in Asia via online sales channels such as setting up its own local e-commerce website Elemis.com in various Asian markets.

L’Occitane International has a medium-term revenue target of EUR2.5 billion, as compared to its FY 2020 revenue of EUR1.6 billion. The company can’t be solely reliant on its flagship brands such as L’Occitane en Provence to drive future sales growth, as they are mature brands with a natural growth ceiling. This implies that the performance of the ELEMIS brand in the next few years determines if L’Occitane International can grow its top line to EUR2.5 billion by FY 2024 as per its targets.

Valuation And Dividends

L’Occitane International trades at consensus forward FY 2021 and FY 2022 P/E multiples of 33.8 times and 16.9 times based on its share price of HK$13.20 as of August 31, 2020. In comparison, the stock’s three-year and five-year mean consensus forward next twelve months’ P/E multiples were 19.7 times and 20.0 times, respectively.

L’Occitane International offers consensus forward FY 2021 and FY 2022 dividend yields of 1.1% and 1.7%, respectively. Sell-side analysts see the company’s dividends per share being cut by -30% from EUR0.02228 in FY 2020 to EUR0.01567 in FY 2021.

Risk Factors

The key risk factors for L’Occitane International include a longer-than-expected time taken for the company to meet its medium-term operating profit margin target of 15%, the newly acquired ELEMIS brand failing to perform in line with market expectations, and a larger-than-expected cut in dividends going forward.

Note that readers who choose to trade in L’Occitane International shares listed as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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