Description

COTY is aiming for ~100% FCF growth year over year, while producing high single digit like for like revenue growth in both its Prestige and Consumer Beauty segments (as of its most recent quarter FY2Q23). It is clear the turnaround plan is more behind us than in front of us as Sue Nabi continues to execute her plan with consecutive beat and raise quarters. The tone on COTY has materially and noticeably shifted from doubts and negatives to positives in a time when the general market has shifted from positive to negative (company and industry specific details below). At ~11% FCF yield, the stock could roughly double from here in 12-months, and more if held long-term.

A year ago, when I wrote-up COTY*, it was finishing up its fiscal year with record high FCF (using all years of public data) of $500-600 million. 25 days ago, COTY released another beat and raise where FY1H23 FCF was $543 million. That’s aiming at roughly a double growth on FCF. The original turnaround plan dated July 1, 2019 – which you can see in this link https://s23.q4cdn.com/980953510/files/doc_presentations/Coty-Turnaround-Plan-FINAL.pdf on page 17 – was calling for FCF to be ~$1B with a worse leader than Sue Nabi (page 13 for the old management team). Sue Nabi joins more than a year later, September 2020, yet turns the business around to meeting and exceeding all 4 of old management’s targets, on their same timeline whether people notice or not (she has her own targets but it is a testament to her ability to meet old management's targets in less than the time they expected to do so). Reminder that historically – since COTY’s 2013 IPO, approx. ~10 years ago – COTY generated ~$250M-$380M in FCF each year and during those years, COTY traded mostly between $15-$30/share vs. $11/share currently with 3-4x the FCF prospective.

*My previous two write-ups on COTY are https://valueinvestorsclub.com/idea/COTY_INC/4018250796#description and https://www.valueinvestorsclub.com/idea/COTY_INC/0187954217#messages .

Regarding the “turnaround” plan, the earnings calls have now transitioned from doubts and negatives – such as worries of execution, to overleverage, to macro, etc. – to positive, such as “momentum…pricing power…the innovation pipeline.” This can be seen by the first two analysts to ask questions in the most recent call (FY2Q23) about the “momentum” in the business:

“Hi. Thank you so much for the question. Just curious with the momentum you saw in Prestige fragrance in fiscal Q2, we're seeing a nice acceleration in volumes in the Nielsen data since the quarter ended. I was wondering if you can comment on the momentum you're seeing post the quarter and to what extent the supply constraints are affecting this as well? Just wondering if you can comment on the momentum that you're seeing post the quarter with acceleration in volumes and to what extent the supply constraints are affecting it?” (Anna Lizzul Analyst, BofA Securities, Inc – FY2Q23)

This is during a time not only when people are worried about recession in 2023 and 2024 but also quoting the torah, bible or any other religious scripture. For instance, Leon Cooperman on CNBC on 1/5/23 says “the pharaoh had a dream, that dream was interpreted by Joseph, and that dream was that we are going to have 7 lean years followed by 7 fat years, so anyone looking for a new bull market anytime soon is looking the wrong way.” Here is the link https://www.youtube.com/watch?v=I0YA359I1m4 . He isn’t the only one, I’ve (angel) invested in a start-up where the CEO said the same to me. Remember, the average recession is just 10-months in length, considering data going back to WW2, ~77.5 years of data. The point isn’t about market direction, but about the negativity about business prospects and that significant business prospects have been deteriorating.

So again, the tone on COTY has shifted from negative to positive in a time when the general market has shifted from positive to negative. Besides momentum in the business, this analyst asks about the incoming price increases (pricing power against inflation) and “the innovation pipeline” (the beauty business is also naturally defensive in recessions and has strong pricing power against inflation):

“Yes, thank you. Good morning. Two questions, if I could. The first one is just around the price increase that's planned for the end of 3Q, just any further commentary you could offer in terms of where that's targeted, how widespread versus how nuanced the implementation of that pricing will be? Number one. And number two, you mentioned a couple of times this morning just the notion that this year's launch pipeline specifically in Prestige fragrances was primarily composed of brand expansions. And I'm just – I'm curious, as we look out to fiscal 2024, an early peak into the innovation pipeline if that is expected to continue or if next year will be a more of an innovation year that has more, kind of, hero products, bigger innovations, that kind of thing. Thank you very much.” (Steve Powers Analyst, Deutsche Bank Securities, Inc – FY2Q23)

The bear cases and risks remain the same: 1) key person risk, if Sue Nabi were to leave the company, which is not in my control (or almost anyone’s), 2) leverage, which continues to come down meaningfully, 3) execution, which should be proven by now, and 4) volatility, however volatility does not determine risk but requires emotional discipline and conviction in one’s ideas.

However, the catalysts continue to expand and come to fruition. See below.

Catalyst

1) Sue Nabi’s highly incentive compensation package of making her a billionaire continues to come to fruition vs. GOOG, MSFT, and AMZN CEOs worth half of that, 2) the gap between COTY and peers’ valuations continues to shrink, but is still material enough to call a potential doubling in the stock price (and sheer value with growth), 3) though this is helped by not only multiple expansion, but also by the debt pay down story 4) combined with simplification of the portfolio, 5) continued beat and raise quarters, and last by not least 6) continued record FCF according to all publicly available data, and 7) further positives below**.

**Further positives: the business is gaining market share in nearly all to all categories of the businesses, consolidated growing as fast or nearly as fast as peers; and Sue has a great track record and highly regarded in the space. She was the youngest CEO of L’Oreal at 37 years old. “Because you’re worth it” campaign was her work, which “revived” the unit to DD growth. She did the same at Lancôme, bringing it to DD growth and “record turnover of 3.2 billion euros” after declines. She is the founder of vegan skincare line Orveda and skincare is a driver at Coty right now. Nabi is also considered a “marketing wizard.”