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Sep 1, 2021
[5 min Read]
Previously, I posted my deep thoughts in regards to $COTY in a reddit post 7 months ago. Since then the stock is up around 50%. I am posting this update here because I think it is important or prudent to follow up with a complicated story like COTY. Many in the industry like to chase things not realizing that sometimes good things take time to play out. I know we all want to make 100% returns daily, who does not, but I see COTY as an excellent long-term hold that offers a very safe business model, with some high-quality brands and operated by an extremely competent management. Also, I like to post on REDDIT to get feedback from people in regard to my thoughts or thesis in a constructive way. I like it all the good and the bad, it keeps me humble and honest.
Nevertheless, COTY is extremely interesting to me because it has so many moving pieces that even WallStreet analyst are divided as to what the value of COTY is today. COTY was like a beaten up F1 that was ran by an incompetent manager, driver and mechanic (the owner is still the same). So, they hired a new manager (Sue Nabi), mechanics (KKR) and drivers (all the new Execs) and were able to sell some car parts, re-do the entire engine, to perform faster and better on the track but has still not gotten a paint job. So, this is why it is so confusing the new COTY is different you just can't see it yet until it wins a few races and proves that it can compete and win there will be doubt.
The bears have hold ratings but keep raising their price targets every quarter as they are still in denial but have to raise price targets as they can't keep them at $4. The bulls have set targets at $15 and over time will be changing those to $18, $20, etc. as the company keeps executing its plans.
· Management change = change in culture top to bottom (takes time)
· Less Brands = less costs and more focus on a few major brands
· Marketing spend better monitored and spent = better results
· Debt reduction means equity value increases
· Less manufacturing assets = more marketing/branding company
· High margins = more profits for shareholders
· China, Direct to Consumer and extension of products with major brands
If I were to sum up the catalysts for the stock over the next year it would be the following:
· Company continues to beat quarterly revenue guidance and guides up (this is due to better product mix and better marketing)
· Company continues to beat Margin/EBITDA guidance and guides up (this is due to the major cost cutting but also DTC offers better margins)
· Brazil IPO nets them $200 million
· Wella Stake is sold for $2 to $3 billion via IPO within the next 6 to 24 months.
· Company continues to reduce debt, therefore value of equity increases.
· Company decides to re-instate dividend within the next 12 to 24 months. I think they should do it next year until.
If you notice in my summary model I have a $17.60 price target by August of 2022 as you all know this is my opinion and NOT a certainty. This valuation was based on a multiple of EV to Revenues ranging from 2x to 5x with an average of around 3.5x EV to Revenues for a business like COTY. If you notice the industry leaders like Estee Lauder and L'Oreal are trading at 7x to 8x EV to revenues and because COTY is no where near the level of GROSS MARGINS, EBITDA MARGINS and NET PROFIT MARGINS of COTY that means it deserves a discount, I used a 50% discount to peers. Now, you can argue that the company should trade at a premium to that in the short-term as the company keeps improving but I like to be more on the conservative side of things. It is what helped me make the decision to start buying the stock at $2.75 last year.
The next model you will see is a 10 year model which I like to do because it lets me see how the numbers can really improve. I know that this is never going to be accurate but what we CAN see are things like CAPITAL EXPENDITURES run rate or how the split of marketing will be higher over time but that all of the cost cutting they have done the past year or so is going to show on the General and administrative line starting next year and the year after. To be able to cut hundreds of millions of dollars in costs during COVID and before given the expertise from KKR is mind boggling. It also lets me see where the growth is coming from or CAN come, ASIA/CHINA.
Nevertheless, these models will change every quarter but I like to see how the business can APPROXIMATELY look like over the next 5 to year years. For example, in this model it does NOT show what happens to the DEBT if the company does sell the 40% stake of WELLA via IPO which has a high chance of happening within the next year or so. This is being valued at $1.3 billion but I think it can be $2 billion or more if they hold it for longer as the market realizes the value of that business, it is a true gem. Also, the company just announced that they want to sell between 20% to 40% of the Brazil division via IPO and seek around 200 million USD. I found this move to be very interesting as it is a KKR type move to extract some value out of an asset but also I think a very good political move as things are very shaky in Brazil on the political side of things and there could be some risks in the future so them taking out cash now while things are hot, I think is an excellent move for shareholders.
In conclusion, I still think COTY is a buy for people who give a damn about owning a piece of an amazing business. I think many will be surprised how this company will keep surprising people for years.