According to a recent Jefferies report, Coty’s fourth quarter and year-end call revealed “a fairly mixed quarter and EPS miss.” The trajectory of improvement in sales going forward depends highly on consumer acceptance of new innovation, persistent double-digit growth from acquisitions and additional M&A to drive cost leverage. The year was a transformational one for Coty, as the firm worked to complete the complex acquisition of P&G’s Beauty Business, fully reorganize into a product and customer focused organizational structure, integrate systems and boost its brand portfolio through the additions of Younique, ghd and the agreement to acquire the Burberry Beauty license. Coty CEO Camillo Pane, said, “Our Q4 results continued to demonstrate that our Professional and Luxury divisions are performing well. Professional Beauty’s positive performance was driven by continued growth in Wella and improving trends at OPI, and the Luxury division delivered strong growth for the second quarter in a row supported by Hugo Boss, Gucci, Chloe and philosophy. On the other hand, our Consumer Beauty division remains under pressure and its recovery is a key priority for us.” Here, Jefferies’ highlights from the call:

Q4 Call Reveals Expected Rebound in Consumer Segment in 2H FY18:
No formal outlook for FY18 was provided but based on commentary on the call, management spoke to its expectation for continued momentum in the luxury and professional segments and substantial improvement in the consumer segment. Space losses in-store have weighed negatively on sales trends; the company expects to anniversary in 2H FY18 and to see improvement in sales rates. Relaunching and modernizing brand positioning for CoverGirl and Sally Hansen will be tied to innovation – compounding sales significantly relies on consumer acceptance. The marketplace in mass beauty continues to intensify competitively – new brand entrants are taking share and legacy brands are fighting harder (with each other) for fewer dollars, as category sales are now down in the U.S. and Europe (per Coty’s call).

Sales: Sales of $2.24 billion increased 5%. Like-for-like [LFL] organic sales (Coty legacy + P&G legacy) declined 3%, including a 1% benefit from accelerated shipments in Europe in advance of the Europe Transition Service Agreement (TSA) termination. As has been the case over the last several quarters (post-merger), the luxury (+5% organic LFL) and professional (+3% organic LFL) divisions were sales growth contributors while declines in the consumer beauty segment have persisted in the double-digit range (-10% organic LFL). We note declines in the consumer division are in-line with scanner trends; professional aligns with category growth; and luxury is slightly better than category growth.

Brand Call-outs: Management noted the following brand highlights – (Consumer) weakness in CoverGirl, Clairol and Sally Hansen; (Professional) strength in Wella and System Professional and moderating declines in OPI; (Luxury) strong sales for Hugo Boss, Gucci, Chloe, and philosophy; CK was weak.

Multiple Reflects Risk; Hard to Justify Multiple Expansion Given Lack of Visibility:
The trading multiple continues to fluctuate based on variability in confidence around underlying assumptions. Few dispute the level of cost savings – it’s based on a fairly academic process of estimation. But the assumption of a recovery in the core consumer business remains debatable, at least to the magnitude expected within the targeted EPS level. Filling the gap with M&A is an obvious way to offset, but it suggests sustainable rates of HSD/LDD EBITDA dollar growth to support the debt. It’s difficult to recommend shares with the level of uncertainty remaining high and reliance on unrealized streams of prospective revenue.

Initial Take on Model: Our bias after a first pass through the model is to give the company the benefit of the doubt on rate change improvement in the consumer segment, although we are hesitant to fully apprise low single digit growth without corresponding step up in A&P spend. The Burberry license is additive and has the prospects to be more meaningful in size to prior license holders, implying the potential for $250M+ in wholesale value. The 1H FY18 estimates need to come down as the benefits are very 2H weighted – another 1-2 quarter push out in net value realization. Combining improved sales rate change and savings step ups, we can get to our $1.20 in core EPS value in FY20 – but it’s not an easy track and will require fairly extreme diligence surrounding the pace of acceleration in the consumer beauty business. To-date, we’ve not observed any improvement in scanner trends; August scanner data is down 11%; Sept QTD down 10% – flat to reported June qtr sales.