COTY INC. Q2 FY2025 earnings call

• Retailer inventory management: Retailers are very cautious with inventory, leading to a gap between sell-in and sell-out. This is seen in various segments including China, Travel Retail Asia, etc.
• Upcoming launches: Coty plans two big blockbuster launches in fiscal '26. Examples include Burberry continuing double-digit growth, Kylie Cosmic being a top volume launch, and Marc Jacobs Daisy Wild being the #1 SKU in the U.K. for innovation.
• Resource shifting: In the first half of the year, resources were shifted from Asia markets (specifically China and Asian Travel Retail) to the U.S. and European markets, especially the U.S., leading to strong sell-out growth prior to the holiday season.
• Gross margin discipline: Coty has a strong focus on gross margin expansion. For example, gross margin was close to 67% end of Q2, with a full-year gross margin expected to be 100 basis point improvement compared to fiscal '23.

Laurent Mercier mentioned that approximately 20% of Coty's business, including China, Travel Retail Asia, Australia, ANZ, and Consumer Beauty, are facing challenges. Prestige Fragrances are performing well with mid- to high-single-digit sell-out. The Consumer Beauty division in the U.S. has challenges, while Prestige Fragrances have high single-digit growth. For example, Fragrance as a whole is performing well with sell-out in the mid- to high-single-digit range, but sell-in is lower due to retailers' cautious inventory management.

• Fiscal '25: Full-year gross margin expected to be 100 basis point improvement. EBITDA margin is expected to grow 70-90 basis points, landing close to 19% at the end of fiscal '25.
• Fiscal '26: Hopes retailers will return to normal inventory levels. Plans to have big launches and distribution gains, including expanding key pillar brands in the Prestige division in the U.S. and other emerging markets.

• Pockets of business challenges: China, Travel Retail Asia, Australia, and Consumer Beauty are areas facing challenges, with about 20% of the business affected.
• Competition: High competition between brick-and-mortars and e-commerce creating additional tension in inventory management.
• External uncertainties: Potential tariff wars and regional uncertainties that could impact the business.

Q: On your commentary about a sell-in relative to sell-out, what are your thoughts about when retailers might undergo replenishment as that's an issue you're seeing? Also on your comments on China, Travel Retail Asia, Australia and Consumer Beauty, I mean how would you characterize the magnitude of the issues relative to what you mentioned?

A: Yes. Some pockets of the business have challenges, and these pockets were expected to stabilize but are worsening in Q2. About 20% of the business, including China, Travel Retail Asia, Australia, ANZ, and Consumer Beauty, are impacted. For example, combination of China, Travel Retail Asia and Australia are impacting Prestige business by roughly 3 points, and U.S. Consumer Beauty challenges are impacting by 3 points.

Q: You obviously touched on it in the release. I was wondering if you could go into a little bit more detail on both the structural challenges that you're seeing in U.S. Color Cosmetics and the competitive challenges. And how you look to combat those going forward?

A: Yes. Some structural challenges in U.S. Color Cosmetics include closures in the pharma/drug store environment. The Color Cosmetics market would benefit from a balance between heritage brands and indie brands. For example, CoverGirl is a legacy brand resisting well, and entering new indie brands can bring excitement. This balance is part of discussions with partner retailers.

Q: You talked about some of the weakness coming out of fiscal '25, persisting potentially in the first part of fiscal '26, but at the same time, you're expecting an improvement in sales growth in fiscal '26. So can you comment on kind of the levers that you have in fiscal '26, as you enter fiscal '26 to kind of accelerate organic sales growth and in terms of like how should we think about the year relative to your medium-term outlook of 6% to 8%?

A: Thank you. Hopes retailers will return to normal inventory levels. The market is offer-driven, so will have big blockbuster launches in fiscal '26. Also, accelerating distribution gains for key pillar brands in the Prestige division. For example, Chloe's expansion in the U.S. market has had strong results.

Q: I'd like to understand some of the puts and takes of the margin outlook a little bit better. Can you just describe a little bit on the fixed versus variable cost structure you're dealing with for the back half? How much deleverage you're baking in with the guidance? And how much reinvestment in A&P and innovation and things like that? And then also, I believe in the prepared remarks, you discussed some softer promotional activity last quarter. Is that something that you might decide to pull on a little bit more here in the back half to help drive volume performance? Or are you committed to other forms of volume activation?

A: Yes. Gross margin has been expanding. H2 gross margin will be slightly lower than last year due to high base but remains 100 basis points above fiscal '23. It's a combination of productivity, pricing effects, and A&CP management. A&CP remains in the high 20s. Softer promotional activity last quarter may not be pulled more, but committed to other forms of volume activation like launches and distribution gains.

Q: I was wondering if you could talk about why you think Prestige Fragrances has been able to hold on better with respect to growth versus other categories. And in terms of the other categories, particularly mass, what you can do to -- with respect to innovation, to help offset the externals?

A: Olivia, Prestige Fragrances hold better because they are not easily replaceable due to uniqueness of creation, quality of juices, and crafted elements. In other categories like Color Cosmetics, need to create entry barriers through agile innovation to fuel growth, going beyond TPMs and launching high-entry-barrier innovations.

Q: The last quarter, you mentioned some upcoming kind of product introductions. Just curious how much maybe you held off on some of those given the environment or maybe if they didn't perform as expected. And then just following up a little bit on Olivia's question on fragrance, being such a strong driver. What's embedded in your underlying assumptions for the second half about the fragrance industry? And then anything you can tell us on fragrance quarter-to-date, that would be helpful.

A: Okay. Some product introductions like Gucci Flora Orchid started with exclusivity but are now rolling out and doing well. Boss has stellar growth due to key innovations. Assumptions for second half include continuing launches, anniversarizing key initiatives from fiscal '24, and back to key innovations behind entry Prestige brands like Davidoff with Charles Melton's innovation in the second half.

Q: I just had one on Asia Travel Retail and just Travel Retail in general. So we've been dealing with pressures there for a while now. So wondering if you could talk about Travel Retail outside of Asia and how you're performing there. And related to that, are there opportunities to perhaps resize or reshape your strategy by rebalancing toward non-Asian regions where maybe there's less volatility and more growth opportunity? I would love your thoughts there.

A: Patty, in the first half of the year, shifted resources from Asia Travel Retail to the U.S. and European markets, mainly the U.S., leading to strong sell-out growth. Americas and Europe are performing very well. Travel Retail in Asia, especially China, is lagging behind due to restrictions between Korea and China affecting Prestige Color Cosmetics, but other categories like fragrances and skin care are growing. Will continue to shift resources to regions with growth.

Q: I was wondering if you could discuss the retailer channel shift you mentioned in your prepared remarks, particularly in the U.S. It seems like some online platforms like Amazon are gaining market share here. I'm just wondering how you're adjusting to this environment. And then also if you can comment on the different parts of your business, Consumer Beauty versus Prestige and just how they're performing on this channel?

A: Yes. Amazon is gaining market share in the beauty industry. Coty was first to partner with Amazon years ago. E-com growth is stellar for both Consumer Beauty and Prestige. For example, CoverGirl is growing faster than the e-com market on Color Cosmetics in the U.S., and Prestige brands are growing very fast on Amazon, outperforming brick-and-mortar.

Q: I was wondering if maybe you could talk about your plans around pricing given the higher FX impact for fiscal '25 now? And I guess where you're expecting pricing to land out versus units for fiscal '25?

A: So indeed, with high inflation, price increases were mid-single digits, but now with inflation slowing, price increases will be low single digits. Will continue price increases moderate, monitoring elasticity to not go against volumes. Fragrance shows good control of pricing equation with mix and volumes growing.

Q: Can you comment on the inventory levels at wholesalers and retailers? I'm just trying to decompose the sell-in versus sell-out, just trying to understand if you're still seeing positive sell-in for Fragrances and your outlook is flattish to negative even in fiscal '26, so -- or entering, rather. Wouldn't retailers run out of inventory in like 6 months or so? And also more near term, can you please comment on the most recent trends from exiting the quarter and if February has improved?

A: Yes. Inventory at wholesalers and retailers still has adjustments. Fragrance category is growing with good sell-out. Expect some improvement in selling Fragrance with upcoming launches and growth engine markets. Recent trends show some improvement, but details on February's improvement are part of ongoing monitoring.

Q: What is your thought process around long-term algorithm? I think this has been a discussion in this forum for the past few quarters. There was clearly some commentary in prepared remarks about adjustments. I think you had talked about best-in-class total shareholder returns, but you have avoided the prior targets that you put out there, clearly, which makes sense given the evolution of the category. I think we could hear more next week, but it feels like an important shift to recalibrate expectations more appropriately for the longer term. So I'd love your thoughts on what the business is effectively trying to accomplish in the coming years with a longer-term perspective. The only second one, which I'll add on, is, can you explain what's going on with the swaps and the prepayment that you have to make in Q3? But mostly, I'm curious on the first question, but I'd love a little bit on the second question as well.

A: Chris, the beauty market growth is normalizing. Goal is to outperform the market with drivers like robust Fragrance category, expanding offering to mass, growing in under-indexed categories (e.g., Prestige Color Cosmetics, skincare), growing online penetration, and strong growth in growth engine markets. On swaps, it's a mechanism to reserve share buyback, with about 48 million shares, and it's an anticipation of future share buyback operations.

Q: So I guess, first on retailer stock levels, what gives you confidence that they will return back to levels over the last couple of years? And maybe if you could comment on whether the inventory levels prior to the recent slowdown, especially in Prestige Fragrance, which had accelerated coming out of the pandemic, was elevated or not relative to historical levels for Fragrances just from a retailer perspective? And then secondly, in the press release, you talked about evaluating the operations to fuel long-term success. You're obviously talking about an increasing focus on reducing leverage. I guess what are you thinking in terms of the business footprint today versus maybe 3 years ago? It does seem like Consumer Beauty is a bit more challenged. You talk about more heritage brands not being the focus of customers at this point. Is the portfolio you have today the right one? Would you consider divesting that business? Would you consider M&A to increase exposure to faster-moving categories? Just any sort of color there would be helpful.

A: On retailer stock levels, it's a transition year with disruptions from COVID and supply crisis. Retailers will eventually return to healthy inventory once the disruption pockets stabilize. On the business portfolio, Coty is evaluating the portfolio, considering both continuing to fight in challenging areas and looking for long-term opportunities and return on investment. The portfolio is under review, with options including divestment or M&A to align with faster-moving categories.

Q: You've got a couple of bonds maturing in 2026. I'm wondering if that's something that you want to get ahead of a year before maturity, so they don't go current. Or does that matter?

A: Carla, bond maturities are always considered, and Coty is working on deleveraging to be in a healthy position, so bond maturities are part of the ongoing debt management.

Q: The Wella stake decline of about 3% sequentially, is that -- and can you give us any update on the performance of that business or maybe the timing of a potential sale of it?

A: The Wella business is performing well, but the value in the books is affected by accounting methodology and interest rates. The standstill period ended in November, and Coty remains opportunistic to monetize the asset when appropriate.