European Dividend Aristocrat in Focus: L’Oréal

European Dividend Aristocrat L’Oréal (OR.PA), the French cosmetics giant, is worldwide known for its cosmetic products and has a very impressive track record.

The company has a long history of steady dividend increases. In fact, L’Oréal is in Europe the Dividend Aristocrat with the longest track record of consecutive dividend increases each year, if its dividend payout was measured in its home currency (EUR). In 2019, the record of dividend increases is 37 years.

This article will discuss L’Oréal’s business model and why the stock could be attractive for income investors based on our Smart Dividend Score. Our Dividend Score System takes into account several fundamental and technical metrics that affect a company’s ability to continue paying dividends and its overall return.

Business model and growth perspective

L’Oréal is active in all cosmetic market segments and the number 1 cosmetics group worldwide in 2018 according to WWB. The four major business divisions are consumer products, L’Oréal Luxe, Professional Products, and active cosmetics. The product portfolio includes 34 well-known brands, such as Garnier, Maybelline & Lancome and is sold in 150 countries.

The worldwide beauty market has strong underlying trends and accelerated in 2018. The growth for 2018 has been the best growth in 20 years, +5.5%. By geography, growth was stable in Western Europe, around 5% in North America plus Eastern Europe, Asia Pacific was up 10%. Looking by sector, Travel retail +22% and e-commerce +25% performed well, resulting in an increase of 9% in Skincare products and 5% in makeup.

Also in the Q3-2019 figures (reported 10/30/2019), the sales growth continued, especially in Asia Pacific, its number one market. Sales growth at Maybelline (L’Oréal’s Luxe division) was faster than expected in the third quarter. This is compensating the weaker sales, like in the United States, where make-up sales are slowing down.

Overall third-quarter sales were up 11% to 7.18 billion euros ($7.98 billion). On a like-for-like basis, revenues rose 7.8%, largely surpassing the 6.3% increase expected by analysts and accelerating from the 6.8% growth in Q2.

The earnings per share (EPS) growth is strong:

2016: Earnings per share € 5.50

2017: Earnings per share € 6.36

2018: Earnings per share € 6.92

2019: Earnings per share € 7.49 (e)

2020: Earnings per share € 8.39 (e)

 

L’Oreal is a market leader and a wide economic moat, a high-quality business and well-positioned in the beauty products market.

Dividend history and dividend growth

It is important that companies that can maintain or even increase their dividend payments in bad times. This is an indication that the company has a strong market position in a stable business that performs well throughout the economic cycle.

The dividend increased in 2019 from €3.55 to €3.85 (+8.5%). This dividend is an annual one and gets paid out in May at once.

Since 1997 the dividend grew from €0.24 to €3.85. L’Oréal is a true European dividend aristocrat with 37 years of consecutive dividend increases. So, also during recession periods, L’Oréal has been able to increase dividends.

 

Dividend Yield

With L’Oréal currently trading around 261 EUR and 3.85 EUR, the current dividend yield is 1.47%. The 5-year average dividend yield is 1.77% (see red-line in the chart). This indicates the stock looks overvalued valued today. This dividend yield is also lower than the industry average of 2.1%.

The dividend payments are reasonably covered by its earnings, given the payout ratio of 54.6%. Looking forward, its dividends in 3 years are forecast to be well covered by earnings (55% payout ratio). In short, investors do not have to worry about the sustainability of the dividend.

Stable cash flow

Without stable cash flow, it is almost impossible to maintain the dividend in times of a downturn. Operating free cash flow and free cash flow are 2 important metrics for a dividend stock. L’Oreal is clearly able to create a continues and growing (Operating) free cash flow.  This results in a growing R&D budget.

 

Low debt ratio

Companies with a low debt ratio have the option of maintaining or even increasing the dividend even during recessions. The (net) debt-to-EBITDA ratio is a great metric to include. The net debt/EBITDA of 0.12 is indicating that L’Oreal’s position is rock solid. This is also well below the 1.5 net debt/EBITDA ratio we prefer for dividend stocks. Peers like Unilever (2.28) and Estee Lauder (1.35) are way above L’Oreal’s net debt/EBITDA.

Valuation

At this moment L’Oreal is at an overvalued based on its PE Ratio (36x) and compared to the industry average (22x).  The forecasted EV/EBITDA is 20.1 is also high.

This valuation is comparable with Estee Lauder (38x), however more than double Unilever’s PE ratio of 15.

Recession performance

It is important to analyze the performance of a dividend stock during a recession period.  We analyze each dividend stock by looking at their earnings, dividends, maximum drawdown (MDD) and stock price performance during the 2007-2009 financial crisis.

L’Oreal had some difficulties during the recession 2007-2009, but manage to increase its dividends and the price-performance was still okay. The table below lists the share-price performance per year, the performance over 2007-2009 and the MDD.

	2007	2008	2009	Period: 2007-2009	Maximum Draw Down (MDD)
L’Oreal SA	24.54%	-37.47%	22.67%	-4.47%	-52.67%

 

Price-performance

Year-to-date L’Oreal is trading up 29%, which is an impressive performance for this stock. The 10-year geometric annual performance is 12.7% annually. Looking at the win-ratio of 39% and a loss ratio of 2.38, the performance is just below average for this stock.

L’Oreal’s performance triangle.

Two noticeable aspects

Investors should pay attention to the shareholder structure of L’Oreal and the loyalty bonus when considering investing in this dividend stock. There are three major shareholders, the family Bettencourt with ~33%, International institutional investors with ~29% and Nestlé with ~23%. Meaning that 85% of the stocks are with this “special” group, probably investing for the long run. The official free float is around 40%, but in practice on ~5% is held by individual shareholders, making L’Oreal less of a short-selling candidate.

Source: L’Oreal annual results 2018

Next to the shareholder structure, another non-standard aspect is the loyalty bonus scheme. L’Oreal is rewarding investors with an additional 10% dividend bonus under certain conditions. When investors register their share, they will receive a loyalty bonus of +10%. For example, this preferential dividend is €3.90 instead of €3.55 for 2018. Registered shareholders will be entitled to receive the +10% loyalty bonus in subsequent years if you hold your shares continuously for two full calendar years. This will typically lead to longer holding-periods for the L’Oreal share.

Both the shareholder structure and loyalty bonus scheme are a strong foundation under the high valuation.

Final Thoughts

L’Oreal is a market leader and a wide economic moat, a high-quality business and well-positioned in the beauty products market. Given the strong competitive advantages and continues growth in the R&D budget, the company has been able to generate stronger cash flows even during recessions, which also resulted in the 37th consecutive years of dividend increases. Making L’Oreal one of the few true European Dividend Aristocrats.

The shareholder structure and loyalty bonus scheme are stabilizing factors for the share price, but also causing also a high valuation and a somewhat lower dividend yield for the investor.

Since the stock is on record-high levels, our recommendation for long-term dividend growth investor would be “Buy the Dips”