Business Breakdowns
· Swetha Ramachandran
Milleri, who is the official CEO, and then there is the Essilor Deputy CEO, Paul du Saillant, who is also in place today. So that has thankfully removed a lot of the distraction from the corporate governance struggles, the impact that that had on the share price for quite some time. And now we're in a different phase. But even very promptly after, even while all of this was going on, they decided to acquire in July 2019 a company called GrandVision, which is a global leader in optical retailing. At that time, EssilorLuxottica's own market cap was about 50 billion euros. And this deal was valued at just over 7 billion euros, at very similar PE, so it was a hugely dilutive deal. But it was a very long, drawn-out acquisition process because the European Commission actually required a lot of concessions and remedies in order for the deal to be approved. And 350 retail stores across Belgium, Italy, and the Netherlands had to be sold. But what the deal did do was to again enhance the company's vertical integration, which is what they had always touted as something that distinguished them from the competition. And this made even more sense actually in the wake of the Essilor acquisition, because what Essilor never had on its own was direct-to-consumer distribution. They had always relied on third-party wholesalers. So coming together with Luxottica, as well as with the added benefit of GrandVision, this really became a full-service manufacturing-to-customer experience proposition under the aegis of one company.
· Zack Fuss
[00:00:00] S0: So now that you have this large, combined, vertically integrated business, zoom out and let's talk about the industry itself. Cyclical versus secular? I understand that 60% or 70% of adults will need corrective vision at some point in their life, so clearly there's sustained demand for their products. How do you think about the way the industry ebbs and flows itself?
· Swetha Ramachandran
[00:00:00] S1: Yeah, it's interesting, because of the two sides of the business. One is not as cyclical in the sense that prescription lenses, they're really a necessity for over 4 billion people worldwide. It's not quite a discretionary product in some cases. For example, we're fortunate enough where eye exams are covered by insurance or employer benefits, which again stabilizes demand. The key feature really is under-penetration in emerging markets, especially in Asia, which drives these long-term structural growth trends in corrective eyewear. It's estimated that uncorrected vision impairment today might cost the global economy north of 300 billion dollars in lost productivity. So there's a huge economic cost to not correcting vision issues. Then of course, you have the other side of the business, which is the frames and sunglasses business. Here, it's much more about brand and quite a bit of fashion as well. And here, we obviously know that luxury spending—spending on discretionary items—does drop during recessions, and so that tends to be more sensitive. So we did see this during the global financial crisis, for example, where the standalone Essilor business at that time continued to grow. People, of course, still need prescription lenses whatever the economy, but the sunglasses business did experience some very moderate, though mid-single-digit, decline, which is somewhat better than what we saw elsewhere in the luxury industry. There may have been an element, perhaps, of this being an affordable luxury, similar to what Estée Lauder coined as the 'lipstick effect', where no matter how bad times are, women will still indulge in a lipstick. But perhaps there's an element of that with sunglasses as well. But there's no doubting that this end of the business is more cyclical. But if we look at the growth drivers for the eye care industry overall, it's clear that an aging population, growing population, and penetration in emerging markets because of rising incomes—all of those are durable and sustainable trends for the long term. Vision impairment is still, today, one of the world's most untreated and undiagnosed disabilities. Basically, 90% undiagnosed in developing economies are at the bottom of the income pyramid, which is really quite astounding, even today. The fact that innovation in eyewear is redefining the entire TAM.
· Swetha Ramachandran
And that, to me, is hugely interesting because, of course, we have the huge hype cycle around smart glasses, which, to no small extent, I think has impacted EssilorLuxottica's valuation in recent months. Could they go mainstream in the same way that smartwatches have? Could that unlock a huge new market? And in this, the Ray-Ban Meta, which launched in October 2023, has really been the only connected glass option to reach mass-market adoption. They just said that they have sold 2 million units of this product. And so, I think that could be really interesting if they manage to make that go mainstream in the same way that perhaps the Apple Watch has. The other innovation could be hearing aids, where they've now announced an expansion into hearing solutions, which is basically a disruptive proprietary technology by the Israeli startup Nuance, which is really at the intersection of sight and sound. So, you've got quality hearing solutions but in the form factor of glasses, and that minimizes the stigma. It also addresses mild-to-moderate hearing loss, which is quite common among the growing aging populations in the Western world. And that, again, is a product that's about to be launched—or is in the process of being launched at the moment—over the counter in the US and at audiologists in Europe. That could be, I think, quite interesting to see how they're able to grow their market beyond their core eyewear market.
· Zack Fuss
[00:00:00] S0: Laying out the strategic motivations of the business, the merger, and understanding the nuances of their go-to-market strategy. Today, I think it'd be helpful if we walk through the P&L of the business from the top line. A business that'll do 25 to 30 billion euros, growing high-single digits, and then down through gross profit margin to operating margins, and all the money that's being spent in between those two. And then, again, you spoke briefly on some of their capital allocation policies. You look at a business here that seemingly you would expect to be somewhat capital-light, but they do reinvest meaningfully below the OCF line. And just curious how you think about the financial profile of the business.
· Swetha Ramachandran
[00:00:00] S1: That I think is quite interesting in that, yes, we're talking about a business that is now 26.5 billion euros in terms of revenues. Yet, if you look at their EBIT line, that is under 3.5 billion euros. So they're generating roughly a 16% EBIT margin despite having a 63%-ish gross margin. So where is all the money going? And this is quite amazing—half of that gross margin is selling expenses. And we must remember that they have a huge network of retail stores—roughly 18,000 retail stores around the world. They also employ close to 200,000 people. And so that is really the bulk of the operating expenses of this company. It's also quite interesting to note that R&D, which we might expect for a company that is quite innovation-heavy, is only about 2% of sales. And even with this, they are outspending about three-fourths of the industry. Which tells you, maybe, that the rest of the industry is increasingly becoming challenged in terms of fighting off the scalability of innovation that EssilorLuxottica might be able to continue generating. So advertising—again, quite an advertising-intensive business because of competition, particularly on the frames and sunglasses side of the business—that is about 7% of sales. And then here, they do have a little bit, in my view, of general admin bloat, if I may, which is about 8% of sales, which tends to be on the higher side. If you consider that they're in 150 different countries with a fully integrated value chain, perhaps there are good reasons for this being as high as it is. The company has targeted that it will, over time, be able to increase its EBIT margin from the roughly 16% levels today to 19% to 20% by the end of FY 2026. It's my personal impression that that is likely to be delayed because their first priority will be to invest in growth. And if they see, for example, smart glasses continue to grow in adoption, as well as Nuance Audio—the hearing aid device—continue to grow in adoption, that those will be prime areas for reinvestment. And then it's also interesting that R&D is only 2% of sales. But CapEx, it has peaked at about 7% and steady state is expected to be about 5%. And so that is really because a third of that CapEx is going into operations and another third into retail.