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Coty's Sales Slide for the Fourth Straight Quarter

Coty's (NYSE: COTY) stock lost nearly 70% of its value last year amid concerns about supply chain disruptions, tough competition from stand-alone cosmetics chains like Ulta Beauty and LVMH's Sephora, and the massive debt the company accumulated after its takeover of P&G's (NYSE: PG) beauty brands in 2016.

Yet the stock rallied nearly 80% this year, with most of those gains occurring after German conglomerate JAB Holding made a tender offer for Coty's shares in February. JAB completed the tender offer in late April, which gave it majority control over the cosmetics maker by boosting its stake from 40% to 60%.

Image source: Getty Images.

However, Coty's third quarter report indicates that JAB still has a lot of work to do. Its revenue fell 10% annually to $1.99 billion, missing estimates by $70 million and marking its fourth straight quarter of declining sales. Its organic sales fell 4%. Its adjusted net income rose 6% to $102 million, or $0.13 per share, which beat estimates by a penny.

The key numbers

Coty splits its business into three main segments: consumer, luxury, and professional products. During the quarter, 37% of its revenue came from luxury products, 42% came from consumer products, and 21% came from professional beauty products. None of those businesses fared well during the quarter.

YOY revenue growth

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Consumer

3%

(6%)

(21%)

(15%)

(18%)

Luxury

19%

15%

4%

7%

(3%)

Professional

10%

5%

(5%)

(4%)

(6%)

Total

9%

(3%)

(9%)

(5%)

(10%)

YOY =Year-over-year. On a reported basis. Source: Coty quarterly reports.

Coty's third quarter numbers look horrendous, but they look better on an organic (or "like-for-like") basis, which excludes discontinued brands and other one-time charges. On that basis, its luxury revenue rose 3%, its consumer revenue fell 10%, and its professional revenue dipped 1%.

Coty attributed the organic growth of its luxury business to the strength of its licensed Burberry, Gucci, Calvin Klein, Hugo Boss, Chloé, and Marc Jacobs products. It also relaunched its Gucci makeup line with a new lipstick collection. It also stated that the unit's supply chain issues "abated" during the quarter.

The consumer beauty segment -- which expanded significantly after the P&G merger -- struggled in the U.S. and Europe as declines in color cosmetics and hair care products offset the stronger sales of body care products. However, the body care business also faced an easy comparison to the prior year quarter, when sales were throttled by problems in Brazil. Coty noted that the unit's ongoing supply chain issues (caused by the consolidation of warehouses and a hurricane) hadn't been fully resolved.

Image source: Getty Images.

The professional beauty segment struggled with soft demand in North America, which was caused by "lingering impacts" from its supply chain disruptions and trade inventory reductions from "certain key customers." However, Coty noted that its OPI brand "returned to solid growth" during the quarter, and that it saw robust demand for its Platinum+ stylers and Glide hot hair brushes.

By region, Coty's sales declined in North America and Europe by both reported and organic measures, and grew 1% as reported and 11% organically in its ALMEA (Asia, Latin America, Middle East, Africa) region.

But it's not all bad news...

Coty's revenue growth looks dismal, and its adjusted gross margin contracted 140 basis points annually to 62.9% on the weakness of its consumer beauty unit. However, its adjusted operating margin expanded 120 points to 11.5%, supported by the higher margins of its luxury and professional units:

Adjusted operating margin

Q3 2018

Q3 2019

Consumer

9.5%

6.6%

Luxury

13.3%

17.3%

Professional

6.7%

11.2%

Total

10.3%

11.5%

Source: Coty quarterly reports.

Those improvements enabled Coty to grow its adjusted earnings even as its revenue declined, and it expects those improvements to help it generate positive free cash flow for the full year -- which could allay longer-term concerns about its total debt (which declined 2% annually to $7.77 billion during the quarter) and the sustainability of its near-5% dividend yield.

JAB plans to unveil a turnaround plan for Coty later this year, which will likely focus on fixing the company's troubled consumer unit. It already pressed Coty to appoint a new CEO last year and a new CFO and COO of Consumer Beauty in February, and those new leaders might get the business back on track.

Should you buy Coty today?

Coty didn't offer exact guidance for the fourth quarter or full year, but analysts expect its revenue to fall 6% this year and rise 1% next year. Its earnings are expected to decline 7% this year before rebounding 14% next year.

Based on those forecasts, Coty trades at 16 times forward earnings. That low valuation goes well with its high yield, but I personally wouldn't touch Coty until JAB reveals its turnaround plans.

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Leo Sun owns shares of LVMH Moet Hennessy L.V. (ADR). The Motley Fool is short shares of Procter & Gamble. The Motley Fool recommends Ulta Beauty. The Motley Fool has a disclosure policy.


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