Turnaround, Meet Headwinds: Coty Shares Downgraded

As part of its review of the household and personal care sector, Berenberg downgraded shares of Coty Inc COTY.

The company's shares have modestly re-rated as earnings downgrades outweigh recent share price declines, analyst Rosie Edwards said in a Tuesday note. 

"Ongoing uncertainty around the path to recovery, with reduced visibility on top-line growth and margin expansion in our view should be reflected in the valuation," Edwards said.

Berenberg downgraded Coty from Hold to Sell and lowered the price target from $17.50 to $15.

The Effect Of An Acquisition

Coty reported a fourth-quarter EPS of zero versus an $0.09 estimate and sales of $2.24 billion against a $2.16 billion estimate before the open Aug. 22.

The company's weak profitability in Q4 led Berenberg analysts to question whether the synergies from Coty's merger with beauty brands "will flow through to the bottom line."

Coty has lost 40 basis points in share, which can be attributed to Procter & Gamble Co PG beauty brands that the company acquired in an acquisition deal last year, Edwards said. That said, the analysts think Coty's transactions have had the most material impact, giving the group its first exposure to color cosmetics through the purchase of P&G beauty brands such as Cover Girl and Max Factor.

Top-line Deceleration

All personal care companies saw a slowdown in growth from 2014 onward, according to Berenberg. The firm indicated Unilever plc (ADR) UL's personal care division and Coty have exhibited the greatest deceleration. Coty has been a laggard, the firm said.

The firm believes 2018 will be another year of negative top-line for Coty, as challenges in consumer beauty offset better momentum in the luxury and professional businesses. The firm said it remains more cautious on the consumer beauty business, as it is key to the growth outlook for Coty.

"Full-scale brand re-launches are in progress with rollouts expected from [the second half of 2018], although we are not convinced that Coty's brands can compete effectively with disruptors like NYX and e.l.f. Cosmetics and whether therefore the damage from years of underinvestment under P&G ownership is irreparable," Edwards said.

Margin Woes

Despite top line deceleration, operating margins across the space have improved — except for Coty, Edwards said.

Coty is an exception to the rest of the space, which have reduced brand investments as a percent of sales in recent years in response to slowing top lines, according to Berenberg.

The firm said Coty's EBITDA margins fell 100 basis points to 10 percent despite cost benefits from the P&G transaction.

Berenberg is projecting an earnings shortfall of $500 million in 2017 due to top-line contraction and a higher fixed cost base, as the company operates under P&G's transition service agreements.

The firm now forecasts higher advertising and promotion spend for Coty in a bid to support consumer beauty re-launches for brands such as CoverGirl and Clairol.

Berenberg expects the headwinds for the company to persist in the first half of 2018 and the positive effects from synergies, if any, to be realized only in the second half. Therefore, the firm estimates only modest expansion in EBITDA margin in 2018, with more material improvement pushed out to 2019 and 2020.

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