Coty Inc. (COTY) Q1 2024 Earnings Call Transcript

Good morning and good afternoon, everyone. My name is Todd, and I will be your conference Operator today. At this time, I would like to welcome everyone to Cody’s First Quarter Fiscal 2024 Question-And-Answer Conference Call. As a reminder, this conference call is being recorded today, November 8th 2023, at 7:30 AM Eastern Time, or 1:30 PM Central European Time. Please note that on November 7th at approximately 4:30 PM Eastern Time, or 10:30 PM Central European Time, Cody 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 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 expectations reflect certain adjustments as specified in the non-GAAP financial measures section of the company’s release. We will now open the line for questions. Our first question comes from Nik Modi with RBC Capital Markets. Please go ahead, your line is open.

I actually had a bigger picture question. Sue, when we recently met in person a few weeks ago, you were very excited about the innovation program at Coty. And I wanted to ask a broader question about skincare and how you think about skincare holistically in the sense that topicals is one thing, but what about injectables? I’m just curious how you think about the category going forward.

Hi Nik, thank you for your question. Indeed, as you say, the bigger and the broader picture. I think what we have shared with all of you several times is that the skincare market, and by the way, the beauty market generally speaking, is going in the direction of medicated beauty, and this is something that we see very strongly. That is the reason why we have decided to reposition some of our brands quite strongly in this area. If you allow me, may I remind everyone that we just launched the Orveda skincare line, featuring the first serum that uses technologies inspired by the medical world, which we call phenolytics. This is the first time a skincare brand is using such technologies in a topical cream. On Lancaster, the story is resonating very well with the idea of using vectors, liposomes that penetrate deep inside the skin, which is making the brand resonate with Chinese consumers. And also in the U.S., we have decided that this brand will stand for wisdom in the crazed world of dermatologic ingredients. As you can see from my words, it's all about a kind of medicated beauty. In beauty, we're using ingredients and formulations that act on the upper layers of skin without penetrating deeper. So when considering injectables, you clearly see this booming trend with other companies selling products that are designed to relax muscles without naming any brands, products that involve injecting galacturonic acid into the skin, vitamins, or medical devices that lower the penetration time of active ingredients. So you are right; this is the direction the overall market is heading, but we have some limitations when it comes to selling skincare from a beauty brand that does not require long-term testing like a medication or drug would require. Ingestibles, on the other hand, seem like the trend that keeps getting called the year but doesn't actually gain traction. My gut feeling is that this category requires strong R&D because many people believe that what you ingest will be digested by stomach enzymes. At the end of the day, what is the difference between eating good food and having ingestibles? This is something we hear from consumers—they believe that ingestibles need to demonstrate their ability to deliver the right amounts of the right ingredients to the body, given that they enter through the digestive system. So that's a big picture I wanted to share. I hope I'm addressing part of your question.

Our next question will come from Oliver Chen with TD Cowen. Please go ahead, your line is open.

Hi, Sue and Laurent. You made a lot of great progress with your digital marketing, and the studio we toured was remarkable. What is ahead in terms of how you are thinking about a digital center of excellence, key principles, and platform occasions as you continue to build this capability across your portfolio? Also, as we look forward, what are your thoughts on pricing and the environment? We are seeing a lot of crosscurrents with consumers in many regions. However, you have been on a really good pace with the fragrance momentum?

Hi Oliver, thank you for your question. So again, on digital centers of excellence. You are totally right. Since 2020, we started to create a center of excellence that is based in Paris. It serves as the global center of excellence. We have been catching up, as the company was a bit behind its competitors in this area three years ago, and now it is the right time to benefit from the global knowledge being created in key regions around the world, namely the U.S. and China, to take two examples where the digitalization of the beauty world is quite advanced and fast-paced. This is exactly where we are now. On consumer beauty, we are also accelerating our ability to create locally in different countries, as this has to be local to fit with the culture, language, and local trends. We are creating studios—let’s call them that—in the U.S., UK, and elsewhere. We created around 15 studios dedicated to TikTok or YouTube, where we co-create content with influencers. Just to give you an idea, until recently, we worked with a few dozen influencers behind key launches of consumer beauty maker brands. Recently, we moved to 100 influencers, and we noticed immediate results. For instance, in the UK, we moved from nowhere in terms of EMV and EIT to the top five or six brands, sometimes ahead of best-in-class brands that have been doing this for years. Now, our objective is to triple the number to surpass the threshold of 1,000 influencers reached by our brands. This is what is happening in terms of centers of excellence, first building globally in Paris, and now extending into different countries such as New York, London, and Shanghai where we are talking today. Maybe Laurent can take the second part regarding pricing.

Yes, absolutely. On pricing, first of all, just to remind you, we implemented several price increases over the last two years at the level of mid-single digits, and these price increases went very smoothly and were successful. A clear demonstration of this is that our volumes keep growing. In Q1, our volumes grew. This was incredibly important in our strategy—to ensure no elasticity on volumes, which was indeed the case. Looking ahead, we are very conscious that the cost of goods sold inflation is beginning to soften. So differently, we are focusing on mix management, which is definitely a number one driver to improve our gross margin. You are seeing concrete examples of innovations we are launching; all of these innovations are mix-accretive, thereby driving the average price up. We have also started opening a stream of strategic revenue management—essentially a dedicated team focused on value analysis across all our products to see where we can extract value. This includes reviewing our promotion policies, trade terms, and pricing format. Last but not least, we will continue to implement targeted price increases, more along the lines of low single digits. We have a team of pricing experts, and we are definitely granular in our approach.

Thanks. The innovation sounds quite exciting. Best regards.

Innovation is part of the game. It is definitely part of the mix management. And, of course, we are ensuring high-quality innovations. The shift is heading towards higher concentrations on prestige fragrances, which again drives the average unit price.

And on Consumer Beauty, Oliver, the same thing holds true. The market’s driving force is premium innovation, not entry pricing, which is crucial for everyone to understand. We are accelerating the pace of innovation as the required level for innovation is shifting from high single digits to now targeting high teens.

Our next question will come from Rob Ottenstein with Evercore. Please go ahead, your line is open.

Sue, given that you were in China, I would be remiss not to ask what you are seeing on the ground in China and in Henan if you are there, both in terms of how the consumer is and how the beauty market is recovering, if it is recovering. Also, could you provide additional details on your execution and what is going particularly well?

So yes, we are indeed in Shanghai. We’ve been here for a few days and will remain until the end of the week. It is very interesting to observe how the market is evolving rapidly, especially in the fragrance category. We previously shared that Chinese consumers have shown a keen interest in this category, and the acceleration is remarkable. For context, we launched Burberry Goddess in this country a little after the rest because we believed the scent represented a bold statement, and the reception has been outstanding. The line is now ranked sixth at Sephora, a position we have never attained with any of our fragrances in this country. This fragrance category is growing by 6%, whereas Coty in this country is experiencing growth two times faster than this level of the market. Burberry Goddess is just beginning its journey here, and we predict it will be a game changer. Another significant trend is the premiumization of the market, with niche fragrances representing almost a quarter of the market today in China, which is 2.5 times larger than in the rest of the world. This premiumization trend toward more niche brands selling in standalone stores is rapidly evolving. When you enter these boutiques, it often feels like visiting a concept space or even a museum. This trend is an opportunity for us to enhance our expertise in developing winning niche brands as well as understanding the retail world on a broader scale, especially regarding freestanding operations. We also inaugurated CIIE two days ago, and it was fantastic, especially for Infiniment Coty Paris, which wasn't fully disclosed to the Chinese audience yet. The response from young men and women entering the booth to smell fragrances and guess their names was outstanding. We're very confident in how this line will resonate with Chinese consumers. Makeup in China is also doing well, growing by 10% with our brands, Gucci Makeup and Burberry Makeup, contributing significantly. Face makeup is particularly in demand as consumers seek an optimal balance between pigmentation and skin benefits. Skincare is still the majority of our sales, although this market has seen slight negative figures recently. It's not that Chinese consumers are using less skincare, but rather, a shift is happening between brands. The promotional level reached recently might be at its limit, leading consumers to seek new brands that connect with their needs without excessive promotions. Our brands, particularly Lancaster, continue to exhibit strong performance, especially online. We are adding to our focus in this area with new innovations planned for January 2024.

Our next question will come from Filippo Falorni with Citi. Please go ahead, your line is open.

Clearly, a very strong start to the fiscal year with 18% like-for-like sales growth. So maybe, Sue, can you comment on what drove the upside relative to the guidance you provided in September? You mentioned many drivers in your prepared remarks, but could you rank them in terms of category growth and innovation contribution? Also, thinking ahead at your guidance for the first half, it implies some slowdown in fiscal Q2 to 4% to 8% like-for-like sales growth. So, what is driving that? Was there any pull forward of shipments in Q1 versus Q2? Any color there would be helpful.

Good morning, Filippo. The drivers behind the updated guidance during the quarter include a continuation of the fragrance market's significant growth, at 10%. This shows a fantastic performance, alongside the 10% growth noted for Q1 fiscal 2023. As we've discussed, this fragrance index phenomenon is far from a one-time event; it reflects a profound shift in purchasing behaviors and preferences toward premium items, additionally fueled by social media driving consumption globally. Our performance in the company aligns with this strong market. While the market grew by 10%, prestige fragrances experienced growth at 25%, indicating strong growth driven by multiple innovations, including Burberry Goddess, which has become a Top 6 fragrance in the U.S., and is also achieving similar results in other markets. We have several brands that are not just growing in the high 20s. We have seven brands performing at that level; some are aided by innovation, while others are not. This exemplifies the excellent work we are accomplishing at Coty in the fragrance sector. The second element worth mentioning is regarding the Q2 projections. Typically, Q1 marks a spike in costs; we've had strong innovation support in Burberry Goddess, alongside other launches. Q2 should see more consistent sales as it is traditionally our strong sell-out period, so we expect to maintain our positive trajectory aligning with or slightly surpassing market conditions.

Our next question will come from Korinne Wolfmeyer with Piper Sandler. Please go ahead, your line is open.

Good morning, and thanks for taking the question. Congrats on the quarter. I would like to follow-up on the China Hainan question. Can you provide insight into what you are seeing with selling versus sellout both in China and Asia Travel Retail? If it isn’t normalized yet, when do you think that might occur? Any early reads from 11/11 pre-sales? Lastly, could you share any information on potential pressures due to current tensions in the Middle East that we're observing? Thank you.

Regarding Hainan, our current inventory levels are satisfactory. There isn't excess inventory on our end. We are facing an easy comparative coming off last year, but our fragrance business is exhibiting high growth, showing triple-digit growth rates, so that’s positive. For China, our prestige inventory levels are also healthy. The only slight issue, which is minimal compared to our overall business (90% prestige, 10% consumer beauty), relates to the CB segment concerning moving from one product line to another at retailers. We had to build a slight buffer stock due to this transition, which inadvertently delayed some items from arriving on the shelves. In terms of 11/11 sentiments, we're observing a strong demand for fragrances overall. More than ever, consumers are exploring diverse, unexpected scents, which is promising news as it indicates our capacity to create full lines reflecting the tastes of Chinese consumers as it should be a dynamic market with greater variety. Regarding the Middle East, this portion represents a mid-single-digit portion of our expertise. Presently, we are not observing any negative impacts on our business in that region, but personally, I am saddened by the ongoing violence and continue to hope for peace and the end of suffering, which was an important point to communicate.

Our next question will come from Anna Lizzul with Bank of America. Please go ahead, your line is open.

I wanted to ask about the quarter, as there was a good deal of operational leverage driving the adjusted EBITDA beat. Could you elaborate on the drivers behind this and how you see it developing through the year?

Yes, absolutely. We are carrying on our strategy to ensure this flywheel effect continues—top-line growth, productivity focus, and effectively allocating resources to support our strategic initiatives while growing our EBITDA. The elements driving this performance in Q1 that exceeded expectations include continued top-line growth pushing us to raise guidance, a consistent gross margin trajectory showing flattish performance in Q2, with expectations for gross margin expansion in H2. This expansion will be fueled by our mix management, which we have discussed, productivity improvements, and initial signs of easing COGS inflation as well as transportation costs. We will continue to channel some of those gross margin increases into strategic initiatives like innovation investments, capabilities in digital, and R&D, while confirming our full-year EBITDA margin growth expectations.

Our next question will come from Olivia Tong with Raymond James. Please go ahead, your line is open.

My first question is around your view on margin contribution by segment this year, and whether you think one division is expected to perform better than the other. Are both divisions expected to grow margins this year in light of the trends observed in Q1? Prestige margins are rising; however, consumer beauty remains down year-over-year. Moreover, could you outline your plans for price increases and your perspective on elasticity and volume trajectory for this year as those price increases come into effect?

Thank you, Olivia. You're correct that prestige is showing notable improvements in profitability, while consumer beauty is experiencing a slower pace of growth. The growth we are witnessing in consumer beauty with a 10% top-line growth is primarily due to very strong performance in body care, which weighs down the overall gross margin. While this shows positive absolute growth, it impacts gross margin negatively. However, we are actively working to enhance the gross margin in consumer beauty. The body care performance in Brazil has been notably strong from a gross margin perspective. We're also leveraging a productivity plan that platforms our innovations across brands, yielding significant savings and enhancing profitability over the following quarters. Alongside this, we are conducting a deep-dive analysis of consumer beauty's value, identifying substantial value opportunities. To answer your second question on pricing, we've executed strong pricing strategies, which have been well-received, leading to minimal impact on volumes. We are implementing targeted price increases in response to insights derived from extensive analysis, ensuring their effectiveness and maintaining sales momentum.

Our next question will come from Andrea Teixeira with JPMorgan. Please go ahead, your line is open.

Thank you for taking my question, and good night there in China. On the Consumer Beauty segment, you mentioned several initiatives. We saw improvements in market share. Should we expect velocity improvements? I remember you mentioned how the shelf space looks ahead, particularly with the upcoming spring resets in the U.S. and UK. How should we think about Consumer Beauty recovering there? When retailers see improvement, they will likely reconsider shelf space decisions for calendar 2025. Lastly, with the investments, we've seen overhead in SG&A total around $740 million per quarter, which ramps up to about $800 million. Is that the level we should project?

Andrea, I will let Laurent address the last two questions, which have shorter answers. Then I will tackle the question on Consumer Beauty, which requires more detail.

Certainly, Andrea. Regarding Wella, I want to provide a full picture. The first element is that we expect to see a very strong cash flow trajectory in the first half of fiscal 2024 and throughout the fiscal year. This gives us confidence to manage our leverage ratio effectively. The second factor is our successful dual listing introduced in September, which helps accelerate our deleveraging. To clarify, the recent developments concerning Wella are not about pricing misalignments, as the due diligence conducted confirmed the company's value. There were minor misalignments related to certain minority rights, but it's important to stress that this doesn't alter our plan—we're still targeting a complete divestiture by the end of calendar 2025. Wella's value is confirmed, as reflected in our records. Regarding SG&A, the key point is that while we are investing, we are growing our SG&A below our sales growth. We are also ensuring investments in our digital capabilities and R&D, balancing productivity measures while creating who value for the business. So that outlines how we manage those elements. Now, on Consumer Beauty, we are diversifying our sources of growth. Currently, a significant portion of our sales comes from color cosmetics, but we are also building the ability for Consumer Beauty to develop mass fragrances. We observe that, globally, there’s demand for fragrances at various price points. This sector is critical for our division as these fragrances offer relatively high margins. We're accelerating premiumized innovation, exemplified by recent launches under brands like CoverGirl, which aim to not only solidify our position but also attract younger audiences. We have been strengthening our brand foundations toward millennials and Gen Z while developing an influencer-driven advocacy marketing strategy around these innovations. Presently, CoverGirl is closing the gap compared to market growth rates; in brick-and-mortar scenarios, we observed a reduction in gap from 8 to under 3 points recently. Online, we see CoverGirl significantly outperforming its category on Amazon. Regarding shelf space, we anticipate stability in our brands’ shelf presence during the spring resets. The objective is to leverage our strong innovation pipeline to regain and potentially grow that space as time progresses.

Our next question will come from Charles Louis Scotti with Kepler. Please go ahead, your line is open.

I have three questions. First, I was impressed by your performance in Asia Pacific. What were the driving forces behind your strong results in the region, particularly compared to your competitors? Specifically, what drove your travel retail channel strength? Can you provide a breakdown of travel retail business by geography? Secondly, regarding inventory, one of your competitors based in Paris mentioned that retailers have rebuilt their inventory levels since supply chain tensions have eased; what’s your perspective on inventory levels across Europe and the U.S. and is the expected deceleration of Q2 growth related to destocking? Lastly, I wanted to circle back to your H1 guidance, which indicates 5% to 8% organic growth for Q2. Was this cautious guidance, and do you have insights on the sellout trends for October and early November suggesting a deterioration?

Hi Charles, this is Sue speaking. Regarding the performance in Asia Pacific, particularly travel retail, this business was mainly an entry prestige fragrance seller two to three years ago. We decided to shift our strategy and capitalize on the whole fragrance spectrum, focusing on prestige fragrances, and that has allowed significant growth. Calvin Klein is one of our fastest-growing brands in this channel. We've also integrated premium brands like Burberry Goddess and Chloe, alongside niche offerings. This full lineup drives growth across different price tiers. We also have three makeup brands—Kylie Cosmetics, Gucci Makeup, Burberry Makeup—that are performing well. This growth in the channel has been quite impressive; fiscal 2023 ended with a 30% growth in travel retail, and we continue to achieve about 20% growth. We’re still below pre-pandemic traveler levels, particularly Chinese travelers—I believe we're at around 30% of prior levels. There’s still potential for further growth ahead should those levels normalize. As for trade inventory in Q2 and broader inventory levels right now, Laurent can provide more insights.

In terms of inventory, we're not seeing any slowdown translated into destocking in October. The inventory levels seem healthy, considering the growth we've experienced. To clarify further, Q1 was particularly strong due to our innovation advancements, prompting a natural refill from retailers regarding the successful product launches. As a result, the strong sell-out we anticipate in Q2 correlates with this trend, allowing us to see notable performance, particularly in prestige markets.

Our next question will come from Chris Carey with Wells Fargo. Please go ahead, your line is open.

Hi, everyone. Just a few quick follow-ups. Regarding the pricing strategy, Laurent, I assumed there would be mid-single-digit increases coming in February and March, but earlier you mentioned low single digits. Is the expectation for less pricing due to the strong performance of the mix? Additionally, about obsolescence—was that simply due to a buildup of inventory in preparation for sell-in that fell short of expectations? Any insights would be appreciated, especially in light of the strong results.

Certainly. I want to clarify the earlier statements. We have never stated mid-single digits as our expectation for February; I want to make that clear. We are indeed seeing low-single-digit increases this year, but this reflects our careful monitoring. The robust mix and the effects from our accretive innovations contribute positively to our pricing approach. As for obsolescence, it seems to be a mechanical accounting effect related to previous demand levels; we had a very low inventory coming off last year due to service-level issues. Hence, we rebuilt inventory levels strategically to ensure we could meet demand and achieve high service levels, currently around 96%. This approach is key to optimizing sell-out success.

Hi, this is Sydney representing Ashley. Can you share your insights on the promotional environment as we approach the holiday season?

Peter, do you want to address this?

Yes, overall, the sellout levels are very strong, and we are experiencing robust demand, which reflects premiumization across both prestige and consumer beauty. The innovation we’re unveiling carries higher value and price points. Consequently, we are not seeing any uptick in promotional activities this year. To elaborate, owing to past service-level issues, our turnover ratios fell last year, necessitating a return to normal levels for category activation. Therefore, we have no concerns regarding promotional activities either increasing or affecting overall performance.

Before we conclude, please allow me to share some final remarks. Firstly, we are pleased with the strong Q1 results, which set a positive trajectory for fiscal 2024. We're excited about the many opportunities that lie ahead for the company. We also want to express our gratitude for the continued confidence and support from all our analysts and investors, as our recent institutional investor rankings place Coty among the leading mid-cap companies in our sector.

Thank you. This does conclude today’s call. We appreciate your participation. You may disconnect at any time.