Business Breakdowns
· 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.
· Swetha Ramachandran, Zack Fuss
So they're still very heavily investing behind their retail presence in order to make sure that they are able to sell both the enlarged suite that they are offering now to customers, all within the same formats, and therefore increase store productivity. Again, I think this is a longer-term margin expansion potential, probably not right away. Of course, eCommerce investment has been huge for them as well. This is an area where increasingly, 7% of their sales are coming from eCommerce, so this has required investment. About 20% of that CapEx is going into investing in digital technology. And I think this is now increasingly table stakes for a business like this which is facing competition, of course, from many other retailers in the eCommerce arena. [00:00:00] S0: It's interesting that you mentioned eCommerce because it's almost impossible to talk about Essilor without mentioning the likes of Warby Parker, which is now itself a public company. And if you think about the direct-to-consumer boom of the last decade, for a very long time, the capital markets afforded their competition to effectively lose money to acquire customers. And that's no longer the case. But I'm curious, as people thought through some of the competitive pressures that a business like this would face, what the likes of Warby Parker meant for their business and how they've staved off such competition.
· Swetha Ramachandran
[00:00:00] S1: Yes, and I think this again brings to the fore their relatively unglamorous approach in terms of this insistence on vertical integration, which is to control everything from global manufacturing to global distribution to an offer like Warby Parker, which is much more centered around the consumer, the end consumer experience at retail. So if we just look back even to five years ago when the phrase DTC was all the rage, particularly for US companies. Consumer brands, for example, like Away in luggage were competing against the likes of Samsonite; Warby Parker in eyewear competing against EssilorLuxottica. And they were seen as disrupting what had traditionally been seen to be very staid, dull but worthy industries. And so Warby Parker's model was really to own the customer experience and outsource mostly everything else. Not everything, because they did control the design element. But for example, manufacturing was done at third-party manufacturers, and they basically controlled the design and the retail elements. So that digital-first model was a huge success during the pandemic, but they've actually struggled to turn a profit. And if you contrast that to EssilorLuxottica at 16% EBIT margins, that's quite a contrast. And it's quite telling that actually the value of scale and the benefits that vertical integration have had for this business have been huge. And it's also, I think, the case that consumers, especially post-pandemic, have voted with their feet in that they want choice. So I think what was Warby Parker's strength at the beginning, which was that single-brand focus, has now perhaps emerged to be a little bit of a weakness in not being able to give customers the full spectrum of alternatives that might be available out in the marketplace. I mean, the other key is of course that EssilorLuxottica has global scale; it's in 150 countries, while Warby Parker is still very US-Canada focused. And so their sales today are still sitting at about 2% of EssilorLuxottica's sales. That's, I think, the real difference is that what was seen as a disruptor is really perhaps now just sort of a me-too wannabe player rather than a true disruptor.
· Zack Fuss
[00:00:00] S0: And then we haven't spoken much to the geographic mix of the business. Obviously it's listed in Europe, but the majority of the business is still in North America. Are there differences in strategy based upon where the footprint of the business is and how aligned or integrated are those business units?