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Coty's Turnaround Plans Include a Simplified Portfolio

Luis Sanchez, The Motley Fool

Hindsight is 20/20, especially when one is looking back on disappointing acquisitions. Four years after announcing a $12.5 billion acquisition of Procter & Gamble's beauty business, Coty (NYSE: COTY) is now restructuring its operations in an effort to turn around poor performance that it squarely blames on the deal.

The turnaround plan, unveiled this month, calls for simplifying the company's product portfolio by investing more in its most successful brands while shedding struggling ones. Coty will also be moving its headquarters to Amsterdam and cutting costs where possible. 

Will Coty's turnaround plan put the company back on track? 


A girl putting on make up in front of a mirror

Image Source: Getty Images.

A disappointing acquisition

To better understand what Coty needs to change about its business, it helps to understand how it got here. On a shareholder call discussing the turnaround plan, Coty's management team put the blame squarely on the acquisition of P&G's beauty business announced in 2015.

The massive acquisition gave Coty over 40 additional brands, doubled its revenue, and added roughly $3 billion in debt. On paper, the deal made a lot of sense. The company would gain household brands such as Covergirl and a large-scale global platform that could operate more efficiently than a smaller company.

Four years later, reality has set in. Coty's CEO has acknowledged that the deal was too complex, which ultimately led to a long business integration process. Making matters worse, the acquired brands have performed poorly as consumer spending has shifted away from traditional mass-market beauty brands in favor of social-media-promoted brands such as the makeup line launched by celebrity Kylie Jenner. As a result, Coty has seen its overall revenue decline and profit margins shrink. The issue is even more pronounced with the legacy P&G beauty brands.

Coty disclosed it will be taking a $3 billion asset writedown this year. The writedown represents the culmination of making a large, transformational acquisition that ultimately disappointed financially. Now it's up to the company to implement changes needed to make its global beauty platform work.

Proposed turnaround plan

To address the poor performance, Coty says it will focus investment around its most lucrative brands and holistically look across its business for areas to reduce costs. The plan will likely discontinue some product lines that are simply not delivering financially.

Justifying its decision to simplify its brand portfolio, Coty disclosed that roughly 25% of brands account for about 60% of its revenue. The company also noted that certain brand/country combinations are particularly strong. Coty believes that it can capture more upside in its most popular brand/country combinations through an enhanced budget for promotion and research and development. To fund the investments in prioritized brands, the company will eliminate underperforming brands (as yet unspecified).

Focusing on best-performing assets is a sound business practice. A more focused portfolio will help Coty reduce its supply chain complexity, resulting in lower costs and higher margins. Providing key brands with greater marketing and R&D budgets should boost revenue growth for those prioritized product lines. Done right, the net result could be a faster-growing and more profitable business.

Coty will also change its global organizational structure. Along with moving its corporate headquarters to Amsterdam, Coty will realign staff from the current product-focused reporting units to geographic business units. Coty didn't specify that there will be layoffs, but it did say the new org structure will result in a more efficient team with fewer layers of management. The changes are projected to create significant cost savings, but layoffs and relocation for some will create some employee grief.

On the plus side, with the acquisition integration now complete, Coty can boast having one of the largest beauty franchises in the world and brand leadership positions in several key markets and categories. Coty has the assets, it just needs to focus in on making them more profitable and competitive.

Aiming high with financial goals

Coty's turnaround plan has several moving parts, which makes it difficult to pinpoint the likely net effects. That hasn't stopped the company from providing specific financial targets it hopes to hit over the next few years. The table below presents Coty's financial targets versus its most recent 12 months of financial performance.

Metric Last 12 Months as of Q3 2019 2023 Financial Targets
Net revenue growth (5.4%) Flat vs. 2019
Adjusted operating margin 10.4% 14% to 16%
Free cash flow $217.6 million $1 billion
Financial leverage (net debt to EBITDA ratio) 5.7 Below 4.0

Data source: Coty financial reports and investor presentation.

Coty believes its turnaround plan can arrest its declining revenue trend, boost profit margins, quadruple free cash flow, and lead to a reduction in the company's financial leverage. These are ambitious goals that will not be easy to achieve.

The toughest goal will be to improve revenue growth trends. While the plan to focus growth around prioritized brands/countries will likely lead to growth for those prioritized product lines, Coty will have to more than offset the revenue from discontinued products to break even. Stabilizing revenue is also the most consequential financial goal because it will be hard to improve margins and cash flow if there is less money coming in from sales.

One compelling statistic cited by management is that Coty's current gross profit margin is 10% below that of its average competitor. This highlights just how much Coty is underperforming and suggests significant margin improvement is possible.

An ambitious plan

Coty's plan to turn around its business is just as complicated and ambitious as its original plan to acquire P&G's beauty brands. There are several moving parts that will result in pluses and minuses across the financial board.

At first blush, the strategy of focusing the product portfolio and consolidating staff makes sense. But achieving the company's financial goals will come down to execution. Execution hasn't been Coty's strong suit lately, and, based on the negative share price reaction at the announcement of this plan, shareholders are skeptical.

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Luis Sanchez has no position in any of the stocks mentioned. The Motley Fool is short shares of Procter & Gamble. The Motley Fool has a disclosure policy.