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15th November 2021


Share Price: €183.52


P/E: 60


Dividend yield: 1.22%


We used to call them 'glasses' but that word is not used anywhere in Essilor-Luxottica's annual report and quarterly results. 'Eyewear' is the favoured expression. The shares in this French-Italian outfit are charging ahead, registering a strong buy signal on the charts - so what is going on here?


The third quarter results announced at the end of October were accompanied with the second upgrade in the earnings forecast for 2021, together with a 9% increase in sales and higher profit margins.


Cash generation must be quite strong, as Essilor-Luxottica has done a share buy back and also completed the takeover of GrandVision for a cash consideration, in the year to date. GrandVision is a Dutch company with 7,000 retail outlets throughout the world. The purchase price is €8.6 billion, slightly more than 10% of Essilor-Luxottica's market capitalization of €80.4 billion.


The Luxottica part of the company, however, has been in the wars with the French Competition Authority which imposed a fine of €125 million for conduct which occurred between 2005 and 2014. It was a long and torturous process, as competition enquiries tend to be, with the French Competition Authority deciding that an earlier investigation done in 2005 was insufficient, and it subsequently initiated a new enquiry in 2017.

The usual response by a company to a reprimand from regulators, it to say that systems and procedures have been radically overhauled since the time that the unfortunate lapses occurred etc. I have never seen a company saying that the regulator is an utter twat, and that the penalty is totally groundless....Well, not until now!

Essilor-Luxottica issued a rather incredible response, which I must admit I find refreshing in its lack of corporate-speak, its honesty and spiky assertiveness, stating: "The company strongly disagrees with the Authority's decision and considers the sanction highly disproportionate and groundless. The company will appeal the decision, confident that it will successfully demonstrate that the decision is wrong both from a factual and legal perspective."

Wow. Tell us what you really think!

I am not too bothered by a highly successful company having a bit of a tangle with the Competition Authorities - it has happened to pretty much every high growth company you care to mention; Microsoft, Google (Alphabet), Facebook (Meta) etc.

It is a fundamental rule of law in most civilized countries, that you cannot be tried for the same offence twice. But Competition Authorities sometimes act like kangaroo courts, compared to courts of law, where rules ensuring fair procedure and due process have developed over centuries.

Essilor-Luxottica makes sunglasses and spectacle frames for brands such as Chanel, Prada and Versace. It has announced similar licensing deals this year with Coach and Tory Burch, so this is an important avenue for growth. Its brands are strong in China, so the shares give investors exposure to that market. The western companies that tend to do well in China, are those with strong brands in the luxury sector.

But are the shares worth 60 times trailing twelve months earnings? That is a very demanding P/E ratio.

The recently upgraded earnings outlook statement, contained in the third quarter results, is somewhat opaque. It states that revenues for 2021 are expected to be higher, in the "mid to high" single digits. Ok, we'll say that means around 7.5% higher. Then we are told that there will be a "100 basis points" increase in adjusted net profit as a percentage of revenue. That means that adjusted net profit as a percentage of revenue, will be 1% higher. The comparative figures used are for 2019 (as 2020 was a covid affected year). These estimates exclude the new acquisition, GrandVision.

In 2019, Essilor-Luxottica had total revenues (i.e. sales or turnover) of €17.4 billion and net profit of €1 billion. That is a net profit margin of 5.7%. Therefore, revenues of €18.7 billion (+ 7.5%) and a net profit margin of 6.7% would result in a net profit of €1.25 billion.

Dividing the €1.25 billion in expected profit by the total shares in issue of around 436 million, gives an earnings per share of €2.87. The current share price €183.52, divided by €2.87, gives a prospective P/E ratio of 64 times.

That looks like a very high valuation, at first glance. However, the balance sheet as at 31st December 2020 was very under-geared, showing a healthy cash and cash equivalents balance of €8 billion, almost enough to pay off all of the longer term debt of €9 billion. The recently completed acquisition of GrandVision will add only €8.6 billion to the net debt. Shareholder's funds were €32 billion as at 31st December 2020, so the long term debt remains very low.

Essilor-Luxottica therefore has plenty of firepower to continue making earnings enhancing acquisitions, financed by increasing this very low debt level to a higher level.

The merger of Essilor with Luxottica took place in 2018, and Reuters reported in May of this year that only €50 million of annual cost savings had materialized to date, compared to the €300 million promised, but that further progress was likely. Morgan Stanley said that a further €200 million of annual costs could be eliminated following the GrandVision takeover. In May, Reuters reported that the shares were trading at 28 times 2022 forecast earnings, which was an average discount of 20% to industry rivals such as the Japanese lens maker Hoya and luxury groups such as Kering. The shares have since closed that gap, on rising 27% since May, now bringing the forecast P/E (based on forecast earnings for 2022) up to almost 36 times.

That is still a high rating, but one that can be justified by the very low level of debt, further expected cost savings, and the pricing power to improve margins, as this behemoth now controls almost 20% of the global eyewear market.

Perhaps Essilor-Luxottica is now so large, it will find it increasingly difficult to make acquisitions on a scale sufficient to materially boost earnings per share? No matter, it could finance a €30 billion share buy-back, at a negligible rate of interest, and cancel those shares, if it could not identify any acquisition targets. The earnings per share (due to 164 million fewer shares in issue), would then rise nearly 40% due to that piece of legitimate financial engineering alone, before the various expect merger cost savings kick in.

My conclusion therefore is that the prospective and historic P/E of around 60 is somewhat misleading. Merger cost savings, a very under-geared balance sheet, and most significantly of all, the pricing power that will result from having a global market share of nearly 20% of the eyewear market, should all act to boost to earnings in the foreseeable future.

I have a high level of confidence that the recent chart buy signal is justified, following my review above of the fundamentals.

And if you are an eyewear consumer - you will be paying more for your specs in 2023 than you are now. I am even more confident about that!

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