We’re Sticking With This Position As the CEO Comes Out Swinging

*Coty management came out swinging today, painting a clear picture of margin improvement and further balance sheet de-leveraging

*The continued mix shift to the higher-margin prestige business remains a key focus as does the even larger skincare market

*Management teased it will “return cash to shareholders” as its turnaround plan concludes

*Our panic point for Coty remains set at $9

We have been looking forward to Coty’s COTY management presentation on Thursday and, based on questions from today’s office hours in the portfolio forum, so have many of you.

Leading up to today’s presentation, we shared that Coty management would need to deliver something more than it did at last week’s presentation. We said this because COTY shares have remained under pressure as of late. Well, today, CEO Sue Naby came out swinging, painting a clearer picture of how the company’s turnaround strategy is accelerating and how that should not only drive meaningful margin improvement in the coming quarters, but eventually allow the company to “return cash to shareholders in a variety of ways.”

While that could take the form of stock buybacks, the comment also suggests Coty and its board may be contemplating a dividend as it completes its turnaround plan in the coming several quarters.

While owning COTY shares has been painful since early March as concerns over inflation and consumer spending have piled up, figures shared during Coty’s presentation today tell us the company’s roadmap should translate into higher earnings and potentially more in the medium term. We recognize that Coty’s story faces an uphill battle and if the prestige market was being challenged, it would give us a reason to view Coty with an even more critical eye. However, the company is winning share, driving cost out of its business, delivering margin improvement and de-levering its balance sheet.

The prospect of the Fed embarking on a rate-cutting cycle bodes well for Coty’s de-leveraging efforts but it could also support consumer spending. The above points to a high probability that COTY shares will be higher in the coming quarters than they are today, and that will see us continuing to own COTY shares. However, we will keep our $9 panic point in place and, if tripped, it may mean parting with this beauty company.

During its presentation today, Coty showed the global prestige fragrance market accelerated to 15% year-over-year growth in the March quarter from 10% in 2H 2024. Helping fuel that acceleration is the ongoing premiumization of products and the expansion in the overall size of the prestige fragrance buyer’s market. In the U.S. alone, that cohort grew by 5 million people in 2023 across Gen Z and higher-income consumers.

Management also shared that it sees the company’s overall prestige business growing to account for two-thirds of its revenue stream, up from 59% just a few years ago. The path to that is the continued premiumization of Coty’s product offering as it leverages existing brands into new products, including skincare. Coty has been in the skincare market for less than two years, but management reiterated that it is the largest opportunity for the company. HTF market research puts the prestige skincare market size at $24.8 billion this year and sees it growing at a compound annual growth rate of 5.8% over the next six years. By comparison, the global prestige fragrance market was about $17 billion last year. If Coty can replicate just a fraction of its prestige fragrance success in the prestige skincare market, management would have to revise its multi-year sales growth targets higher

For now, management reiterated its medium-term sales growth target of 6% to 8% and that it continues to target balance sheet leverage near two-fold by the end of calendar 2025. Our thinking is that the mix shift toward prestige and further cost reductions should continue to drive free cash flow, which management can use to work that leverage down. There is also the expected monetization of the Wella assets that Coty owns, which could accelerate its debt reduction and free up cash for share repurchases or a potential dividend. Exiting the March quarter, Coty’s 25.8% stake in Wella was valued at $1.1 billion.

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At the time of publication, TheStreet Pro Portfolio was long COTY.