Wide-Moat L’Oréal Reports Strong First-Quarter Sales, but Shares Overvalued

We are impressed with L’Oréal’s 13.5% like-for-like first-quarter sales growth, which tops the 8% growth of the global beauty market (company estimates), with management reporting market share gains in all geographic zones and product divisions. The strength was driven by the post-pandemic recovery in makeup, L’Oréal’s ongoing momentum in active cosmetics (an 18% like-for-like boost), and market share gains in the professional division, given investments in e-commerce. This growth is notable considering many challenges faced during the quarter, such as stay-at-home orders in many large cities in China, and supply-chain constraints prohibiting L’Oréal from filling all orders. Product shortages were especially pronounced in the U.S., where backlogs at shipping ports prevented the import of necessary raw materials, but this bottleneck should improve in coming months as cargo is now moving through terminals at faster rates. The firm is also navigating inflation well, with consumers not pulling back on beauty purchases in any markets. However, with inflation continuing to accelerate, we suspect L’Oréal’s 2022 gross margin may now contract slightly (compared with our preprint expectation for a 10-basis-point gross margin increase to 74.0%). Management expects it can offset this pressure with a modest pullback in marketing expenses, and we do not think this would impair its strong brands (an important pillar of its wide moat) given last year’s surge in marketing investments to 32.8% of sales from the 30.6% average over the three prior years.