Earnings Call: Q1 2023

Nov 8, 2022

Good morning, ladies and gentlemen. My name is Gretchen, and I'll be your conference operator today. At this time, I would like to welcome everyone to Coty's first quarter fiscal 2023 question and answer conference call. As a reminder, this conference call is being recorded today, November 8, 2022. Please note that earlier this morning, Coty's issued a press release and prepared remarks webcast, which can be found on its investor relations website. On today's call are Sue Nabi, Chief Executive Officer, and Laurent Mercier, Chief Financial Officer. I would like to remind you that many of the comments today may contain forward-looking statements. Please refer to Coty's earnings release and the reports filed with the SEC, where the company lists factors that could cause actual results to differ materially from these forward-looking statements. In addition, except where noted, the discussion of Coty's financial results and Coty's expectation reflects certain adjustments as specified in the non-GAAP financial measures section of the company's release. With that, we will now open for questions. If you'd like to ask a question at this time, please press star and one on your touch tone phone. You may remove yourself from the queue at any time by pressing star two. We'll take our first question from Ashley Helgans from Jefferies. Hey, good morning, and thanks for taking our questions, and congrats on the quarter. To start, it was nice to see China return to growth. Can you just talk about some of the drivers in the region and your expectations for recovery for the balance of the fiscal year? Thanks. Yes, good morning, Ashley. This is Sue speaking. Yes, China is slightly positive, which is in a way a good news for us, even if this region of the world and this country is only 4% of our net revenue. In a way, we are protected against all these lockdowns that we've been seeing since a few months now that are continuing and that we do not see improving in the coming quarter and probably quarters, if I may. At the same time, starting from a small base, sorry, Coty is seeing a lot of potential of upside in this country, of course, with the fragrance business. Again, I'd love to remind everyone that this business in this country is only 3% penetration. Our brands, if you think about Chloé, that's the number one niche brand at Sephora, Gucci, Burberry, Calvin Klein, Hugo Boss, all these brands that are doing fabulously well globally, are growth engines for the near future and the, I would say far future for the company, of course, as you can imagine. On makeup, again, we started, you know with, Gucci makeup and Burberry makeup, and both brands had a fantastic start before lockdowns. This is the category I would say that the most impacted by the recent series of lockdowns. Last but not least, skincare. 70% of the Chinese market of beauty. Huge, huge potential for the company, as you can imagine. There we are starting with the first brand, which is Lancaster. As you've seen during the presentation, Lancaster in Hainan saw its sales multiplied by 5 year-over-year, which is a great demonstration of the desirability for the brand towards the most demanding Chinese consumers. This is one. Second, Lancaster, which is at Sephora as a niche exclusive brand until recently, is, you know, the number one niche skincare brand at Sephora in China. And this gives us a great confidence, specifically after the Investors' Day that we've done 1 month and a half ago, to start with this brand as the first, I would say, foray into the big, huge skincare market in China. This is the way I would describe the situation in terms of how we are, in a way, doing quite okay in China despite all this, very difficult environment. Great. Thanks. If I could just throw in one more. We're starting to hear about some, you know, trade down in some beauty categories. We're curious if you've seen any of these trends within your consumer division and overall expectations for the consumer division if we do go into a recession. Yes, that's a good question that we hear a lot. Honestly, we don't see any kind of trade down nor slowdown, by the way. No trade down at all. If you see our prestige division, in a way, we are running after supply, you know, because the market is booming. This is what we love to call the fragrance index, because our innovations are doing fantastically well, and we see it also in the way retailers are ordering, you know, from us, including sometimes ordering in advance during Q1 for the Q2 season. On this part, we don't see this. The second element is that our consumer beauty business, as you've seen in the figures, plus 12% like for like, is doing also fantastically well. This is thanks to, you know, the great work that the teams at Coty have done behind the different brands, making sure to take these brands from large heritage, you know, brand that people trust into still the same qualities, but on top of this, what we call cool brands. I'd love to talk about smart shopping also. A lot of consumers are also shopping there saying, "This brand is a cool brand, and it proposes products that are the quality of other products that are more expensive." Therefore, you can see that in both divisions, the premiumized beauty, be it the desirable one from luxury or the cool smart purchase in consumer beauty. These two premiumized parts of the business are doing great, and this is what explains, in a way, the results that you see across both divisions. Our next question comes from Anna Lizzul from Bank of America. Hi, good morning, and thank you so much for the question. On the mass beauty side, some of your competitors are gaining shelf space at key retailers domestically, such as Walmart and Target and the drugstores. Just as you're continuing to stabilize and gain market share, can you talk a bit about your distribution of brands such as CoverGirl, and are you happy with the current shelf space of the brand? Is there any opportunity to gain shelf space from struggling brands such as Revlon? Thanks. Yes. Hi Anna. Good morning. Thank you for your question again. When it comes to the shelf resets for the consumer beauty division, I would say that for spring 2023, which is, you know, the next I would say slot, we expect to maintain a stable shelf space for our consumer beauty business globally. We also expect, at the same time, pockets of incremental shelf space gains, particularly in the UK, driven by the outstanding success behind Rimmel Kind & Free, new vegan and sustainable line of makeup, mascaras, and powders. Also behind Sally Hansen, that's seen in many markets, as you know, the undisputed leader of the nail business, and therefore many countries are now giving more space to Sally Hansen. Last but not least, Bourjois, which we have very successfully repositioned recently. You know, remember, Bourjois has the number one selling mascara in a very competitive country like France. Bourjois is re-entering several markets, including recently U.K., where the brand is exclusive to Superdrug and doing very, very well over there. We also expect incremental gains for CoverGirl in a mix of tracked and non-tracked channels. This is, I would say, the overall picture that I can share with you when it comes to the shelf space, you know, future movements. Thanks very much. Our next question comes from Nik Modi, from RBC Capital. Yeah. Hi, good morning, everyone. Good morning, Nik. The question, two questions. One is just more of a housekeeping item and trying to understand what's actually happening with glass. I mean, if you can just provide, you know, what's actually the derivation of the supply shortages. Then the bigger picture question, I'd love your kind of big picture thoughts on this. It looks like the fragrance category is shifting, you know, away from gifting and more towards kind of self-consumption, at least from what we can see. I'm just curious how you know, do you agree with that statement, number one? How does that change your strategy as you move forward to kind of keep the momentum going? Yes, Nick, thank you so much. These are two indeed very important questions that we are asking ourselves on a daily basis. Let me share with you the way we see it at Coty. On glass, this is quite factual. In fact, it's really about the reduced number of suppliers doing quality glass. They are not a lot and mainly European-based. This is what explains, in fact, the tension that we are seeing today. This tension, in fact, is exacerbated by the fragrance index, in fact, and for Coty, by the big success behind our innovations from 2021. This is, I would say, very simply said, the overall picture. Small number of suppliers, booming category worldwide, and booming innovations at Coty far above, you know, our best expectations from last year. This is what explains this, I would say, tension around glass. When it comes to the fragrance business and the shifting away from gifting to self-consumption, this is absolutely true, and this is great in a way for our business, because as you can imagine, our, you know, self-consumption of, you know, fragrances is much more dilutive for us than gift sets, which are dilutive in general. That's a great, I would say, sign of a category whose penetration is increasing. We are less into, I would say, the classical consumption of gifting, which people do automatically year-over-year, and we are more into, "I'm buying something for me. I'm buying something if I am a young Gen Z that I'm going to show on social media, or if I am, you know, any other consumer I'm going to wear, hopefully for the remainder of the year or for many, many years." This shift is clearly a structural shift that we are seeing, and the best demonstration is the fact that people are buying more and more, I would say, expensive items. They are moving strongly from eau de toilette to eau de parfum. Eau de parfum in larger sizes, which is clearly another demonstration of self-consumption. Second, a lot of them are moving from the eau de parfum into what we used to call the niche category, which I do believe is not anymore a niche category, given the growth and the size this category is starting to have in many, many areas around the world. This is clearly what is at play behind the famous fragrance index. You can relate this to, of course, social media. I have to say too also a heightened quality from U.S. suppliers of fragrances. You know, there used to be years and years where the beauty industry, including on prestige, was launching fragrances that were honestly not at the right level of quality. Since maybe seven, eight years, this has been corrected, probably because of niche brands showing the way to most of the other brands. Today, the heritage brand captured that totally and very strongly, and this is what we are seeing today in terms of fragrance index. That's sometimes called the wellbeing index, and I think it's totally right. Our next question comes from Andrea Teixeira from J.P. Morgan. Hi. Good morning. This is Shimei Fan from, speaking on behalf of Andrea. Okay. I was wondering about like low single digit pricing in the beginning of calendar year 2022, mid-single pricing across the portfolio in like late summer and another round of like planned low single digit price increases in full fiscal quarter third. Are you assuming volumes will be declining in the current guidance? Thank you. Well, hello. Absolutely. I mean, it's important indeed to remind that we anticipated, and this is something that we built more than a year ago. We built a pricing office exactly to be able indeed to implement price increase. And this was, of course, absolutely needed to mitigate, to offset, inflation. You've seen tangible results as we are growing gross margin by 70 basis points. Indeed we did pricing mid-single digit recently, and we continue. We are not seeing any volume decline. Definitely, when we are doing this price increase, we do it in a very granular manner. We are taking opportunity also of the great momentum that we're having on our brands and the support that we are putting on our brands and also great innovations. It's really part of all these equation that we are doing. The tangible result is that our volumes fragrance are growing and volumes in consumer beauty are growing. Thank you. Your next question comes from Olivia Tong from Raymond James. Good morning. Thank you. Wanted to talk a little bit about the shortages hitting fragrance and where you stand relative to the past in terms of the glass quality and what have you. To what extent you think it could impact holiday, your ability to supply gift sets during what is obviously an important period, continuing. Thanks. Hi, Olivia. Definitely. We confirm our guidance 6%-8%. You see there is no change on our guidance either for H1, 6%-8% excluding Russia or full year. We confirm the 6%-8% growth excluding Russia. This is following a strong Q1 as we just published. The demand is very strong. At the same time, indeed, we are monitoring very closely all the tensions that we are facing on components. Fragrance, yes, is the number one tension that we are seeing, but we are seeing also, as all our peers, also tension on caps and to some extent on pumps. We are monitoring tightly, but despite this tension on components, we are confirming our guidance H1 next year. Got it. Thank you. Can you give any color into what you think the impact of the glass shortage had on the results this quarter? Broadly, just in terms of SG&A, I mean, this is the best performance, the lowest SG&A we've seen in several years, even prior to COVID. Can you just talk about the SG&A opportunity in front of you? What's driving that improvement this quarter, particularly against what you know arguably a bit more of a challenging comp for you guys? You know, the comps obviously get a fair bit easier as the year progresses. Just if you could talk a little bit about the SG&A opportunity in front of you, that would be fantastic. Thank you so much. Yes. Good morning, Olivia. I'm going to take the first part, which is around the impact of the shortages on the results in Q1. Again, you know, our mass service level is in the low 90s, which is, you know, quite good compared to what we are seeing around us. On prestige, it's roughly under 80%, which is not good, if I may say, but in the same level of our peer set, so we're not worse than the others, but we're not better than the others. I can just give you how much, you know, the potential of our prestige quarter would have been if we didn't face this kind of, I would say, limitations. The sell out for prestige in the quarter was in the low teens, and the performance of the division was 7% like for like excluding Russia. This gives you an idea of how strong is our fragrance business at the moment. Thank you. On Olivia, on your second question on SG&A, there is one specific element you need to consider, which is the Forex. As I highlighted during my presentation and a few times, we have, of course, a very significant Forex headwind on top line, and we say, you know, it's about 6%-8%. But on P&L side, I shared also that we have a natural hedging in Coty because we have cost of goods which are sitting in Europe. We have factories in Europe. It's also the case on A&CP and SG&A because we have teams in Europe. To be more specific on SG&A, we have HQ in Amsterdam, we have also a team in Paris, and we have also a sizable team in U.K. There is a mechanical effect of currency which is lowering SG&A in reporting numbers in dollar. Having said that, we keep working, of course, on SG&A reduction. This is completely part of our All In to Win agenda. We keep this work, we continue, and definitely we amplify and we have some additional initiatives, especially on support function to continue, you know, how to have a nimble organization within Coty and to manage our equation. Our next question comes from Steve Powers from Deutsche Bank. Yes. Hey, good morning. Thank you. It's just on the full year reaffirmation of guidance, it sounds like you've assumed, you know, more or less current consumer demand conditions remain intact. I guess within that, I'm wondering if you have, you know, any allowances embedded, you know, for even modest demand slowing or allowances for retailers to potentially pull back in inventory, if they foresee potential slowing, you know or alternatively, what levers you have at your disposal should those conditions arise. Thank you. Hi, Steve. Indeed, we confirm our full year guidance top line 6%-8% and the EBITDA guidance $965-$965. Obviously we confirm our roadmap towards 4x leverage ratio by end of calendar 2022. Indeed we are, as Sue shared and mentioned, and you see confirmation in the numbers, we are not seeing any slowdown in the demand. Even in Q1, as we just shared, I mean, the demand and the sellout is even stronger. Definitely there is good momentum on consumer beauty and prestige. We are not seeing any slowdown and all the plans that we have in place give us full confidence about this momentum and this dynamic. At the same time, definitely, we are monitoring really all the actions that we have been All In to Win are giving us also some ammunition to manage and to mitigate the equation. This is really the way we monitor. Also, on your specific question about retailers destocking and so on, what we are seeing definitely we are not seeing any destocking. I mean, even in the context of supply chain tension, we are seeing more of a need really to fulfill and really to push for selling. This is what we are seeing in Q1, and we see currently. Okay, that's very helpful. If I could, I have to ask on Gucci, because while you and Kering at this point have both acknowledged that license has a number of years left remaining, you know, Kering, as I'm sure you know, continues to talk pretty openly about work they're doing to potentially take that license, that business back in house over time, even if years down the road. I guess I'm just wondering if there's anything you can, you know, additionally offer on the current standing of that relationship, whether renewal ultimately is at your discretion or Kering's and if it's at theirs, a question I keep getting from investors is how that impacts your willingness to continually invest in a franchise that has been, you know, central to your ambitions, especially in prestige makeup, et cetera, you know, with the risk that that portfolio may, you know, one day revert back to the original brand owner. Just how you're thinking about that. Thank you. Yeah, thank you, Steve, for this question. Again, first of all, again, what we have heard is that beauty is a very attractive category. This we see it of course even more today, given what's happening around us and specifically the fragrance index. It makes sense that others would do some initial work on that space. What we have heard has nothing to do with Gucci, if I'm not wrong. We hold the license for the long term as confirmed by Kering themselves, and there is also no mechanism for an early exit. The other thing I want to share with you is that this is one of the growth engines of the company. It's certainly not the only one. I can tell you that the success we are seeing behind our prestige division is clearly widespread across the different brands. Every quarter we have a new brand, thanks to the work we are doing, yeah, that's joining the pack of growth drivers into the company without even talking about skincare. That's the biggest upside potential for the company, I would say in the coming years. Last but not least, I can tell you that the relationship between us and Gucci is fantastic, I have to tell you. The results we got behind Gucci Flora Gorgeous Gardenia last year and Flora Gorgeous Jasmine this year are unprecedented as you've seen it during the presentation today. I was last week in Singapore and together with Marco Bizzarri, and we made the opening of a beautiful, fantastic new boutique in the middle of Singapore. Our next question comes from Rob Ottenstein from Evercore. Great. Thank you very much. Apologies if you covered this this morning. You're saying you're not really seeing any weakness. Can you kind of break that down into Europe? You know, given everything we hear, right? About a context of extremely increasingly strained consumer, maybe touch on a little bit more on Max Factor and Rimmel, you know, what you're seeing there. And then also, you know, if you can touch on travel retail, your initiatives in travel retail. Everywhere I travel, I do, you know, absolutely see more and more of your brands. So maybe talk a little bit about that and how they see the December quarter, outside of Hainan, in terms of increased traveling and the impact on your business. Thanks. Yes, good morning, Rob. Thank you for your question. Again, I confirm that we are not seeing any weakness, including in EMEA. You've seen that EMEA is growing double digits. Part of it is, of course, travel retail, that's doing fantastically well. I come back on this part later in my answer. On the fragrance part, you know, Europe is doing also very well. Our brands are doing very well. Recently, we even saw France, that used to be an entry prestige market, mainly moving towards premium or ultra premium slash luxury fragrances, which is a first and says a lot about where consumers are going, including in the biggest country in Europe, which is France. When it comes to our consumer beauty business, you're right to point out that Max Factor and Rimmel, these are the two brands that are, in a way, strongly taking our market shares up. Rimmel, again, we've presented to you the plan of Rimmel, which was first to lead on clean beauty, which has done fantastically well thanks to Kind & Free, which is today representing more or less 10% of the net revenues of the brand and a big success in many, many parts around the world, opening the brand to the younger generation in a massive way, I have to say. Remember, I spoke to you about how we are learning quickly how to create products that can become TikTok sensations. Thrill Seeker, the latest mascara from Rimmel, is exactly the embodiment of all of this. It was created with TikTok in mind by TikTokers that we have in-house and with TikToker in part of the TV commercial as you've seen it a few minutes ago. The result is that Thrill Seeker is the second mascara of the UK market and the biggest mascara launch for Rimmel since many, many years. On Max Factor, the brand is gaining market share consistently and globally. This is thanks to a strategy that's very well developed between base business and new innovation. This brand, once it has been repositioned towards late millennials and Gen X, is doing fantastically well its job, which is to capture this audience that has the spending power, that is more sophisticated, and that is looking for products that stand the test of time. This is exactly what Max Factor is all about today. Last but not least, the last part is about travel retail. Even if travel is still 20%-30% below the levels of 2019, we see this part of the business booming at Coty, plus 30-something% growth. This is thanks, of course, to our fragrance dynamism, the dynamism of our brands, the fragrance index, but also because we added two new legs to this business. The first one is prestige makeup. Think Kylie Cosmetics, that's doing very, very well everywhere we are opening this brand. Also skincare, thanks to Lancaster. That's again booming in Hainan, which is this, I would say, you know, central place now when it comes to travel retail in the Asian region, but also elsewhere. In a way, we do not see, you know, this weakness happening. At the moment, we are really running after rebuilding the stocks behind our fragrance products. Our next question comes from Chris Carey from Wells Fargo. Hi, good morning. Can you just expand on what you mean by modest gross margin expansion in Q2 and for the full year? Laurent, just some of the gives and takes that we should be thinking about as far as tailwinds and headwinds. Hi, Chris. I mean, first of all, I mean, as we are very proud, you know, of the results we delivered in Q1 with 70 basis points gross margin expansion. This is definitely a testament to all the actions that we have implemented. Let me give you a little more color, you know, this is what you are calling tailwinds and the headwinds. The headwind is inflation. It's about 2 points net revenue. It's in line with what we shared last quarter. There are some positive and negative, but all in all, this is quite in line. How we mitigate and we more than offset this inflation, we continue the work on cost reduction, cost of goods reduction. A clear example is, we announced more than a year ago, closure of factory, prestige factory in Germany. This is now implemented, and this is a way to increase utilization rate of fragrance, and this is definitely helping for fixed cost absorption and helping gross margin. We are working also on market value analysis, so is really to reduce, to simplify components, platforming of our products, and this is a powerful way also to reduce costs and to improve efficiency. This is really on the cost side. There is a big element which is mix. We continue. This is what we kicked off 2 years ago, and all the initiatives, all the work we are doing is always focused on mix and the gross margin accretive. This is valid for prestige. This is also valid within consumer beauty. All the new initiatives that we are launching, sometimes some of these initiatives are even, you know, gross margin equivalent to prestige. Number three, which is absolutely key, is pricing. We did a low single-digit% beginning calendar 2022. We just implemented a mid-single-digit% price increase during summer, September. We are implementing a new price increase mid-single-digit% also beginning calendar 2023. You see that all these elements. Thanks to all these elements, we are able to confirm modest gross margin expansion within fiscal 2023. Our next question comes from Lauren Lieberman from Barclays. Great. Thanks. Good morning. I know in the press release, you'd mentioned that, you know, I think the hundredth month for market share gains for CoverGirl. I was hoping we could get a little bit of an update on performance there, some additional thoughts on skincare launch, how that's progressing or really, you know, how you'll look to migrate that to kind of even stronger performance in 2023. A lot of the prepared remarks stay focused on some of the other brands. Thanks. Good morning, Laura, and thank you for your question around CoverGirl. On CoverGirl, it's interesting to give you, I would say, the overall picture and the way I see it. You know, remember when we started to talk about the brand, it was somewhere around September 2020. We were in a way listing the difficulties this brand has been facing for years and years and years. The work that we have done at Coty since September 2020 until very recently was to reposition the brand, to reinforce the brand equity, to make this brand the undisputed leading brand when it comes to selling clean, sustainable, healthy beauty to American people. This has been delivering fantastic results as you've seen it until recently. We got into the supply constraints when it comes to the Lash Blast line, which is a big net revenue maker into CoverGirl, which we went out, let's say, recently, just at the end of the summer. Recently, we are back in stock with CoverGirl with Lash Blast, sorry. In the meantime, what we've done is, of course, we've continued to invest behind the brand, and we invested behind a younger line called Exhibitionist Mascara, which is doing fantastically well, by the way, strong market share, et cetera. This line is not having the same halo effect on the overall CoverGirl market share as Lash Blast used to have. What we are doing now is, now that we solved the supply constraints, we still have a few little ones here and there, but let's say that overall, these are behind us. We are fine-tuning the media mix behind CoverGirl, which is very, very specific. There it's really test, learn, retest, learn, implement. We understood what needs to be done. Hopefully by Q3, and already starting a little bit now, we are playing the playbook of Thrill Seeker, leveraging the power of TikTok behind Lash Blast line. The real, I would say, comeback of Lash Blast into media will happen somewhere around the next quarter. That's overall the big picture I can share with you around CoverGirl. The good news is that all the fundamentals, such as, you know, the demand, you know, the penetration among Gen Z, the penetration among the, you know, Hispanic consumers, has increased dramatically versus, you know, just two years ago. When it comes to skincare has done its job. The part of skincare that we launched a year ago is, as you know, it's stocked in the makeup aisle. So by definition, it was for us a place where we could test, learn, fine-tune again, et cetera. We learned a lot of things that we intend to continue to, you know, implement and progress on this part of the business of CoverGirl, probably here again in quarter three and quarter four. Everything is on track when it comes to CoverGirl, and the brand dynamics and the health of the brand is intact. Our last question comes from Carla Casella from J.P. Morgan. Hi. I have a question on the debt structure. You've got a lot of debt maturing in 2025 and 2026, so I know it's not imminent that you need to do anything, and the rate markets aren't great. Any sense for how far in advance the maturities you feel you would need to address or lengthen your debt structure? First of all, as you rightly said, Carla, we made, you know, the right things over the last two years is to extend debt maturity 25 and 26. We have many years to go and we continue to pay down our debt. This year, confirmation is that our deleveraging agenda is perfectly on track, delivering $400 million free cash flow at a minimum per year till 25. On top of this, we have, as you know, the Wella stake with a value which is $1 billion at a minimum. With all these elements, I mean, we are in full confidence in our deleveraging agenda. With debt maturity 25, 26, we are in a very good place. Okay. Thank you. I'm sorry. Yes. I'm sorry, Carla. Please go. Oh, just one business follow-up. You're doing so well in the prestige cosmetics. You filled out Gucci and Burberry and Kylie. What percentage of sales are those today? Oh, this part of the business is in the low single digits, and so it's still a small portion of our business. Growing, good, but it's small portion of the business. Okay, great. Thank you. Thank you, Carla. Thank you. Thank you, Laurent. Thank you everyone. I would like to, you know, close this Q&A session with some closing remarks, if you allow me. The first one is that, again, we have, you know, shown how much we are all about consistency since 9 quarters in a row now, which is a very important element for us and for you, of course. The second thing is that you will start to hear us talking about a leverage that's going towards 3 times by the end of next calendar year. This is a big step change for Coty as a company. The third element as a closing remark is, you know, the one of ESG. You've seen recently, because we've been questioned a lot by a lot of you around this element, you've seen that the company has been rated by Sustainalytics, you know, in the top quartile of personal products company, which is great news. This is just the beginning of what this company is doing around the sustainability and ESG topic. I do believe that again and again, this is the best and the right moment to enter Coty's investors base. Thank you very much for your attention. Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect.