Coty’s TJoy Unit Continues To Disappoint, Driving $253.3 Mil. Loss In Q3

Coty Inc. recorded a $316.9 million asset write-down in the third fiscal quarter related to its TJoy skin-care business in China, driving a $253.3 million loss overall. The firm will reorganize its mass-market business in the country to improve profitability in Skin & Body Care, which booked an 8% increase in global revenues on the strength of the firm’s philosophy brand, among other highlights, despite TJoy’s drag on the segment’s performance.

[Coty Inc.] plans to reorganize its mass-market business in China after efforts to improve profitability of its TJoy skin-care business came up short, driving a net loss of $253.3 million in the firm’s fiscal 2014 third quarter.

Overall revenue was up 1% on a reported basis to roughly $1.01 billion for the period, according to the New York-based firm’s May 14 earnings release.

However, a $316.9 million asset impairment charge related to TJoy encumbered Coty’s Skin & Body Care segment and contributed heavily to the overall loss, which compares with profit of $20.4 million in the same period a year ago.

In a same-day call, CEO Michele Scannavini said that recent efforts to revamp TJoy, acquired from China-based TJoy Holdings in 2010, have not improved cash flows as expected. Marketed as “Balancing Your Qi, Awakening Your Beauty” – skin’s Qi being “the root of energy and revitalization,” according to the brand – TJoy offers a range of ginseng-based whitening and anti-aging creams.

“The brand has lost momentum in part to a very, very competitive mass market,” Scannavini explained. The stumble came despite a recast of the unit’s management team and the distribution network behind the line, as well as the December 2013 launch of a new TJoy Hydractive collection.

Coty purchased TJoy for $352 million in a deal that analysts now say was overvalued (Also see "Poised For IPO, Coty Bills Itself As Emerging “Multi-Segment” Beauty Firm" - HBW Insight, 20 May, 2013.).

“The TJoy under-performance is currently a drag to the profitability of our channel operations and the overall skin- and body-care segment,” Scannavini said. “We are currently working on scenarios to reorganize our overall [business] in China with the objective of bringing significant benefit to the profitability of Coty,” he said. Those plans will be revealed during the firm’s fourth-quarter call.

Coty says action taken with the non-cash impairment charge will reduce amortization expenses by $8.3 million annually.

Adjusted operating loss in Coty’s global skin- and body-care segment totaled $9.6 million, reflecting ramped-up advertising and promotion investments to support the division’s growth, according to the release.

Outside of TJoy, Coty’s skin-care brands – including Lancaster and Adidas – are “growing very nicely” in China, Scannavini said.

In prestige fragrance, which accounts for 50% of the firm’s business in China, internal revenues and profits grew on the performance of Calvin Klein, the No. 3 brand in the market, and strong results from Chloe and Marc Jacobs.

The Asia Pacific region recorded 14% growth in the third quarter, ended March 31, to reach $126.6 million.

U.S. Struggles As Brazil Accelerates

In the Americas region, emerging markets including Brazil and Argentina saw strong revenue growth, though those markets could not offset an 11% sales decline in the U.S. to $382.2 million.

“In the U.S., the market environment remains challenging, particularly in the mass channel,” Scannavini said. He noted the fragrance sector struggled and color cosmetics slipped 2% in the quarter.

Coty’s nail business experienced a 12% consumption falloff compared with a 12% increase in the third quarter of last year, according to the exec. “Lower consumption was driven by lower traffic in-store, high inventory in consumers’ houses and the contraction of the special-effects makeup category,” he said.

Coty’s nail segment slumped markedly last year as weaker consumption in the overall market drove retailers to destock products (Also see "Coty Projects Slight Q1 Decline, Citing “Drastic Drop” In Nail Segment" - HBW Insight, 23 Sep, 2013.).

Market researcher Kline & Company recently reported that after several years of strong innovation and double-digit gains in the category, nail-polish sales were flat in 2013 (Also see "Hair Care Springboards Off Skin-Care Trends, Nail Color Slips In 2013" - HBW Insight, 21 Apr, 2014.).

Regarding prospects for improvement, Scannavini said: “At this stage, we have no visibility on when the U.S. mass channel market will improve in color, particularly in nail. However, we have reason to be optimistic about our business in the second part of the calendar year due to a stronger innovation [platform].”

The exec noted that Coty is making strides in a comprehensive plan to upgrade and rejuvenate Sally Hansen, including online, offline and in-store communication.

In June, the firm will introduce a new product under the brand called Sally Hansen Miracle Gel, positioned as providing “the highest standard of nail lacquer performance guaranteed by [a] gel formula with a much easier, faster and consumer-friendly application,” according to Scannavini. In contrast to classic gel formulas, Miracle Gel will not need curing with an artificial light and can be removed as easily as normal nail polish, he said.

A robust marketing plan will support the launch, including digital, TV and print advertising. “We are optimistic that these initiatives will help Sally Hansen regain momentum in the second half of this year,” Scannavini said.

Coty also reported that it has finalized its partnership with Avon in which the direct seller will distribute Coty fragrances in Brazil via its 1.5 million representatives.

“At this stage, we expect our brands to start to be included in Avon product catalogs in time for the 2014 Christmas holiday season,” Scannavini said. The agreement was first announced on a tentative basis in February (Also see "In Brief: N.Y. Eyes Triclosan Ban; Avon To Sell Coty Scents In Brazil; More" - HBW Insight, 24 Feb, 2014.).

“I’m very happy and very excited about this new [deal] because I believe it’s really going to give us penetration with our fragrances in the most important market in the world,” the exec added.

In Europe, the Middle East and Africa – Coty’s largest business segment – total sales climbed 10% on a reported basis to $499.9 million, with emerging markets, the U.K. and Southern Europe performing well, the firm notes in its release.

Category Breakdown

Net sales in Coty’s Skin & Body Care segment managed to climb 8% to $155.7 million, despite the firm’s TJoy struggles. The unit benefited from the philosophy brand, which recorded strong growth for the fourth consecutive quarter across key distribution channels, including retail, QVC and e-commerce, according to the company.

In fragrance, revenue growth of 4% on a reported basis to $508.1 million was generated by “power brands” Calvin Klein, Davidoff, Marc Jacobs and Playboy. In color cosmetics, the struggling nail segment in the U.S. contributed to a reported 6% decline in sales to $344.9 million.

Coty plans to increase its advertising and promotion spend in the fourth quarter from its normal range of about 23%-24% to around 26%. The ad boost will continue “because we believe in the potential of our brand but we need to be sure that we have enough investment in a very competitive and crowded environment,” Scannavini said.

Coty raised just under a billion dollars in its June 2013 initial public offering – one of the largest for a consumer-products firm to date – but shares of the stock, which started at $17.50 apiece, have remained essentially flat, closing at $15.97 May 15.

In a May 14 analyst note, Deutsche Bank analyst Bill Schmitz suggested that while the “encore following the much anticipated” IPO was “lackluster,” it does appear that Coty and the market in which it operates are positioned for growth.

“We believe the worst category growth days are behind them (especially in Europe), nail category challenges and U.S. mass inventory destocking are largely complete and restructuring savings should accrue going forward which should support a stock that many have largely forgotten about since the IPO,” Schmitz said. He maintains a buy rating at $18.