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4 Reasons Coty Could Surprise the Naysayers

Beauty may be in the eye of the beholder, but many Wall Street analysts appear to think cosmetics and personal care company Coty (NYSE: COTY) is putting lipstick on a pig with its efforts at transformation.

Six major analysts give the company a neutral or hold rating, according to Zacks Equity Research, while three are strong buy and one is strong sell, meaning 70% have a neutral or worse rating on the stock. The company also saw a stock market drop on June 9 when it increased the amount on bonds it's issuing to 700 million euros' worth.

Despite the fairly neutral to a bit negative outlook, there may be gleams of bullish light at the end of the tunnel that those focused on a few narrow fundamentals might be missing.

Here are four reasons you might want to give Coty a more favorable look:

Image source: Getty Images.

1. Costs are dropping, margins rising

Investors appeared displeased with Coty's May 10 fiscal 2021 third-quarter report, with the company's stock value dropping 10.5% in the first 30 minutes of trading after the earnings release. The thumbs-down likely resulted from Coty's share value already pricing in considerable gains, even as the bottom line turned in a narrow earnings miss below analyst expectations.

While Coty's turnaround plan hadn't improved its basic financial metrics enough to wow Wall Street by the time of the fiscal Q3 report, executive remarks during its Q3 earnings conference call and data provided in an accompanying slide deck showed major cost and efficiency gains. These are likely to result in significant growth moving into 2021's second half.

Reining in expenses and boosting gross margin are both signs Coty is likely executing well on its strategic transformation, with top- and bottom-line improvements slightly lagging. Gross margin jumped 450 basis points year over year, reaching 62.2%, with CFO Laurent Mercier stating that regarding "the gross margin improvement delivered this quarter, we are confident that approximately half is structural, and therefore, can be maintained." Mercier also highlighted that Coty's "fixed cost reduction program has allowed us to redirect capital to accelerate our brands and focus on profit delivery," with fixed costs dropping 15% year over year. According to his statement, the company is "on track to achieve" cost-cutting of $300 million this year and $600 million by 2023.

2. Aggressive product mix improvements

Rather than simply relying on its existing product mix to carry it forward, Coty is actively cutting support to brands failing to deliver adequate returns, while developing and supporting its profitable sectors. This process is strengthened by the fixed cost savings from improved efficiency noted above, with the company redirecting the money saved into investments in marketing. CEO Sue Nabi noted a "virtuous circle of stepping up our media spending and reinvesting behind our newly repositioned brands."

While underperforming brands are getting their support cut, the company's push to bolster successful product lines appears to be creating measurable results. On June 11, Evercore ISI gave Coty a 70% upside potential based on successfully building momentum for the key CoverGirl brand, considered to be an indicator of the whole company's health. The analyst noted CoverGirl is gaining market share and Coty has been increasing its shelf space since Q2.

Coty's slide deck presentation digs deeper into the successes of its new marketing strategy. According to its information, focusing marketing investment on successful brands and away from those dropping off in popularity has led to "sell-out growth" in the double or triple-digit percentages for various luxury fragrance and prestige makeup brands, such as Gucci, Burberry, Hugo Boss, Calvin Klein, and Marc Jacobs, with some of the best growth occurring in Chloe Atelier des Fleurs in the Asia-Pacific region, surpassing 800% in Q3. (Sell-out growth refers to actual sales to customers, rather than just sales to retailers, which may not accurately reflect consumer demand.)

Other brand successes include an approximate 100% increase in Chinese sales of Lancaster skincare products. Coty's skincare is also making significant gains in the U.S. market, with its sales reaching 200% of the skincare market average in the most recent quarter and beating its own pre-pandemic 2019 sales by 10%. Kylie Skin is up 20% and exceeded sales expectations on rollouts in France and Russia this spring.

Overall, this data suggests Coty's focused investment in brands already gaining traction is likely to accelerate sales through the rest of this year and beyond.

Some of the numerous brands that Coty works with. Image source: Coty.

3. Other metrics look bullish

Driven in part by pandemic-related lockdowns of retail during 2020, Coty is continuing the development of its e-commerce segment. E-commerce sales jumped 30% in the fiscal third quarter, led by consumer beauty (56% year-over-year growth) but with good luxury sector sales improvements, too (20% growth). While Coty's e-commerce sales are still only 10% of the total, the company isn't ignoring this increasingly important channel, either.

While New World sales fell 6% during the quarter, Chinese sales soared by 27.7%, though they remain roughly a third of sales in the Americas, Women's Wear Daily reports. This again indicates Coty is successfully pushing through one of its turnaround goals, since increasing its presence in the massive China market is "a key pillar in our strategy," according to Nabi.

4. The current CEO has a positive track record

Nabi has been Coty's CEO since mid-2020 and is an experienced beauty sector executive with past successes at turning around cosmetics and personal care brands from faltering to growing and profitable. Working at personal care company L'Oreal SA from 1993 through 2013, Nabi reconfigured its Lancome brand, focusing on the introduction of new luxury products to its line. These included a $350 facial cream, according to Vogue, and the high-profile La Vie Est Belle perfume.

According to Coty, Nabi's management raised Lancome's turnover to 3.2 billion euros during a three-year period, with positive sales growth every year, sometimes topping 10%. While no single individual is a guarantee of business success, Nabi's experience looks potentially well suited to developing the potential of Coty's other strengths.

Is Coty poised for a bullish breakout?

While Coty's Q3 basic top and bottom-line results weren't extraordinary and its guidance remained conservative, the four factors described here show a trend of movement toward strong upcoming growth. The multiple lines of efficiency improvement, cost-cutting, strong market, and brand and market focus are all arguably building strategic momentum, which will manifest as strong revenue and earnings gains in the coming quarters and into the longer term.

It's also worth considering Coty's current price-to-book ratio is approximately 2.17 times, well below that of competitors like The Estee Lauder Companies, with a price-to-book ratio of around 19.4 times, suggesting Coty is not currently overvalued. Those investing in consumer discretionary stocks or luxury brand stocks may want to give this personal care and beauty company a closer look and consider adding it to their portfolio.

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Rhian Hunt has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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