L’Oreal Remains “Neutral” Even If Nestle Sells Stake: Citi

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Citi Research published a report yesterday focusing on French cosmetics and personal care concern L’Oreal SA (EPA:OR). The report highlights Citi analysts Toby McCullagh, Robert Dickinson and Ravi Sharma’s conviction that Nestle SA (VTX:NESN) will not go ahead with the sale of its 29% interest back to the company, and even if they do, that it will not prove as accretive to earnings as L’Oreal’s management has suggested.

The report reiterates Citi Research’s Neutral recommendation and $125 target price for L’Oreal SA (EPA:OR).


Citi’s take on Nestle/L’Oreal deal

The report’s central conclusion is that L’Oreal SA (EPA:OR) is not a compelling investment opportunity with or without the buyback of Nestle’s holdings. The analysts in particular point to the high P/E multiple that L’Oreal enjoys relative to its peers, and the likelihood of that multiple slipping. “Although we expect Nestlé to maintain the status quo, if we are wrong we see gradual post deal P/E multiple contraction (down to ~20x), effectively offsetting the mechanical earnings accretion (of ~15-20%), which broadly supports the current share price, but does not provide any basis for significant upside.”

Nestle likely to retain its holdings

McCullagh et al. provide three reasons they believe that Nestle will not follow through with the stock buyback deal with L’Oreal SA (EPA:OR):

“Our central view continues to be that Nestlé retains its holdings:

1. Nestlé has no pressing need for funds

2. Nestlé maintains financial flexibility if it retains the holding

3. Selling the stake to fund a buyback has a relatively immaterial (about 2-3%) impact on Nestle’s EPS.”

Good, but not great, sales growth for L’Oreal

The analysts also argue that L’Oreal SA (EPA:OR)’s sales growth is likely to start slipping over the next few quarters, and this could serve as a catalyst for the contraction of the firm’s P/E multiple.

“We think the days of L’Oréal sustainably delivering 6-8% organic sales growth are gone. We expect the company to deliver ~5% growth on an ongoing basis, which is strong, but broadly in line with other leading global staples companies.”

In European trading earlier today, L’Oreal SA (EPA:OR) closed down 4.20 euros at 124.80 euros and Nestle SA (VTX:NESN) closed down .55 Swiss francs at CHF67.

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