On February 20th, I opened up a long position on Coty Inc, ticker symbol COTY. In this article, I’m going to be giving you an analysis of the stock that supports my decision to enter this position.
Coty Inc. manufactures, markets, sells branded beauty products, including fragrances, color cosmetics, hair care products and skin & body related products. Coty is leading global beauty company, currently holding the #2 global position in fragrances, the #4 global position in color cosmetics, and a strong regional presence in skin & body care. Coty operates in over 130 countries and currently pulls in revenues of roughly $9.2 billion per year. Coty owns licenses to “power brands” such as Adidas, Calvin Klein, Chloe, Davidoff, Marc Jacobs, OPI, Playboy, and Rimmel.
On October 1, 2016, Coty acquired the P&G Beauty Business in order to further strengthen the company’s position in the global beauty industry. This deal cost Coty roughly $4.5 million, which they funded with a combination of debt and equity financing. Coty issued 409.7 million shares of common stock which significantly diluted shareholder equity. The reduction in shareholder equity can be seen in their stock chart as we see the price per share fall from roughly $30 to $18.
Because of the major acquisition cost, the company reported a loss in its November earnings report which further increased selling pressure on the stock. Taking a closer look at Coty’s fundamentals I began to see some benefits that I believe will lead to a turnaround in share price.
- The combined company now holds the #1 global position in fragrances, the #3 global position in color cosmetics and the #2 global position in hair salon
- In the second quarter 2017 earnings results, net revenues of $2,296.7 million increased 90% as reported compared net revenues in the prior-year period
- Taking a look at their most recent balance sheet we can see that total assets almost tripled while total liabilities only doubled
- Of their 3 main segments, Luxury net revenues of $835.0 million increased 52% from prior year same quarter, Consumer Beauty net revenues of $1,001.7 million increased 68%, and Professional Beauty net revenues of $460.0 million increased 560%.
- Taking a closer look at the companies operating income, we can see that the company was only operating at a loss due to the large cost associated with the merger.
- **Lowering Marketing cost** Consolidated expenses for advertising and promotional costs were $967.6 million, $1.008 billion and $1.070 billion in fiscal 2016, 2015 and 2014, respectively.
- **In-house Manufacturing** Coty manufactures approximately 68% of our products in eight facilities around the world
- **Increasing Dividend** In August 2016, our Board of Directors approved a 10% increase in their annual dividend to $0.275 from $0.25 per share in the prior year and further increased the annual dividend per share to $0.50 after completion of the P&G acquisition, demonstrating their confidence in the ability to generate substantial cash flow.
- **Insider Purchases** CEO Camilio Pane bought approx. 72k shares on Feb 16th and JAB Cosmetics, 10% owner of the company, bought 4.09 million shares on Feb 14th.
As you can see in the chart above, Coty has consolidated from its downward trend and has found a support level at roughly $18.08 (touched 3x)
The primary concern with this trade is Coty’s ability to successfully integrate P&Gs products into their own. In the most recent quarterly report, the CEO talks about how they are experiencing growing pains while learning to control the new levels of inventory that they have acquired. If they cannot successfully integrate P&G business, then they will fail to be profitable in the future. The revenue they are experiencing from this acquisition is enormous so if they can keep their cost under control then I believe we will see a significant rise in EPS over the next few years. Other risk factors to keep an eye on for this trade include:
- Consumer Discretionary Products-if we see a downturn in the economy then Coty’s products will take a bigger hit because they are discretionary items. These items are first to be cut during recessionary periods as they are not necessities to our everyday living. Revenues at Coty will be significantly affected.
- Rationalization Cost-In May 2016, Coty announced that they intended to rationalize six to eight percent of combined company net revenues by divesting or discontinuing non-strategic brands. It will take time to execute this strategy, which may result in expenses and charges as they exit such brands, and their ability to successfully do so could impact their results.
- Seasonality– Coty experiences seasonal purchasing with their products so we will see much more revenue around the holiday season. This could affect short-term profitability in the stock.
For this trade, I bought Leap calls options:
Jan 18, 2019 Calls @ 35 strike
40 Contracts @.32 cents for a total cost of $1,280
For this trade, I believe that COTY will return to a share price of $30 dollars by September 1st 2017. This prediction is based on future revenue projections and reduced cost from amortization of acquisition expenses. If COTY does reach this number by the time I calculated, then my total profit will be:
This is a 6:1 risk reward ratio. I am risking $1,280 to make $8,300. I intend to double my position if Coty established a clear upward trend on the charts and crosses its 50-day exponential moving average.
As I showed you earlier, Coty has formed a clear support line at $18.08. If Coty breaks this support line I would exit the position and take on some losses. As time goes on I will continue to monitor the trade and analyze quarterly statements to see if Coty is successfully integrating P&Gs business. If they are failing to overcome cost or are experiencing losses, I would exit the trade. Since I am buying leaps that are 2 years out, I have plenty of time for this trade to unfold. Even if it takes an entire year for Coty to reach $30 a share, I would still profit over $5k.
Homework: For additional information on COTY’s fundamentals, check out their investor relations website and dig into some of their most recent 10-Qs.