Eyewear Oligopoly On Discount (OTCMKTS:ESLOF)

Thesis

Generally, an organization’s intrinsic worth is derived from discounting the remaining lifetime of future money flows again to the current worth. Due to this, I consider it’s important to judge the sturdiness of these potential money flows in addition to the acquisition worth of the safety in relation.

EssilorLuxottica (OTCPK:ESLOF) is the worldwide chief in designing, manufacturing, and distributing eyewear lenses, frames, and sun shades. Not solely does EssilorLuxottica management a dominating portion of the eyewear market share, however in addition they management their complete vertical from R&D, to manufacturing, to the distribution community, to insurance coverage. An necessary cause I consider their moat is so giant is due to their portfolio of well-known manufacturers, together with proprietary manufacturers like Ray-Ban and Oakley, in addition to licensing agreements with many designer manufacturers. Sturdy designer model names coupled with the human necessity for prescription eyewear creates a novel demand construction for EssilorLuxottica in my view.

I consider this demand construction might proceed to assist constructive free money circulate resulting in extra substantial acquisitions, constant dividends, and reinvestment within the enterprise to maintain natural development. After buying and selling down ~30% from all-time highs set late final yr, EssilorLuxottica at present trades at a free money circulate a number of corresponding to the depths of 2008 offering a doubtlessly advantageous entry level.

Background

Trade

The worldwide eyewear trade is estimated to be value round $107 billion in annual shopper income and is predicted to develop within the low-to-mid single digits for the foreseeable future. The trade is damaged up into 5 segments and the market share is proven within the chart beneath:

The eyewear trade has been traditionally fragmented, with quite a few totally different firms created over the previous two centuries. Over time, EssilorLuxottica has taken vital market share via natural and M&A-related development. Beneath is the record of M&A historical past for the corporate:

Firm

Over the course of historical past, via natural enterprise breakthroughs and consolidation of the trade, EssilorLuxottica has grown to the place it’s as we speak. As a substitute of specializing in a particular trade area of interest, EssilorLuxottica controls your entire worth chain within the eyewear vertical. From designing iconic eyewear and high-quality contact lenses; to growing optical devices; to manufacturing frames, lenses, and lab tools; to distribution; to insurance coverage, this one firm controls all of it:

Not solely does EssilorLuxottica management the worth chain, however in addition they have a portfolio of manufacturers I consider are beloved by shoppers across the globe. Proprietary manufacturers the corporate controls embody names like Ray-Ban, Oakley, Transitions, and Kodak Lens. Prestigious licensed manufacturers other than the corporate’s household additionally embody Giorgio Armani, Bulgari, Burberry, Chanel, Coach, Dolce & Gabbana, Ferrari, Michael Kors, Prada, Ralph Lauren, Tiffany & Co., Tory Burch, Valentino, and Versace. The corporate additionally produces lens surfacing and coating tools for opticians, optometrists, and ophthalmologists worldwide with manufacturers like Essilor Devices and Satisloh.

It is also necessary to notice that EssilorLuxottica’s distribution community contains ~18000 shops worldwide that provide merchandise on to shoppers in addition to high-quality imaginative and prescient care. Shops beneath the corporate’s umbrella embody an array of various brick-and-mortar and e-commerce platforms, with a few of the most notable together with Sunglass Hut, LensCrafters, and Apollo.

Whereas EssilorLuxottica’s enterprise mannequin is huge and sophisticated in nature, I do not need to fill this text extensively with info purely relating to their mannequin. To uncover extra about their operational construction, worth chain traits, and model/licensing info; pages 10-50 on their Annual Report have glorious, consolidated info.

Thesis Assist

Innovation

I consider an necessary a part of EssilorLuxottica’s enterprise comes from the very begin of the worth chain, analysis & growth plus new improvements. EssilorLuxottica is concentrated on natural product innovation via design craftsmanship, new sustainable supplies, and breakthrough merchandise with the objective of bettering livelihood for hundreds of thousands. With over 11000 eyewear-related patents, the corporate continues to innovate in addition to shield its mental property.

Model Demand

Sparked via acquisition and natural innovation, EssilorLuxottica has constructed a portfolio of eyewear manufacturers that rank among the many highest ranges by way of shopper satisfaction. The full portfolio of proprietary manufacturers and licensing agreements are beneath:

Whereas the corporate has internally acknowledged its manufacturers are extremely ranked, two on-line surveys present the corporate controls on common 75% of the highest 20 rated manufacturers. Each surveys had Ray-Ban on the #1 spot, a proprietary EssilorLuxottica model. Continued buyer satisfaction and excessive regard for his or her portfolio manufacturers will probably be key for sustained future development in my view.

Secular Developments

In keeping with the Imaginative and prescient Council of America, roughly 75% of adults within the U.S. use both eyeglasses (64%) or contact lenses (11%). For development context, the full U.S. grownup inhabitants carrying protecting eyewear in 1965 was ~45%. This quantity additionally will increase with age. Whereas 59% of People between 25-39 put on corrective eyewear, that quantity jumps to 93% for these between 65-75 years previous. Together with corrective eyewear, 85% of the inhabitants makes use of sun shades.

I consider if the worldwide inhabitants continues to develop, the know-how and accessibility to corrective eyewear will increase, and the necessity for multipurpose eyewear (readers, driving-specific eyewear, transition lenses) heightens, EssilorLuxottica will profit from potential secular traits. Additionally, as life expectancy will increase globally and the potential want for corrective eyewear will increase due to the destructive results display time has on our eyes, EssilorLuxottica might expertise long-term tailwinds.

In keeping with information gathered on Statista, the worth of the worldwide eyewear market will improve at a CAGR of 5% each year via 2027:

Whereas these statistics are based mostly on the USA and EssilorLuxottica is a world firm, I nonetheless consider it’s a good proxy for worldwide eyewear statistics because the U.S. is the biggest retail market.

Financials

Discounted Money Stream

After analyzing the basic enterprise behind the money flows for the corporate, I performed a reduced money circulate [DCF] evaluation to seek out EssilorLuxottica’s intrinsic worth. Beneath I’ve enclosed my intrinsic worth calculation, my DCF sensitivity desk, the weighted common value of capital [WACC] calculations, and the DCF inputs:

Valuation

Not solely do I consider EssilorLuxottica is discounted to its potential future money flows, nevertheless it’s buying and selling at a traditionally low a part of its market cap. / FCF vary:

Traditionally, buying the corporate’s inventory beneath 18x LTM FCF has offered nice returns for shareholders transferring ahead.

Danger / Reward

Even when EssilorLuxottica’s free money circulate a number of contracted to the earlier all-time low set in 2003 (13.5x) and free money circulate stayed fixed, that will put the potential draw back at -23% from present ranges. Evaluating that bear case to the potential 252% low cost derived from my DCF, I consider EssilorLuxottica at present trades with a excessive margin of security.

Dangers

Competitors

I consider a key cause EssilorLuxottica has had constructive efficiency over the previous decade is that their market share of the full eyewear trade continues to develop, benefitting their economies of scale. Not too long ago, competitors from firms like Warby Parker has made sturdy efforts to steal market share again from EssilorLuxottica. If profitable, a declining market share for EssilorLuxottica may have detrimental results.

A number of Suppression

If EssilorLuxottica sees aggressive strain eat at their rising market share, I consider the corporate may see valuation multiples contract because the inventory could also be much less enticing to traders. Declining market share in an trade anticipated to CAGR at 5% for the subsequent 5 years may additionally proceed to burden their declining return on invested capital [ROIC]. Traditionally, the corporate’s ROIC has stayed between 10-12.5% however has just lately declined following the merger between Essilor and Luxottica to the place it at present sits beneath 4%.

Whereas free money circulate might proceed to assist dividends and future acquisitions, declining profitability may suppress multiples resulting in reductions within the inventory worth, in my view.

Abstract

By controlling their complete vertical, having a portfolio of family names, and creating demand from each luxurious and medical prospects, I consider EssilorLuxottica’s future money flows are very sturdy. With greater than 11,000 patents, 2,350 designs, and three,460 emblems, I additionally consider they’ve the mental property to additional substantiate their moat within the eyewear trade. With Essilor and Luxottica finishing their mixture in late 2018, I nonetheless consider the potential synergies as a product of the merger aren’t totally mirrored, particularly within the inventory worth at present.