Description

L'Occitane - Hidden Access to Fast Growing Brands Sol De Janeiro and Elemis at 13.5x earnings

L’Occitane is a $4.2 billion multi-brand skin-care and beauty company listed in Hong Kong. The company is best known for its namesake brand, L’Occitane en Provence which specializes in body skin care, and was founded in the 1970s. Over the last several years, L’Occitane has acquired several growing brands, including Elemis, Sol De Janeiro, and Grown Alchemist. L’Occitane is controlled by Reinold Geiger who owns 70% of the group and serves as the company’s Executive Director and Chairman.

We believe L’Occitane is a hidden gem on the HK stock market with Asian investors under appreciating the rapid growth of Elemis and Sol De Janeiro while European and North American investors lacking exposure to the group’s success in Asia. As a result, shares of L’Occitane trade for just 13.5x earnings, which is a 50%+ discount to Western peers, despite the opportunity to double operating profit by FY27 with high cash generation. We believe the stock is at an inflection point and the valuation gap will narrow over the next year as the company accelerates growth and margin expansion. If the valuation does not improve, we suspect the company’s majority shareholder, will evaluate strategic options, including a take-private with an eye to re-list in Europe in the future.

Background

Shares of L’Occitane have materially underperformed beauty peers since the company listed in 2010 for HKD$15 per share vs. ~HKD$22.00 today. L’Occitane struggled as the touchpoint with customers moved away from the mall to social media, ecommerce, and luxury stores. Additionally, between the company’s IPO in 2010 and 2018, L’Occitane made three acquisitions of nascent brands – Melvita, Erborian, and Limelife. None of these brands reached escape velocity and despite revenues increasing 50% between 2011 and 2018, margins declined 720bps, resulting in a mid-single digit increase in operating income and a significant decline in ROCE.

Recognizing the underperformance, L’Occitane announced a new corporate strategy, called Pulse. This strategy is focused on customer engagement, employee incentives driven by profitable growth, digital transformation, and a category shift into higher quality products. Changes at the company became evident over the course of the next year. New experiential stores in New York and France were opened and the company had a successful launch of a face serum under its ‘hero product’ strategy. In late 2018, there were rumors that L’Occitane was approached by private equity firm Advent International. However, in early 2019, L’Occitane announced the acquisition of Elemis, a luxury skin care brand, for $900mn or ~6x sales. As a well-established brand in the UK with strong management, Elemis was a shift in the company’s previous acquisition strategy, which had previously focused on smaller, nascent brands.

The pandemic has had a mixed impact on L’Occitane. On the negative side, Elemis launched in China in early 2020, prior to the onset of the pandemic. The environment was not conducive to establishing a foreign brand in China, and Elemis has deferred its growth ambitions in the region. On the positive side, Elemis has continued its momentum in the US and the UK with sales ~33% greater than its run rate upon acquisition, and L’Occitane executed several value enhancing initiatives across the group. L’Occitane was able to accelerate the right sizing of its store portfolio in the US by shedding 25% of its store fleet through a bankruptcy process. Additionally, L’Occitane doubled down on its new M&A strategy, acquiring Sol De Janeiro in November 2021 and Grown Alchemist in Spring 2022. Since its acquisition, Sol De Janeiro has grown rapidly in the US: its Brazilian Bum Bum cream became the number one SKU at Sephora. Over the last year, Sol De Janeiro has expanded beyond a single product with a very successful Fragrance Mist (i.e. fragrance offered at a more accessible $30-40 price point). Sales have increased rapidly growing from a ~$100M run rate in November 2021 to a $500-600M run rate in April 2023.

Elemis, Sol De Janeiro, and L’Occitane en Provence banners have all shown promising momentum leading to expectations for double-digit growth for the group. Management has outlined mid-term targets for FY26 of €3.0bn in sales and 16% operating profit margins vs €2.1bn and 15% margins in FY23. Shares reacted positively, reaching the mid-30s in 2021. L’Occitane’s stock, however, has now retraced its 2020 – 2022 gains, and is approaching pre-COVID levels despite much higher earnings and more brand diversification. L’Occitane trades for just 13.5x earnings and 12x EBIT vs western peers that are valued at a 50-100% premium despite expectations for the company to achieve faster growth with more margin expansion potential.  

1. Sol De Janeiro is a hidden rocket ship with sales increasing ~10x from 2020 to April 2023 run rate and has potential to rapidly reach $1 billion in sales

• Sales have increased 10x to a $500-600 million run rate as of April 2023 from the brand’s $60 million in sales in 2020
• Large runway for expansion
  • Asia - Sol De Janeiro plans to launch in China, Southeast Asia, and Travel retail in the current fiscal year, which are the world’s largest beauty markets
    • Asian markets are 50% larger for the company’s core L’Occitane en Provence banner
    • Launch will have a very significant benefit to FY24 sales as the company sells into retail partners for its launch
      • Sol De Janeiro plans to enter the Asian markets through a partnership with Sephora, which should drive significant brand awareness
  • Retailers – current exclusivity in the US ends with Sephora in early 2024, allowing Sol De Janeiro to expand its number of doors
• Sol De Janeiro has margins of 28% in H1 FY23 which are much higher than the broader L’Occitane Group – which averaged 15% during FY23
• We believe that Sol De Janeiro can reach $1 billion in sales starting in FY27 and approach those levels starting in FY26 after the launch in China and Southeast Asia
• L’Occitane acquired the majority of Sol De Janeiro for $450 million in November 2021 vs current sales run rate of $500-600M

2. L’Occitane is successfully high grading its core banner L’Occitane en Provence into higher quality end markets

• L’Occitane grew HSD last year excluding company’s exit from the Russian market and China, which suffered from COVID lockdowns but has since reopened
  • L’Occitane has benefited from the China reopening but has indicated that they are expecting a slow recovery
• L’Occitane continues to high grade product lines with new Hero Product launches in high value categories
  • Successfully launched Face Care product, Immortelle Reset Serum, prior to the pandemic that was rapidly adopted by consumers
  • Taking learnings from Immortelle reset and applying them to premium body care and hair care, which are high potential growth categories for L’Occitane
• Expanding travel retail presence which is just 7% of group sales vs 20%+ for EL and L’Oreal
• Launching new products in several high value categories with hero SKU strategy

3. Latent growth opportunities in existing brands and platform for accretive capital allocation

• Elemis can become a €1 billion brand over time vs current sales €250M
  • Strong growth of 30%+ in US and APAC that was offset by culling channel relationships in the UK that were heavily discounting product, finishing the year with 18% growth in Q4
    • Cut orders totaled €8M during FY23, lowering Elemis growth rate by 4pts
  • Significant social media presence with Tribe Media putting Elemis as a Top 10 skin care brand in earned media value in the US and UK
  • Low overlap between L’Occitane’s existing distribution and Elemis creates potential to accelerate Elemis growth
  • Plan to relaunch Elemis in FY24 in China through existing Sephora relationship, TMALL and travel retail
    • Lapping lock down and COVID challenges in China during the last fiscal year
    • Elemis only has a few counters globally in Travel Retail, creating a lot of whitespace for expansion
  • Premium positioning at Elemis makes the brand capable of generating 25%+ operating margins which the brand has achieved in the past
• Grown Alchemist launching across APAC in Summer of 2023
  • Smaller acquisition with completed in Spring 2022
    • Small base of ~€20M sales in FY23 with undisclosed price
    • Minimalist and health-conscious positioning with branding reminiscent of AESOP, which was recently acquired by L’Oreal for $2.5bn
  • Launching in China and Southeast Asia with wholesale channel partners
    • Encouraging initial performance from the travel retail channel creating optimism for the brand in APAC
• L’Occitane believes it’s capable of doing more M&A but doesn’t have a currency at the current valuation
  • Playbook of scaling brands that have strong values and market share in local markets to a global customer base
  • Capital efficient playbook of leveraging relationships with global partners to establish brand momentum in new markets
  • Raising equity that dilutes Reinold Geiger would benefit the stock’s liquidity

4. Margin expansion driven by mix shift into higher value categories and operational improvements

• Highly profitable brands – Elemis, Erborian, and Sol De Janeiro – with margins >20% are increasing their mix of sales, moving from 30% of sales in FY23 to 36%+ in FY24 and 40%+ FY25
  • Every 1% increase in mix from Elemis, Erborian, Sol De Janeiro, and GA sales creates a 10bps improvement in margins
• Margins improvement will be restricted in FY24 as the company makes significant investments in APAC to grow its brands but operating profit will benefit from growth
• L’Occitane’s core banner, L’Occitane en Provence, is improving sales mix into higher value categories such as face care, premium body care, and premium hair care vs core body care lines
• We expect management to address unprofitable brands Limelife and Melvita over the next 1 to 2 years – which could eliminate €10-15M in losses
• Eliminated unprofitable stores in the US during the pandemic through a bankruptcy process which resulted in the closure of 25% of L’Occitanes US store base

Financials and Valuation

With the above thesis points in mind, we believe L’Occitane will see durable revenue growth and margin expansion over the next several years. The key factors driving margin expansion are the growth of high margin business lines, particularly Sol De Janeiro and Elemis, ongoing profit improvement at L’Occitane en Provence through high margin hero products, and the elimination of loss-making brands – such as Limelife and Melvita. As a result, we believe shares will re-rate in line with Coty, but believe there would be room for further multiple expansion if L’Occitane increased liquidity.

Catalyst

• Successful Brand Launches over the next year of Sol De Janeiro and Elemis
• Opportunity to re-list in Europe to improve peer group and widen investor base
• Improved liquidity over time if Reinold decreases his stake will benefit the stock
• We believe L’Occitane is likely attracting private market interest given its valuation, growth opportunities, and brand strength
  • Poor public currency and desire to do grow group may catalyze a deal