Morning Note: Market news and an update from EssilorLuxottica.
Market News
US equities were little changed last night as traders priced in less monetary easing after yesterday’s economic data. Initial jobless claims were 241K vs. 259K expected, while US retail sales grew by 0.4% MOM, slightly faster than the 0.3% expected, and the Philly Fed manufacturing index came in at 10.3 vs. 3.0 forecast. The 10-year Treasury yield rose back up to 4.11%, while gold moved above $2,700 an ounce as tensions in the Middle East remain elevated.
The euro weakened as the ECB lowered interest rates for the third time this year, to 3.25%. Christine Lagarde said incoming data suggests economic activity has been somewhat weaker than expected, with risks to growth on the downside. Inflation is expected to drop back to target in 2025. Officials see a December cut as very likely, with traders assigning a 20% chance of a 50bps cut.
In Asia this morning, equity markets are mostly higher – Nikkei 225 (+0.2%); Hang Seng (+3.5%); Shanghai Composite (+2.9%) – after after the People’s Bank of China said it set up a relending mechanism with an initial 300bn yuan ($42.1bn) quota for bank loans used in share buybacks. Data also showed that the nation’s latest gross domestic product, industrial production, and retail sales figures beat estimates. Bridgewater told investors it would buy more China stocks after the recent rally boosted its onshore fund’s nine-month returns to 31%. The yen weakened to 150 vs. the dollar for the first time since August.
The FTSE 100 is currently trading 0.4% lower at 8,357. UK retail sales (+3.9%) grew faster than expected (+3.2%) in September and ahead of the 2.5% in August, driven by computer sales and other electronic products. Sterling is trading higher at $1.3050 and €1.2050 as traders bet the pace of monetary easing may slow.
Source: Bloomberg
Company News
Yesterday evening, EssilorLuxottica released Q3 results that were a touch below market expectations. However, on the call the company highlighted trading in the current quarter has accelerated. The group reiterated its 2026 revenue growth and margin targets, although a new sales target was introduced which was a little underwhelming. In response to yesterday’s results, the shares are little changed this morning.
EssilorLuxottica is the global leader (with a 25% share) in the eyecare and eyewear industry with exposure to the design, manufacture, and distribution of ophthalmic lenses, prescription frames, and sunglasses. We believe the long-term outlook for the industry is positive, driven by an ageing population, increased incidence of poor eyesight (caused in part by the increased use of smart phones and tablets), a growing emerging market middle class, increased education regarding sun protection, and the growth of eyewear as a fashion accessory. By 2050, uncorrected poor vision is predicted to reach epidemic proportions with over 50% of the world’s population expected to suffer from myopia (short-sightedness), many with serious vision-threatening side effects and long-term implications.
The company’s competitive advantage is based on its scale, portfolio of premium brands (such as Ray-Ban and Oakley), product innovation, flexible manufacturing base, quality service, routes to consumer, and partnerships. Essilor owns licences for some of the best-known luxury brands, including Chanel, Prada, Armani, and Jimmy Choo. The group also owns a majority interest in GrandVision (GV), a global leader in optical retail and an online presence, ownership of which expands its global retail footprint (to 17,500 stores) and reduces the competitive risk of retailer consolidation. The company states that its mission is to prevent industry commoditisation in Western markets, whilst promoting premiumisation in emerging markets.
Earlier in the month, the company completed two acquisitions. The first was an 80% stake in family-owned Heidelberg Engineering, a German company specialising in diagnostic solutions, digital surgical technologies, and healthcare IT for clinical ophthalmology. The deal brings expertise in early detection and diagnosis and will enhance the group’s presence in the med-tech space. There is little overlap with the group’s current instruments offering, and new and better access to doctors and clinics, strengthening relationships that could lead to cross-selling opportunities. The company did not disclose financial details.
The company has also paid $1.5bn in cash for the streetwear brand Supreme, known for its lifestyle apparel, footwear, and accessories. The company runs a digital-first business and 17 stores in the US, Asia, and Europe. At first glance, the move appears somewhat of a diversification from the group’s core business – the rationale is that it will provide a direct channel to an audience that is very difficult to reach and adds a margin accretive business to the group. We have some reservations and will watch to see if the deal is a misallocation of capital.
Back to the results. During the three months to 30 September 2024, revenue grew by 4.0% at constant exchange rates (CER) to €6.44bn, just below the market forecast of €6.58bn. The growth rate slowed versus the 5.3% in the first half, in part due to a more challenging environment in the US and China, and the disruption caused by the Paris Olympics. The 9-month growth rate stands at 4.9%.
EssilorLuxottica is a vertically integrated player whose go-to market strategy is based on two distribution channels. Professional Solutions includes the supply of products and services to third-party eyecare professionals (i.e., wholesale). In Q3, revenue grew by 3.4% at CER to €3,017m.
Direct to Consumer includes the sale of products and services directly to end consumers, that is the retail business, comprised of brick-and-mortar stores and e-commerce platforms. In third quarter, revenue grew by 4.6% at CER to €3,420m. E-commerce grew at the same pace as the whole group.
By geography, North America, the group’s largest region (44% of sales), grew by 1.6% at CER, in line with the first half. The Sun business continued to be impacted by the slowdown in discretionary spending, although the unit turned positive at the end of the quarter. Elsewhere, growth was stronger: EMEA (+5.6%); Latin America (+10.8%); and Asia Pacific (+5.0%). China remained in positive territory despite macroeconomic headwinds, supported by Stellest’s 40% growth.
In addition to underlying market trends, growth is being driven by high quality and differentiated product innovation across the existing product line and in new markets. For example, Stellest (myopia management) is being rolled out to additional markets in EMEA and grew by 70%, Varilux XR lenses powered by AI have been successfully launched, and Ray-Ban Reverse (which can shift from traditional convex to concave lenses) has delivered disruptive design and technology. These new products will be accretive to both price/mix and margin.
In September, the company extended its partnership with Meta Platforms (the owner of Facebook) by entering into a new long-term agreement under which the parties will collaborate into the next decade to develop multi-generational smart eyewear products. The two companies have been collaborating successfully since 2019, resulting in two generations of Ray-Ban branded smart glasses to turn glasses into the next major technology platform. The collection is performing better than expectations and currently demand is outpacing supply. Regarding the prospect of Meta taking a stake in Essilor, CEO Mark Zuckerberg has said that ‘an investment in Essilor is more of a symbolic thing’ driven by a belief that ‘they are going to go from being the premier glasses company in the world to one of the major technology companies in the world’. On last night’s call, Essilor said there was ‘nothing to report at this stage’, but has previously said any investment by Meta wouldn’t involve the issue of new shares or impact the company’s ability to enter into commercial relationships with rivals like Google and Apple.
The company has also diversified into the hearing solutions market with a disruptive new technology (i.e., lenses with acoustic technology) to meet the needs of the 1.2bn consumers suffering from mild to moderate hearing loss. The audio component is completely invisible, removing a psychological barrier that has historically stood in the way of consumer adoption of traditional hearing aids. The product (called Nuance) has seen positive results in consumer testing in the US and should be rolled out at the end of the year.
Although this was only a revenue statement, we would remind investors that the company has been able to translate its revenue growth into substantial margin expansion, leveraging its vertically integrated business model and successfully absorbing the inflationary pressures on most of the main cost items. Gross margins are high (64.3% in the first half), with pro-forma operating margin at 18.5%.
The business generates strong free cash flow (€971m in the first half) and is financially robust. The group ended the first half with net debt (including lease liabilities) of €9.8bn, 1.5x EBITDA, although acquisitions since then will have pushed up gearing. As a sign of the group’s confidence in the outlook for the business, a dividend of €3.95 was approved at the AGM May, up 29%, equating to a 2% yield.
It was reported last week that the company has spent €170m to take a 5.1% stake in Japanese camera maker Nikon Corp as a long-term financial investment to support the company and its management. The investment deepens ties between the two companies who have a joint venture for the creation of Nikon-Essilor, a wholesale lens business entity.
Looking forward, Essilor doesn’t provide near-term guidance. Encouragingly, however, revenue growth is expected to accelerate in the final quarter of the year, and on the call the company also confirmed that the pace of margin expansion this year would be ahead of the 60 basis points generated last year.
Essilor remains confident in its strategic vision and its ability to deliver on its long-term outlook for annual revenue growth of mid-single digit between 2022 and 2026 and adjusted operating profit margin of 19%-20% in 2026 (vs 16.9% in 2023). A new target of €27bn-€28bn of revenue in 2026 was introduced which on the face of its appears a little light of the current consensus forecast – we note 5% growth versus 2022 would generate €29.8bn. Currency movements might explain some of the discrepancy and on the call the group highlighted the figure doesn’t include growth from Stellest outside of China, online banners, and wearables. Either way, the company will probably need to provide further clarification.
Source: Bloomberg