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ESSILORLUXOTTICA

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EssilorLuxottica : A mariage of convenience

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07/22/2019 | 02:28pm EDT

Essilor, a major French entrepreneurial success story, entered a new dimension in January 2017 with its merger with the Italian company Luxottica.

The €50 billion wedding gave birth to the world’s first leading optical health group, one of the fastest growing industries in the consumer goods sector.

 

 

 

With a market share of almost 30% in a market that is estimated at €90 billion, and without exagerating, EssilorLuxottica literally leads the competition. Its closest rival J&J is still far behind and only has 5% of the market share. 

Two billion people wear corrective lenses. Half of those lenses are made by Essilor and there still is a lot of opportunity left there: almost 3 billion people are not yet equipped with glasses due to insufficient purchasing power or adequate healthcare infrastructures.

Luxottica is the world’s leading manufacturer of glasses and sunglasses and the owner of famous brands like Ray-Ban and Oakley. The wedding is thus a marriage of convenience and the logic behind it is undeniable: first there are the lenses, where the technology and sophistication of the production equipment prevail, and then there are the frames, an activity with higher margins where the brand image counts more than anything.

Both Essilor and Luxottica rely on unparalleled production and distribution networks. The group’s management cautiously expects saving targets of around 300 million euros per year. Some analysts expect twice as much, providing, however, a fortunate combination of higher selling prices and lower costs thanks to economies of scale and the elimination of duplicates in the supply chain.

On paper, the fusion of these two masters and their kingdoms should thus create the empire of the Glasses and a European industrial champion. Unfortunately, things didn’t exactly turn out that way. In fact, the honeymoon period was rather short and the dishes will soon by flying around. 

At the heart of the problem: a battle for power between the French - led by Essilor’s CEO Hubert Sagnières, famous for its efficient management - and the Italians, represented first and foremost by the charismatic Leonardo Del Vecchio, an orphan who started with nothing and the founder of Luxottica, now one of Italy’s biggest fortunes. 

Those who know this case well aren’t afraid to say that the French miscalculated. Or rather, that they were fooled. While they thought that Mr. Del Vecchio would retire at last - at 83 years old the timing seemed right - he emerged again as soon as the merger was completed and showed no intention of wanting to let go of the reins.

Del Vecchio had, by the way, no problem putting obstacles in the way of his brand new partners; he went as far as referring the matter to the arbitration court of the International Chamber of Commerce to assert his right of control which he considers to be violated! (The complaint has been withdrawn since.)

Mr. Del Vecchio owns one third of the shares and voting rights: it is impossible to act without him. These difficulties remind us of the fact that perfect mergers between equals only exist on paper. In reality, one party always has the upper hand, especially when billions are at stake. 

The mix of two very different corporate cultures could also cause friction; there is a big difference between a family group managed Italian style and Essilor’s almost military-like organization which is fully focused on efficiency, cost control and seducing the financial markets. 

On a larger scale, these cultural differences highlight an issue faced by all major European groups - a problem that American or Chinese competitors don’t have.

Luxottica would have a lot to learn from its French half. Despite its good financial performance, the company’s profitability is more often than not disappointing rather than impressive, especially when compared to the intrinsic quality of the business - for example comparing the unit manufacturing cost of a pair of Ray-Bans with its retail selling price.

These shortcomings can by explained by the family, or even paternalistic, culture of Luxottica - the company’s management has, for instance, refused to eliminate positions that had become redundant after the merger - and its founder’s obsession with buying out competitors. This certainly consolidates the group’s market shares but weighs on the margins and returns on capital invested nevertheless, especially when one hasn’t looked too well at the prices paid for acquisitions.

Some people claim, by the way, that Luxottica did this to neutralize Essilor - because that’s how certain analysts describe the situation - while rumours of a rapprochement between the French and frame manufacturers like Safilo were becoming more pressing. 

The first results of the EssilorLuxottica group, which were released in March, were positively received. The impact of an unfavorable exchange rate on the profit didn’t concern many people. The great unknown remains the way in which the governance of the group will be structured in the next two years and the - normally contractual - retirement of Mr. Del Vecchio.  

Will he succeed in imposing his right hand Francesco Milleri and thus assign the takeover of Italians over the French? Some shareholders, like Comgest - which didn’t hesitate to become an activist - worry this could be the case.  A waste of time: their proposal to appoint two independent directors was outright rejected by the Italians.

In addition, these adventures could be good for the competition. Luxury giants like LVMH and Kering - driven by high margins and long-term growth prospects - have also started to manufacture eyewear - rather than outsourcing it to companies such as Luxottica. As such, they have set up new factories in northern Italy.

Despite these tensions, the analysts who follow the group - whose consensus is surveyed in real-time by Greattor , the company behind MarketScreener, are betting on the easing of said tensions and remain confident that EssilorLuxottica's management has the ability to deliver the results that meet their expectations.

This vote of confidence is reflected in the valuation of the group, which is still optimistic at around 30 times the profit of the previous financial year and 25 times the expected profit in 2020.

(The author is not a shareholder.)


Neelie Verlinden
© MarketScreener.com 2019
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Size 2019e 2020e
Capitalization 51 806 M € -
Entreprise Value (EV) 53 253 M € 53 494 M €
Valuation 2019e 2020e
P/E ratio (Price / EPS) 28,0x 26,0x
Capitalization / Revenue 3,02x 2,87x
EV / Revenue 3,10x 2,95x
EV / EBITDA 14,2x 13,2x
Yield (DPS / Price) 1,68% 1,84%
Price to book (Price / BVPS) 1,54x 1,49x
Profitability 2019e 2020e
Operating Margin (EBIT / Sales) 16,0% 15,8%
Operating Leverage (Delta EBIT / Delta Sales) 1,11x 0,77x
Net Margin (Net Profit / Revenue) 10,8% 10,7%
ROA (Net Profit / Asset) 3,91% 3,67%
ROE (Net Profit / Equities) 5,56% 5,84%
Rate of Dividend 47,0% 47,9%
Balance Sheet Analysis 2019e 2020e
CAPEX / Sales   5,31% 5,20%
Cash Flow / Sales 16,1% 15,9%
Capital Intensity (Assets / Sales) 2,78x 2,91x
Financial Leverage (Net Debt / EBITDA) 0,39x 0,42x
Income Statement Evolution
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Mean consensus OUTPERFORM
Number of Analysts 18
Average target price 118,82  €
Last Close Price 119,10  €
Spread / Highest target 19,2%
Spread / Average Target -0,23%
Spread / Lowest Target -25,3%
Consensus revision (last 18 months)