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Here’s Why Coty (COTY) Stock Crashes Despite Q1 Earnings Beat

Zacks

Coty Inc. COTY has been in the red zone for quite some time now, with its shares down a substantial 58.3% this year, much wider than the industry’s dip of 2.5%. In fact, this cosmetics behemoth has crashed close to 26% within a span of just two days, following its first-quarter fiscal 2019 results. While this quarterly outcome was largely hurt by supply-chain disruptions, the company has long been struggling with its Consumer Beauty segment.



Evidently, the Consumer Beauty segment, which accounted for almost 41% of Coty’s top line in the first quarter, has been posting soft organic sales for quite some time now. Unfortunately, the murky trend lingered this time as well, which further dented investors’ sentiments. On that note, let’s delve deeper into Coty’s quarterly outcome.

Quarter in Detail

Adjusted earnings of 11 cents per share surpassed the Zacks Consensus Estimate of 7 cents and jumped 10% year over year. The bottom line gained from lower taxes.

Coty generated revenues of $2,031.3 million, which tumbled 9.2% year over year and also lagged the Zacks Consensus Estimate of $2,157 million. The company’s organic (LFL basis) revenues fell 7.7%, mainly on account of supply-chain hurdles, which hit LFL revenue growth by nearly 5%. Underlying weakness in the Consumer Beauty segment was also a deterrent.

The company’s supply-chain woes included disruptions related to warehouse and planning center consolidation (in Europe and United States). This had an adverse effect on all three business units. Further, shortages from various external suppliers marred the Luxury unit that was also largely hurt by Hurricane Florence.

Adjusted gross margin contracted 120 basis points (bps) to 60.4% in the quarter under review, mainly due to supply-chain hurdles and escalated freight costs in the Consumer Beauty and Luxury divisions. Additionally, adjusted operating income slumped 28% to $140.8 million due to soft revenues and gross margin along with currency headwinds. This was partly compensated by lower fixed costs stemming from the company’s synergies.

Segmental Details

Luxury: Luxury net revenues rose 3.7% to $792.9 million, while LFL revenues slipped 2.1% due to supply-chain headwinds. Nevertheless, underlying growth was backed by strength in Gucci, Tiffany TIF, Chloe and Miu Miu brands. The company also witnessed sturdy results from Burberry, which will form part of Coty’s LFL base in the second quarter of fiscal 2019.

Region wise, the segment witnessed strong performances in Europe and in emerging markets, especially Asia. On the contrary, North America and Ttravel retail businesses were hit by supply chain and impacts from the hurricane. Management intends to fully offset the lower shipments stemming from hurricanes in the second quarter, which includes the crucial holiday season. Also, the company is on track to resolve supply-chain hurdles.

Consumer Beauty: Consumer Beauty revenues plunged 20.6% to $828.8 million and LFL sales declined 14%. Results were hurt by supply-chain disruptions, including customer penalties and increased promotions. These factors led to a sequential decline in the segment. Also, underlying weakness owing to persistent softness in mass beauty categories in United States and Europe dented results.

Professional Beauty: Professional Beauty net revenues of $409.6 million fell 4.9% year over year and 2.6% on LFL basis as disruptions at Coty’s North American distribution center hampered its hair and nail businesses in the region. The segment otherwise witnessed underlying growth, fueled by brands like Wella, and robust growth in ALMEA and Europe. Also, contributions from ghd drove underlying performance.

Regional Results

On a regional basis, net revenues declined 14% (down 15% LFL) in North America due to continued softness at Consumer Beauty, including supply-chain hurdles. Also, effects of hurricanes and supply chain on Professional Beauty hit the region.

Sales in Europe tanked 10% (9% LFL) as improvements in Luxury and Professional Beauty units were countered by weakness in the travel retail and Consumer Beauty. Sales in the ALMEA region dipped 1%, though it rose 5% LFL, courtesy of solid momentum in Luxury and Professional Beauty, and modest improvements in Consumer Beauty.

Other Financial Updates

Coty, which shares space with Estee Lauder EL ended the reported quarter with cash and cash equivalents of $423.3 million and net long-term debt of $7,789.7 million.

During the first quarter, the company used $81.9 million as net cash from operating activities and free cash flow was negative $215.5 million.

In a separate press release, the company announced dividend of 12.5 cents a share, payable on Dec 14 to shareholders of record as on Nov 30.

Outlook

Coty’s performance remained disappointing and weaker than expected in the first quarter, owing to supply-chain headwinds and persistent weakness in the Consumer Beauty unit. While the company is on track to mitigate supply-chain issues, it is expected to be fully offset only by the third quarter of fiscal 2019.

The company also announced plans to modify its distribution center to minimize the effect of these hurdles on its business. Despite these efforts, the company continues to expect synergies of about $225 million in fiscal 2019 and $750 million by the end of fiscal 2020. Barring supply-chain hurdles, the company’s performance remained strong in the Luxury and Professional Beauty units, driven by robust innovations and solid demand.

The Consumer Beauty unit however remained weak on an underlying basis as well, due to softness in certain developed markets, stiff competition and challenges associated with certain brands. Nonetheless, Coty is on track to stabilize this unit. Also, it is making aggressive efforts to resolve the supply-chain related barriers. The company is also on track with the integration of P&G PG Beauty business.

Though supply-chain issues are likely to impact fiscal 2019 results, the company anticipates operating profit and margin to improve in the fiscal on the back of considerable reductions in fixed costs and impacts from synergies. Also, Coty is committed toward deleveraging and anticipates achieving a net debt to adjusted EBITDA ratio of less than 4.0x by the end of 2020.

For second-quarter fiscal 2019, management envisions underlying net revenue trends to improve sequentially in all segments, even amid supply-chain headwinds. Management expects Luxury and Professional Beauty segments to revert to year-over-year LFL revenue growth, though Consumer Beauty segment LFL revenues are expected to fall at a high single-digit rate.

Coty’s operating income in the quarter is likely to decline moderately on account of currency woes and the remaining supply-chain obstacles. Moreover, bottom-line growth is expected to bear the brunt of a tough year-over-year comparison stemming from tax gains recorded in the year-ago period.

Coty currently carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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