Earnings Call Transcript - COTY Q2 2025

Operator, Operator

Good morning and afternoon, everyone. My name is Margo, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Coty's Second Quarter Fiscal 2025 Question-and-Answer Conference Call. As a reminder, this conference call is being recorded today, February 11, 2024, at 8 a.m. Eastern Time or 2:00 p.m. Central European Time. Please note that on February 10 at approximately 4:05 p.m. Eastern Time or 10:05 p.m. Central European Time, Coty 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 now 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 necessitate adjustments as specified in the non-GAAP financial measures section of the company's release. With that, we will now open the line for questions. We will now take our first question from Oliver Chen with TD Cowen.

Oliver Chen, Analyst

On your commentary about a sell-in relative to sellout, what are your thoughts about when retailers might undergo replenishment as that's an issue you're seeing? Also on your comments on China, Travel Retail Asia, Australia, and Consumer Beauty, I mean, how would you characterize the magnitude of the issues relative to what you mentioned? China is not a large percentage of total, but it sounds like things are more cautious there.

Laurent Mercier, CFO

Yes. Thank you, Oliver. Thanks for the question. So just to give you, I would say some insights regarding the magnitude, indeed, as we flagged during the last quarter. I mean, we discussed that we were seeing some pockets of the business where there were some challenges. And we were expecting that these pockets would stabilize, and in fact, we see that they are worsening in Q2. We are talking about 20% of our business, so China, but also Travel Retail Asia, Australia, ANZ, and also Consumer Beauty. So this is really the scope we are discussing. And indeed, the combination of China, Travel Retail Asia, and Australia is impacting our Prestige business in terms of selling by roughly 3 points. This is what you need to keep in mind. And if we look at the Consumer Beauty side, we are also seeing challenges in U.S. Consumer Beauty, which is impacting by 3 points. These are really the two areas of disruption, if I can call them that way. At the same time, we had good sellout in Prestige, especially in Fragrance during the holiday season, but we are seeing low replenishment from retailers. They are managing their inventories very cautiously, which indicates the gap between the sell-out and the sell-in. For example, on Fragrance, we see a sellout being between the mid- to high single digits, but we are seeing selling below due to this cautious behavior by retailers. However, the sellout is very healthy.

Sue Nabi, CEO

And Oliver, this is Sue. Just to complement Laurent's answer. We don't see this replenishment happening in H2. That's what explains our prudent guidance, and we hope that this will happen at some point, especially given what Laurent described, which are the very strong sellout we saw during the holiday season, and we continue to see behind our Fragrances in both divisions.

Operator, Operator

Our next question comes from Rob Ottenstein from Evercore.

Robert Ottenstein, Analyst

You obviously touched on it in the release. I was wondering if you could go into a little bit more detail on both the structural challenges that you're seeing in U.S. color cosmetics and the competitive challenges and how you look to combat those going forward?

Sue Nabi, CEO

Yes, this is Sue speaking. So indeed, you're right; you mentioned some structural challenges. Some of them are challenges at the moment, specifically when it comes to the closures we are seeing in the pharma drug store environment. So it's not just structural, but a bit of these challenges is indeed structural. The color cosmetics category is healthier in Prestige; it's the combination of both heritage couture brands and indie brands, which is not what we are seeing today in the Consumer Beauty color cosmetics space, where only new brands are favored, and these new brands cannot make up for the market decline. It takes two to dance, and I believe that the strength of the market relies on Heritage brands, which are still doing the majority of the sales. I believe that the color cosmetics market, specifically in the U.S. and elsewhere, would benefit from a balance between Heritage brands and new indie brands. This is part of our discussions with our partner retailers. If this occurs, I see no reason for the color cosmetics market not to return to its traditional low single-digit growth.

Operator, Operator

Our next question comes from Filippo Falorni with Citi.

Filippo Falorni, Analyst

You talked about some of the weakness coming out of fiscal '25 persisting potentially in the first part of fiscal '26. At the same time, you're expecting an improvement in sales growth in fiscal '26. So can you comment on the levers that you have in fiscal '26 to accelerate organic sales growth, and how should we think about the year relative to your medium-term outlook of 6% to 8%?

Sue Nabi, CEO

Thank you very much, Filippo. First, let me remind everyone that this half and the second half is compared to our best year ever. Fiscal '24 was a year where the company experienced the highest growth potential in Prestige at 18%, and the highest growth ever in the Consumer Beauty division at around 7%, if I recall correctly. This explains how high the comparative has been for us regarding fiscal '25. In fiscal '26, we hope to see retailers return to more normal inventory levels because they cannot keep their inventory at this level indefinitely. This reflects an overreaction to post-supply chain crisis stocking a year and a half ago. Hopefully, there will be some stabilization. Our market is driven by offers; some competitors speak about stimulus, but we focus on an offer-driven market. We anticipate two significant blockbuster launches for fiscal '26. Coty has been launching some of the best performers in the industry, with Border continuing to grow by double-digit percentages year-on-year, which is unprecedented. The #1 volume launch in the U.S. and U.K. is Marc Jacobs, which has become the #1 brand of the division and the company. It's an offer-driven business. We have significant innovations in the first half and the same in the second half. We are also accelerating our distribution for key Prestige brands in the U.S. and emerging markets, which will help us return to growth in fiscal '26, combined with hopes for more stable retailer inventory levels and improvements in Travel Retail in Asia and China.

Operator, Operator

Our next question comes from Korinne Wolfmeyer with Piper Sandler.

Korinne Wolfmeyer, Analyst

I'd like to understand some of the puts and takes of the margin outlook a little bit better. Can you describe a little bit the fixed versus variable cost structure you're dealing with for the back half? How much deleverage you're baking in and how much reinvestment in A&P and innovation? And also, I believe in the prepared remarks, you discussed some softer promotional activity last quarter. Is that something you might decide to pull on a bit more in the back half to help drive volume performance? Or are you committed to other forms of volume activation?

Laurent Mercier, CFO

Yes. Thank you. First of all, I want to highlight that we are showing in fiscal '25 and in H1 that we have a very healthy P&L and balance sheet. The results indicate that with gross margin expansion in H1, close to 200 basis points, we reached nearly 67% gross margin at the end of Q2. This shows that all the work we are doing in managing the full equation is done in a disciplined manner. We maintain strong focus on gross margin expansion, a key performance indicator as it fuels our brand investments. Now looking ahead and regarding gross margin, we had strong gross margin expansion in H2 last year, around 160 basis points, which set a high base for this year. Our H2 gross margin will be slightly lower than last year due to that base but will remain 100 basis points above fiscal '23 gross margin. This forecasting suggests a full-year gross margin improvement of about 100 basis points. The revenue structure combines productivity with favorable pricing effects, more pronounced in H1. We will have some positive impact in H2, benefiting from the mix as well. Our ongoing initiatives support the initiatives Sue described and continue to fuel the sellout. Overall, we are putting in place strong savings initiatives confirming $120 million this year. The combination of short-term and long-term actions will support our margin next year, ensuring we can manage and continue EBITDA margin improvement even in a more uncertain and volatile context. We confirm our expectations of EBITDA margin growth from 70 to 90 basis points in fiscal '25, reaching close to 19% by the end of this fiscal year.

Operator, Operator

Our next question comes from Olivia Tong with Raymond James.

Olivia Tong Cheang, Analyst

I was wondering if you could talk about why you think Prestige Fragrances have been able to hold on better with respect to growth versus other categories? And in terms of the other categories, particularly mass, what can you do with respect to innovation to help offset the externals?

Sue Nabi, CEO

Olivia, thank you for your question. This is a very interesting topic because it's really a key element of market growth. I believe that Prestige Fragrances hold up better because they are not easily replaceable. When you like a scent, you will buy that scent. Anything close is not exactly the scent you prefer. In contrast, in other categories, such as Color Cosmetics, if you like a specific color or primer, you will always find something similar to buy. The entry barriers for Prestige Fragrances are higher due to the uniqueness and quality of the creations, developed over two to three years of careful crafting alongside scientific know-how. We are also adding molecules that enhance fragrance longevity. These entry barriers explain why Prestige Fragrances are resilient compared to other categories. In terms of innovation for other categories to drive growth, the answer lies in creating higher entry barriers. Currently, the Color Cosmetics world lacks real innovation and more so relies on third-party manufacturers, leading to a focus on cheaper options. This is what we are fighting against and working to implement agile innovations to be on-trend while creating high-entry-barrier products that justify their price and reacquire consumer interest.

Operator, Operator

Our next question comes from Ashley Helgans with Jefferies.

Ashley Helgans, Analyst

Last quarter, you mentioned some upcoming product introductions. I'm curious if you held off on any of those given the environment or if they didn't perform as expected. Following up on Olivia's question on fragrance being a strong driver, what are your underlying assumptions for the second half regarding the fragrance industry? Anything you can tell us about fragrance quarter-to-date would be helpful.

Sue Nabi, CEO

Let me address the questions part by part. Last quarter, we mentioned some upcoming launches, which we did release. One of the biggest highlights was the Gucci Flora Orchid, a major success in Q1 and Q2, although not as impactful as our launch two years ago. It began with exclusivity at a key retailer worldwide, limiting our benefit from its impact. Now it's widely available, and we see it doing very well. We are continuing key innovations on BOSS as both the scent and the Elixir have shown stellar growth, close to high single digits. Regarding assumed fragrance category growth in the second half, we plan additional launches without revealing specific details yet. Some initiatives we launched in fiscal '24 will continue in the second half, including anniversaries of previous innovations. Lastly, we are back to key innovations in prestige brands. We have exciting innovations launching in the second half, such as a strong presence represented by an exciting model.

Operator, Operator

Our next question comes from Patty Kanada with Goldman Sachs.

Patrice Kanada, Analyst

I had one on Asia Travel Retail and just Travel Retail in general. We've been dealing with pressures there for a while now. I wonder if you could talk about Travel Retail outside of Asia and how you're performing there? Are there opportunities to perhaps resize or reshape your strategy by rebalancing towards non-Asian regions where there’s less volatility and more growth opportunity? I would love your thoughts.

Sue Nabi, CEO

Pat, this is Sue. This is a good question. We have started to do this, in fact. In the second half of the first half of this year, meaning October, November, and December, we shifted significant resources from the Asia market, specifically China and Asian Travel Retail, towards the U.S. and European markets, primarily the U.S. Consequently, even if we aren’t communicating this, our sell-out reached some weeks at 50-60% growth prior to the holiday season. This was a direct result of reallocating resources to regions, particularly the U.S., where there is growth, especially with the Fragrance category. The Prestige Fragrance category is growing in the high single digits, and adjacent categories like Body Mist are booming. We will continue this strategy. Regarding Asia Travel Retail, you are right that it lags behind other regions. The Americas and Europe are performing much better, with the Asian Travel Retail significantly behind, particularly in Prestige Color Cosmetics, where restrictions between Korea and China have hurt sales streams. However, Fragrances and even Skin Care continue to perform better than Color Cosmetics.

Operator, Operator

Our next question comes from Anna Lizzul with Bank of America.

Anna Lizzul, Analyst

I was wondering if you could discuss the retailer channel shift you mentioned in your prepared remarks, particularly in the U.S. It seems like some online platforms like Amazon are gaining market share here. I'm just wondering how you're adjusting to this environment. And if you can comment on the different parts of your business, Consumer Beauty versus Prestige, and just how they're performing on this channel?

Sue Nabi, CEO

Yes, thank you very much, Anna. You're right that one of the reasons for the fierce competition between online and offline players is impacting retailers' cash management through inventory management. Amazon is gaining market share in the beauty industry, and many players, including some of our brands, are moving to Amazon. We were among the first to partner with them around 6-7 years ago, and this relationship has been key. Our e-commerce growth is stellar in both divisions; for example, CoverGirl in Consumer Beauty is growing faster than the e-commerce market, gaining market share and stabilizing in the U.S. Meanwhile, our Prestige brands are also doing very well on Amazon, growing faster than in brick-and-mortar locations, which indicates strong brand health. Online sales truly reflect consumer perceptions of brand equity, unlike the influences seen in brick-and-mortar stores. For us, this is a strategic channel where we are outperforming both divisions.

Operator, Operator

Our next question comes from Susan Anderson with Canaccord Genuity.

Susan Anderson, Analyst

I was wondering if you could talk about your pricing plans, given the higher FX impact for fiscal '25 now? Where are you expecting pricing to land versus units for fiscal '25?

Laurent Mercier, CFO

Indeed, as you know, we shared many times last year that, with high inflation, we implemented price increases of mid-single digits, and at some moments even higher. Looking ahead, we will continue with more moderate price increases, around low single digits. Innovations empower our pricing power. Thus, we will keep closely monitoring and managing against elasticity to ensure it doesn't negatively impact volumes. Fragrance is a clear example of our effective management in both Prestige and mass segments, with improved mix and growing volumes.

Operator, Operator

Our next question comes from Andrea Teixeira with JPMorgan.

Shovana Chowdhury, Analyst

Can you comment on the inventory levels at wholesalers and retailers? I'm trying to decompose the sell-in versus sell-out. Are you still seeing positive sell-in for Fragrances when your outlook is flattish to negative even in fiscal '26? Wouldn't retailers run out of inventory in like 6 months? Also, more near term, can you comment on the most recent trends as we exit the quarter and if February has improved?

Laurent Mercier, CFO

Yes. Inventory at wholesalers and retailers is what we flagged. We're still seeing adjustments along with competition between brick-and-mortar and e-commerce, which creates tension. Regarding Fragrance, it remains where we see robust sellout. Indeed, the category continues to grow within both Prestige and mass segments, indicating positive selling. We’re optimistic about improvements in Fragrance sales, attributed to launches and opportunities in the U.S., e-commerce, and growth engine markets.

Operator, Operator

Our next question comes from Chris Carey with Wells Fargo.

Christopher Carey, Analyst

What is your thought process around long-term algorithm? There was commentary about this in prepared remarks regarding adjustments to prior targets. I’d love to hear your thoughts on your long-term objectives.

Sue Nabi, CEO

Chris, this is Sue speaking. This year, beauty market growth is normalizing to steadier levels. Low to mid-single-digit growth aligns with prior estimates, though the market was previously higher. Our growth algorithm was based on a market growing between 3% and 4%. Like before, we aim to outperform the beauty market. However, given the macro and regional uncertainties, it’s imprudent to set specific sales growth targets, but we're committed to outperforming regardless of market growth. How? We have several drivers in hand: a robust Fragrance category with increasing penetration and usage, expansion of our offerings to reach mass, underindexed categories where we aim to perform better like Prestige Color Cosmetics and skincare, a focus on growing online market share, and growth in emerging markets. These five drivers will enable us to grow sales above the market while aiming to enhance gross margin and EPS growth.

Laurent Mercier, CFO

Yes, regarding the swaps, I would like to remind you that we’ve reached a leverage ratio below 3x over the past eight years. At some point, we will return to shareholders via buybacks or dividends. The swaps mechanism we implemented reserves $48 million for share buybacks. Now, given the pullback in our stock price recently, we need to provide cash payments to the banks according to the current stock price. This is an anticipation, confirming we will indeed operate the share buyback in the future.

Operator, Operator

Our next question comes from Mark Astrachan with Stifel.

Mark Astrachan, Analyst

First, on retailer stock levels, what gives you confidence they will return to levels over the last couple of years? Could you comment on whether inventory levels before the recent slowdown were elevated relative to historical levels for Fragrances? Secondly, regarding operations to fuel long-term success, are you considering divesting the Consumer Beauty Color Cosmetics brands or M&A to increase exposure to faster-moving categories?

Laurent Mercier, CFO

On retailer stock levels, we need to understand that there were many disruptions in the market over the past 2-3 years, starting with COVID and then the supply crisis. Some retailers had to rebuild inventory. Currently, we see them lowering inventory levels, but we believe they will stabilize eventually. However, the disruption pockets mentioned in Asia and in U.S. Consumer Beauty are not yet resolved. So this uncertainty continues within our inventory management discussions.

Sue Nabi, CEO

Mark, on evaluating operations for long-term success, it's encouraging that our Cosmetic brands in the U.S. and Europe are outperforming legacy players due to our strong innovations and advocacy strategies. We are agile in bringing innovations to market every six months, and operating across multiple beauty categories and channels provides robust opportunities. We are continuously evaluating our portfolio, ensuring long-term ROI from each brand across markets.

Operator, Operator

Our last question comes from Carla Casella with JPMorgan.

Carla Casella, Analyst

I have a couple of questions. One, you've got a couple of bonds maturing in 2026. Is that something you want to get ahead of a year before maturity? Does that matter? And the second question is about the well-state decline of about 3% sequentially. Can you provide an update on this business or the timing of a potential sale?

Laurent Mercier, CFO

The business is performing well. The value reflected in the books relates to accounting methodology affected by interest rates, not the actual performance. We ended the standstill period in November and remain opportunistic and pragmatic in monetizing this asset, which is a valuable part of our portfolio.

Operator, Operator

I would now like to turn the call back to our speakers for any closing and final remarks.

Sue Nabi, CEO

Thank you very much. To conclude, as we said during the earnings call, we are not satisfied with the current sales trend, but we remain confident in the beauty category, specifically Fragrances, as a growth driver in the future. We are pleased with our improved fundamentals over the last four years, especially this year, with gross margin, EBITDA growth, double-digit EPS growth, and our lower debt leverage, which is under 3x. We continue to outperform the market categories we operate in. Sell-out remains the ultimate indicator of brand health, and it continues to be strong. Thank you very much.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes today's conference. We appreciate your participation. Have a wonderful day.