17 March 2017 Europe Equity Research Luxury Goods
Eyewear Industry Research Analysts SECTOR REVIEW Catherine Tillson 44 20 7888 6052 [email protected] Visions are changing Guillaume Gauvillé, CFA 44 207 888 0321 ■ Providing a more holistic view of the eyewear industry. We broaden [email protected] our eyewear coverage by initiating on Essilor (Outperform, TP €127), GrandVision (Underperform, TP €19) and Safilo (Neutral, TP €6). This broadens our coverage to include all of the key eyewear players, enabling us to provide a more detailed industry view. This comes at a time of considerable change with the launch of the mega-merger between the two largest players in the industry: Essilor and Luxottica. ■ Three areas of differentiation. i) We initiate on Essilor and provide a detailed pro forma EssilorLuxottica model and explicit synergy forecasts. ii) We dissect the online vs. omni-channel dynamics, turning more bearish on the impact of online on the eyewear industry, especially for retailers. iii) Using the Optical Business Barometer, a survey carried out by Jobson Optical Research covering c300 ECPs in the US, we can provide a more transparent view of the largest eyewear market. We find sentiment in the US is improving, supporting our company forecasts. ■ Essilor (O/P, TP €127) and Luxottica (O/P, TP of €58 increased from €50). Essilor and Luxottica have traded sideways over the past month after losing some of the share price gains made on the day of the merger announcement. We see this as an attractive entry point into both names as, combined, we expect EssilorLuxottica to grow faster than the market, with greater margin accretion than the two companies would generate separately. Supported by strong cash generation, we forecast a 15% TSR from FY17-19e. (full note here) ■ GrandVision (U/P, TP €19). Following our analysis of online and what it means for pure play retailers and industry profitability, we are more bearish on GrandVision. We believe medium-term earnings are at risk as GrandVision will need to invest more significantly in omni-channel and reduce store expansion, in our opinion. (full note here) ■ Safilo (N, TP €6). Safilo could be an attractive turnaround story as it implements its ‘2020 Vision’ strategic plan, addressing inefficiencies in its operations and promoting its own brands. However risks around licenses (especially Dior) leave us cautious at this stage. (full note here) Figure 1: The eyewear value chain including key players
Source: Company data, Credit Suisse research
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 17 March 2017
Table of contents
Key charts 3
Investment thesis 4 Outperform-rated stocks ...... 4 Neutral-rated stocks ...... 5 Underperform-rated stocks ...... 5 Valuation and operating metrics...... 6
Sector review 8 Underlying market trends remain constructive...... 9 EssilorLuxottica would be best placed to capture profits ...... 14
Key theme #1: EssilorLuxottica highlights the need for new growth 15 A wave of eyewear consolidation...... 15 Consolidation will continue in the eyewear industry...... 18 Essilor/Luxo acquisition history has been strong ...... 19
Key theme #2: Online vs Omni channel 23 Omni-channel better placed in developed markets...... 23 Store rationalization will have to happen regardless...... 26 Profit implications are negative for online ...... 29 Stock implications from our online analysis ...... 31 Proprietary e-commerce survey ...... 33
Key theme #3: The US 37
Luxottica Group (LUX.MI) 45
GrandVision N.V (GVNV.AS) 46
Essilor International SA (ESSI.PA) 47
Safilo Group Spa (SFLG.MI) 48
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Key charts
Figure 2: We believe the eyewear market’s strong Figure 3: Analysis suggests lens finishing in labs underlying growth drivers remain intact has the largest profit pool along the value chain Estimated eyewear market segment size at retail value (€b, lhs), y-axis: CFROI – discount rate, x-axis: proportion of total gross forecasted 3 yr CAGR, cc growth (%, rhs) investment base. (134.33 Yen/€), FY15
50 9% 20% 8% 45 8%
40 7% 15% 35 6% 30 10% 5% 5% 25 4% 20 3% 5% 2% 3% 15 2%
10 2% 0% 5 1%
- 0% -5% Frames Lenses Sunglasses Luxury frames Luxury sunglasses Essilor Luxottica Fieldmann Hoya GrandVision Safilo 2016 2019e 3 yr CAGR
Source: Euromonitor. Historical constant 2016 prices, forecast constant 2016 prices Source: Company data, Credit Suisse HOLT®, Credit Suisse research
Figure 4: The eyewear industry remains very Figure 5: We grow more constructive around online, fragmented with consolidation likely to continue estimating it to become 10% of sales by 2025e % of total optical retail sold through the internet channel
55%
30%
20%
12% 12% 10% 11% 8% 7% 8% 8% 6% 7% 7% 5% 4% 4% 5% 4%4-5% 3% 3% 2% 0%
Fragrances Colour Sportswear Footwear Apparel Mobile Phones Wearable Eyewear* Cosmetics Electronics 2008 2013 2015
Source: Essilor FY15 results presentation Source: Euromonitor, *Eyewear data Essilor 2014 Investor day, Credit Suisse research
Figure 6: We expect online to increase pricing Figure 7: We introduce the OBB which suggests competition and negatively impact industry profits sentiment in the US optical market is improving Variation in frame and lens prices across countries, local currency Across the entire US, how do think the overall optical business trend will be for the next 6 months
4.0 12% smartbuyglasses.com, $ rayban.com 10% glassesusa.com 3.9 glasses.com 8% framesdirect.com 3.8 coastal.com 6% netzoptiker.de, € 3.7 4% framesdirect.com (uk), £ 3.6 glassescomplete.co.uk 2% eyewearbrands.co.uk 3.5 pretavoir.co.uk 0% smartbuyglasses.co.uk misterspex.co.uk 3.4 -2% lensway.co.uk glassesdirect.co.uk 3.3 -4% 0 50 100 150 200 250 300 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16 Frame Lens Future US Optical US Optical, % change
Source: Company data, Credit Suisse research Source: Jobson Optical Business Barometer (OBB)
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Investment thesis Outperform-rated stocks Essilor: Initiate with an Outperform rating (Full note). Recent share price weakness opens up an attractive entry point into Essilor and the EssilorLuxottica story, in our view. Valuation on 12-month forward EV/EBIT is trading back below EssilorLuxottica’s ex synergy average of 17.3x at 15.6x EV/EBIT on our FY18 pro forma numbers. We believe the companies will outperform in the long term as the merger should address many of their individual legacy problems and could end the capital-intensive diversification story at Essilor. We believe the market is underestimating the synergy potential. We estimate only c€150m (NPV) of synergies are currently priced in, based on a comparison of the market caps of both companies pre and post announcement and a WACC of 7%. Management has guided towards an EBIT impact from synergies over the mid-term of €400-600m. We forecast peak synergies of €540m by FY21 split evenly as per guidance between revenue- driven synergies and cost-driven synergies. This leaves us forecasting a pro forma TSR over the next three years of 15%, higher than our underlying estimates for Luxottica and Essilor individually. We set our target price at €127. Our target price for Essilor is backed out of our pro forma EssilorLuxottica merger model, as we believe the merger will go ahead. The pro forma model is built up from our underlying Essilor model (as detailed in the financial tables in the separate initiation note published today: Seeing EssilorLuxottica clearly), underlying Luxottica model and estimates of synergies on the revenue and cost lines. We then use a DCF with WACC of 6% and our Credit Suisse HOLT® Linker to reach our target price of €127. On our target price and FY18 pro forma EBIT we believe the company will trade on an EV/EBIT multiple of just under 18x. This is ahead of the historical EV weighted average but justified in our opinion given the higher barriers to entry and greater competitive advantage we believe the combined entity will have. Blue Sky valuation of €137, grey sky valuation of €90. Our Blue Sky scenario assumes EssilorLuxottica can implement synergies faster, grow further ahead of the market and generate greater margin improvements than assumed in our base case. This leads to a 10% increase in operating profit for FY18. Taking the historical EV weighted average EV/EBIT multiple of Essilor and Luxottica of 17x, leads to a Blue Sky valuation for Essilor of €137. Our Grey Sky scenario assumes the merger does not go through and FY18 operating profits are reduced by 15% as the eyewear market sees a marked slowdown in growth and Essilor’s relationship with the independents suffers from the launch of the merger. Using an average historical multiple of 16x leads to a Grey Sky valuation for Essilor of €90. Key risks to our investment thesis for Essilor. We highlight the following key risks to our investment thesis: i) the merger does not go through either because it is rejected by Essilor shareholders at the annual shareholders' meeting on 11 May (two-thirds must vote in favour for it to be approved) or anti-competition authorities rule against it; ii) the eyewear industry sees a material slowdown in underlying growth; iii) EssilorLuxottica loses wholesale market share as independents move away from the larger conglomerate; or iv) the merger goes through but is executed poorly. Luxottica: Reiterate Outperform (Full note). We do not believe the proposed merger with Essilor derails the equity story for Luxottica. We expect the self-help initiatives to be run to completion and with the help of Essilor some of the legacy issues to be solved. For example, Luxottica can leverage Essilor’s relationship with the US independents, can benefit from insourcing of lens costs and develop LensCrafters omni-channel faster with Essilor’s online expertise.
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Increase our target price to €58 (from €50). Given the terms of the deal specify an explicit exchange ratio of Luxottica shares for Essilor shares, with one Luxottica share equal to 0.461 Essilor shares, we back out our Luxottica target price from our pro forma Essilor target price. This leaves us forecasting a €58 target price for Luxottica. Similarly our Blue Sky scenario is backed out of Essilor’s Blue Sky valuation of €137, giving €63. Grey Sky scenario assumes the merger does not happen. Luxottica’s Grey Sky valuation is based on the underlying Luxottica operating profit for FY18 declining by 15%. We assume the merger does not go through, LensCrafters does not reaccelerate growth and North America wholesale organic growth does not re-accelerate after it laps the impact of the MAP policy. Applying Luxottica's 10-year average EV/EBIT multiple of c15x leads us to a Grey Sky valuation of €41. Neutral-rated stocks Initiate on Safilo with a Neutral rating (Full note). Although we think Safilo looks relatively attractive on valuation (EV/Sales), we do not see this as a good time to buy the name. Admittedly, we see the potential for a turnaround story as the company implements its '2020 Strategic plan’. This includes such initiatives as SAP implementation, insourcing of volumes and cost savings of €25-30m from FY17-19, which could support margin accretion and topline outperformance. However, we are not fully assured that Safilo’s earnings are no longer at risk from further licences leaving or that the investment plan will not be derailed by the loss of licences or be executed poorly. The company's revenues are still overexposed to licenses, at 75%, and its own brands are struggling to gain momentum. Moreover, based on the recent commentary from LVMH and its JV with Marcolin for its eyewear brands, we think Dior is likely to leave at the end of its contract in December 2020. We estimate that the Dior license and LVMH licenses account for almost a quarter of Safilo's annual sales. Valuation looks stretched on EV/EBIT but undervalued on EV/Sales. Following FY16 results we look at EV/Sales given the volatility of the earning story. On this metric the company is trading on a 0.4x multiple on our FY18e, below history of 0.7x and the eyewear sector of 3x. If we look at the normalized EV/EBIT multiple over the next 5 years on our adjusted EBIT forecasts the stock trades on 20x, ahead of its historical average of 10x. Target price set at €6. Our target price is based on an average of a DCF and our Credit Suisse HOLT Linker™ valuation. We remain conservative with our DCF metrics, with a 1.5% long-term growth rate, 3.5% operating margin and 8% WACC. Our Blue Sky scenario assumes the company is able to execute the '2020 Vision' plan fully and meet its targets, accelerates the turnaround of the own brand portfolio and executive cleanly on the EyeWay transformation. This gives scope for a 10% increase in earnings, in our view. Applying a multiple of 13x, 1std deviation from the historical average EV/EBIT multiple gives us a Blue Sky valuation of €10. Conversely if the company suffers further deterioration of own brands and EyeWay does not go as planned, introducing new disruption, we see the potential for a 25% decrease in operating profit. Applying a trough EV/EBIT multiple of 7x leads to a Grey Sky valuation of €3. Key risks to our investment thesis for Safilo. On the downside: i) Dior terminates its contract earlier than expected, ii) the own brands do not regain momentum; iii) the '2020 Strategic plan’ is executed poorly. To the upside: i) Dior does not leave; ii) own brands reaccelerate growth; iii) the company is able to buy in another strong brand with the help of HAL Holding (majority shareholder). Underperform-rated stocks Initiate on GrandVision with an Underperform rating (Full note). The stock price is up just over 20% since its trough in December 2016. This is against the Amsterdam Index up 14% over the same period. Given there have been limited consensus earnings upgrades,
Eyewear Industry5 17 March 2017
this has led to a recovery in EV/EBIT multiples from a trough of <14x. Although it still trades broadly in line with its historical levels of 16.5x (albeit over a short history) at c16x, when we compare it with a basket of European retailers and Specialty retailers, it sits at a 31% premium on 12-month forward EV/EBIT compared to a historical premium of 26%. We believe the company is underestimating the impact of online and underinvesting in the channel. To remain competitive, we think GrandVision will have to significantly increase investments and – as we expect online to be a lower-margin channel – is likely to face margin pressure in the future. Moreover, we believe most of the initiatives the company has deployed since FY11 to grow margins are now largely played out. We therefore expect EBITDA margins to plateau after FY19 at just over 16%. Target price set at €19. Our target price is a simple average of a DCF and our HOLT Linker. Our DCF uses a WACC of 8% and terminal growth rate and margin of 3% and 10%, respectively. We calculate our Blue Sky scenario assuming the company can resist profit pressure from omni-channel initiatives and the move to online eyewear sales happens at a slower rate. This gives around 15% potential upside to our profit numbers. We apply an EV/EBIT multiple of at least one standard deviation above the historical average, giving a Blue Sky valuation of €30. We base our Grey Sky scenario on further channel shift to online and over expansion of retail outlets. Additionally we assume no positive impact from deregulation in France. This leads to our forecast operating profit being 25% lower than our current estimates. We then apply an EV/EBIT multiple of at least one standard deviation below the historical average, deriving a Grey Sky valuation of €16. Key risks to our investment thesis for GrandVision. i) online channel does not take off; ii) the US faces significant de-regulation; iii) management moves into lens finishing which improves margins; and iv) consumers become more promotion–driven, supporting topline outperformance. Valuation and operating metrics
Figure 8: Eyewear sector valuation table
Source: Company data, Credit Suisse estimates, Thomson Reuters; Priced as of close on 14 March
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Figure 9: European retailing and specialty retailing peers EV/EBIT P/E CY17e CY18e CY17e CY18e Hennes & Mauritz 14.4 12.6 18.9 16.7 Inditex 20.3 18.1 28.0 25.2 Marks & Spencer 10.5 10.1 11.4 11.1 Next 8.9 9.7 9.8 10.6 OVS 9.3 7.8 13.2 11.6 XXL 17.4 14.0 21.4 17.0 Matas* 10.6 11.4 10.3 10.8 KappAhl* 8.2 7.5 11.5 10.3 SportsDirect Int.* 14.2 12.9 18.7 17.0 Dufry 26.3 22.3 16.4 14.5 Kingfisher 10.1 8.7 12.0 10.5 Dixons Carphone 6.8 6.2 9.4 8.8 Pets at Home Group* 10.1 9.8 12.4 11.9 European retail simple avg. 12.9 11.6 14.9 13.5 Source: Company data, Credit Suisse estimates, Thomson Reuters, * consensus numbers, Priced as of close on 14 March
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Sector review We add Essilor, Safilo and GrandVision to our eyewear coverage. Given the announcement on 16 January 2017 that Essilor and Luxottica have agreed to merge, targeting completion in 2H17 (assuming all necessary approvals are received), we initiate on Essilor as a standalone company with a fully working pro forma model of the new EssilorLuxottica entity. ■ For now Essilor International is a €24bn market cap company, generating c€7.1bn in revenues in FY16. While Luxottica is the leading manufacturer and distributor of high- end branded frames, Essilor is the leading manufacturer and distributor of lenses. The company also has some exposure to sunglasses and online platforms providing direct- to-consumer access. ■ GrandVision is a €6bn market cap company and generated c€3.3bn in revenues in FY16. It sits at the high end of the value chain as a pure play optical retailer. ■ Safilo's business model is most similar to Luxottica’s, but with lower retail exposure and on a smaller scale. The company manufactures branded frames under own brand labels and license agreements. It generated c€1.3bn in revenues in FY16 and has a market cap of c€400m.
Figure 10: An overview of the eyewear value chain and key players. We discuss where the profit lies later in this section Eyewear value chain
Source: Company data, Credit Suisse research
We estimate a global sell-out market share based on a €96bn industry. There are many ways to calculate market share for these companies, given: i) the broad definition of the eyewear industry, which can include sunglasses, prescription (Rx) glasses, contacts and surgery; and ii) the companies’ mixes of retail vs. wholesale. For Essilor the company states it has a c40% market share of the lens industry based on volumes, with Euromonitor estimating a c30% market share based on retail value. For Luxottica and Safilo we have market share data from Euromonitor for the frames, sunglass and luxury eyewear markets (see Figure 12). Essilor estimates the global sell-out value for contact lenses, spectacle lenses, readers, sunglasses and frames is c€96bn in FY15 (source FY16 results presentation). Using this we find GrandVision has a market share of c3%, based on FY15 revenues. Additionally, assuming a 2x markup between wholesale and sell-out revenue, Luxottica would have a c13% market share, Essilor c14% and Safilo c3% of the global retail sell-out.
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Figure 11: Euromonitor estimates a c30% market Figure 12: Luxottica is the largest frame share of the lens market for Essilor manufacturer, followed by Safilo Estimated global lens market share by retail value, 2015, % Market shares for Luxottica and Safilo, by retail value, 2015, %
Industrias de Optica 0.3% 50% JIN Co Ltd 0.3% 44% New Tian Hong Optical 0.3%
Rupp+Hubrach Optik 0.5%
Nikon Corp 0.5% 23% Fielmann 1.3%
Rodenstock 1.9% 14% 12% Carl Zeiss 6.3% 6% Hoya 7.9%
Essilor 31.3% Frames market Sunglass market Luxury eyewear market Luxottica Safilo
Source: Euromonitor, Credit Suisse research Source: Euromonitor, Credit Suisse research
The new EssilorLuxottica entity would therefore be the market share leader by far. This is not new to the market and could be a sticking point for some investors who believe the planned merger may face significant scrutiny from anti-competition authorities. In the merger presentation, released with the announcement, the companies gave market share data by region. We extend this analysis with market share by product category (see Figure 13 and Figure 14).
Figure 13: A combined company would neutralise some of Luxottica’s overweight N. America and Figure 14: Product market shares puts the underweight Europe combined entity on a global market share of 33% Regional exposure of separate companies and combined entity, % Market share of proposed EssilorLuxottica entity, at retail values, % 2015
27% 55% 50%
17% 17% 16% 31% 31%
11% 10% 10% 23% 23% 9% 8% 7% 7% 6% 6% 5% 4%
4% 0% 0% Europe Asia-Pacific, Middle East, North America Latin America Global Africa Frames Sunglasses Lenses Essilor Luxottica EssilorLuxottica Luxottica Essilor Combined entity
Source: Company data, Credit Suisse research Source: Euromonitor, Credit Suisse research Underlying market trends remain constructive Eyewear market expected to grow at 3% CAGR to 2019. In Figure 15 we detail the current size and expected future size of the overall frames, lens and sunglass market, breaking out expectations around the luxury subsector – sunglasses and spectacle frames. Currently the frame market sits at c€32bn based on retail value and the lens market at over €42bn. These markets are both expected to grow at an average CAGR of 2% over the next three years, according to Euromonitor. The Luxury segment (which includes luxury frames for prescription glasses and luxury sunglasses) is set to grow faster than the industry as a whole, favouring Luxottica’s and partly Safilo’s product exposure. Luxury sunglasses are forcast to grow at 8% over the next three years and luxury spectacle frames at 5%. Both of these markets currently sit at c€8bn based on retail value.
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Figure 15: Total eyewear market expected to grow at a 3% CAGR to 2019 Estimated eyewear market segment size at retail value (€b, lhs), forecasted 3 yr CAGR, cc growth (%, rhs)
50 9% 8% 45 8% 40 7% 35 6% 30 5% 5% 25 4% 20 3% 3% 15 2% 2% 10 2% 5 1% - 0% Frames Lenses Sunglasses Luxury frames Luxury sunglasses 2016 2019e 3 yr CAGR
Source: Euromonitor. Historical constant 2016 prices, forecast constant 2016 prices
Sunglasses continue to grow ahead of the prescription market. The broader sunwear market is expected to grow by 6-7% per annum to 2018, according to Essilor. We note this is double Euromonitor's expectation, at 3%. The luxury sunglass segment is set to grow by c8% (source: Euromonitor). The market can be split into three segments: luxury fashion, performance and entry/mid-tier. The luxury segment is the largest by value. Euromonitor calculates that it was worth c€8bn in 2015. However, on volumes the luxury segment is the smallest at c28m units (source: Euromonitor) while entry/mid-tier accounts for >500m units and performance for 25-30m units. A more cyclical, discretionary purchase... Although the sunglasses market is expected to grow at almost double the rate of the prescription market, it is more exposed to cyclical trends such as the weather. We have seen this more recently for both Essilor and Luxottica, with weak sun sales in 2Q16 because of unfavourable summer weather conditions in North America.
Figure 16: Luxury sunglass segment to grow at c8% Figure 17: Sunglasses remain fairly over the next three years, ahead of the market underpenetrated with significant potential Volume, value, ASP split of growth for luxury sunglasses, % Global penetration of products, %
10%
100% 8% 90%
6%
4% 50%
2% 30% 30% 20% 0% 10%
-2% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017e 2018e 2019e 2016 Potential 2016 Potential 2016, in Rx 2016, in non- Potential sun Rx sun unit price, € per units Volumes, '000s units retail value, fixed fx, €m Sunglasses Rx sunglasses Polarised lenses
Source: Euromonitor, Credit Suisse research Source: Essilor US Field Trip 2016, Credit Suisse research
… which plays into affordable luxuries. However, we believe this category is becoming increasingly important to investors looking for exposure to the Luxury space given sunglasses fall under ‘affordable luxuries’. Although we look at the eyewear category in terms of GDP and disposable income, when we think of it in the context of the Luxury space we focus on wealth accumulation. The Credit Suisse Research Institute recently reduced its medium-term forecasts for global wealth accumulation from 7% to 5%. We
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believe this will drive lower growth of higher-priced luxury goods. As such, we believe affordable luxuries will outgrow high-end luxuries in the medium term. We reiterate our positive stance on the eyewear industry. In our initiation of Luxottica last June (Attractive entry point for the long-sighted, 15 June 2016) we walked through the underlying growth drivers of the eyewear industry, particularly prescription (Rx) and luxury sunglasses. We reiterate this positive view as: 1. Vision correction remains an underpenetrated market. Of the global population (7.2bn), 63% need vision correction according to Essilor. However, only 1.9bn (i.e. 42% of those requiring correction) are in fact corrected. Given eyeglasses account for 86% of the vision correction in the world (source: Essilor Investor Day 2014) there is a clear preference for this correction solution across developed and emerging consumers. Additionally, with only c30% of the world's population owning a pair of sunglasses and 10% of Rx wearers owning prescription sunglasses (see Figure 17), this product category is also significantly underpenetrated. 2. Demographics are still supportive. As development of long sightedness (or presbyopia) is an age-related process, ageing populations provide a significant contribution to the growing number of people that require vision correction. Essilor expects the number of people with presbyopia to increase at a CAGR of 2.5% between 2015 and 2030 (source: FY15 results presentation). 3. Move to online and increased ‘screen time’ is also supportive. Although this has not been clinically proven to cause direct eye damage, the strain it causes can contribute towards the occurrence of myopia or shortsightedness. Essilor forecasts the number of people suffering from myopia to increase from 1.7bn in 2015 to 2.7bn in 2020, a CAGR of 3.3% (source: FY15 results presentation). Myopia is corrected by simple single vision lenses and as lens innovation turns to more preventative solutions, vision damage from screens has opened up a new category of lens innovation with anti-blue light properties.
Figure 19: Emerging markets (or ‘fast-growing Figure 18: Amount consumers spend on lenses is markets’) show significant value growth potential as closely correlated to wealth and disposable income GDP per capita increases Bubble size in proportion to lens market volumes Value growth potential. Price to consumer (log $) on y-axis, GDP per capita (log $) on x axis
Source: Essilor 2014 Investor day Source: Essilor 2014 Investor day
4. Emerging market story remains. Figure 18 shows the positive correlation between consumer wealth and spending on lenses, as the lens spending per capita (y-axis) increases as GDP per capita increases (x-axis). The ability to afford vision correction is more often a limiting factor for EM consumers, and of the 2.5bn people requiring
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vision correction worldwide in 2013, c95% were in emerging markets (source: Essilor). We therefore see the growing middle class and increasing disposable incomes in emerging markets as positive trends for this industry (see Figure 19). Moreover, the development of the online channel opens up distribution and education, supporting growth.
Figure 20: Worldwide value added lenses are still Figure 21: There are still strong regional differences relatively underpenetrated in the replacement rate of spectacle lenses Penetration of total worldwide lens industry in volume, % Replacement cycle (years)
57% South Africa 4.2 48% Japan 4.1
France 3.0
Brazil 2.9
India 2.9 14% 15% 15% 12% 9% 10% 7% 7% China 2.8 1% 2% USA 1.9 2007 2013 2007 2013 2007 2013 2007 2013 2007 2013 2007 2013 Progressive Antireflective Thin lenses Photochromic Prescription Polarised Australia 1.6 lenses lenses lenses sun lenses lenses
Source: Essilor Investor day 2014 Source: Essilor investor day 2014
5. Premiumisation makes developed market opportunities as attractive as emerging markets. Developed market growth is also supported by the potential for shortening replacement cycles and driving multi purchases. Premiumisation has had a greater influence on the frames market given consumer habits. Estimates from Euromonitor suggest the luxury spectacle frames market has outgrown the overall spectacle frames industry since 2011 although was subject to a greater deceleration during the financial crisis, see Figure 22. Splitting the components of growth into volumes and ASP, we have seen lower volume growth from the luxury segment which has been compensated by a higher degree of pricing power. We find a c500bps growth differential between the ASP of luxury spectacle frames and the total spectacle frame industry (see Figure 23 ).
Figure 22: Luxury frames have outgrown the Figure 23: Luxury frames have greater pricing market, driven by pricing power power than the broader frame market Retail value growth, € constant currency, % ASP YoY growth, %
10% 4%
2% 5%
0% 0% -2%
-5% -4%
-10% -6%
-8% -15% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017e 2018e 2019e 2020e 2021e Luxury Spectacle Frames Spectacle frames Lenses Spectacle Frames Luxury Spectacle Frames
Source: Euromonitor Source: Euromonitor, Credit Suisse research
6. Premiumisation is a lens story, as well as a frame story. For lenses, the process of trading up is more technical, looking to add layers with additional properties; e.g. anti-UV. Given 70% of the lens EBIT value comes from coatings and materials, (source: Essilor FY14 investor day), and these only come at an incremental cost to the
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manufacturer, this clearly provides a positive mix contribution. The prescription lens market is expected to grow by 3-4% over the next three years (source: Essilor FY15 results presentation). We see four negatives for the industry at this stage: 1. Online may help topline but will suppress industry profits. Although we remain positive around the underlying growth trends for Rx and sun, online does have the potential to disrupt industry growth. Overall we expect online to be positive for the top- line growth in emerging markets as it opens up distribution and awareness in countries that lack infrastructure and education around eye health. We expect the additional volumes here to outweigh the pricing pressure it brings in developed markets. However, it also has the potential to shift revenues to new more online- focused players from more established players that are perhaps slow to invest in the channel. Additionally and more importantly, we believe online has the potential to depress industry profits as investing in the channel and providing basic e-commerce functionalities such as free returns all come at a considerable cost. 2. And 2016 has seen a strong deceleration in growth. Looking at the Euromonitor data for 2016, overall eyewear industry constant currency growth decelerated from +3% in 2015 to flat in 2016 as spectacle frames and lenses fell from +2% and +5%, respectively, to 0%. This was the first time in five years the industry reported almost no growth. The luxury segment saw stronger growth, with luxury spectacle frames maintaining growth at 4% in 2016 while sunglasses continued to grow by high-single digits (8.5% 2015 vs. 7.5% 2016). We believe this slowdown was driven largely by the US, the world's largest eyewear market, where growth slowed across the retail industry and consumers were more focused on the election at the end of the year. Essilor estimates the US market is worth $30bn based on the sell-out value for contact lenses, spectacle lenses, readers, sunglasses and frames (source: Essilor US Field Trip), out of a total of c€96bn – i.e. the US is c30% of the market. 3. Contacts could gain market share. We do not currently see contacts as a significant threat to prescription glasses but we continue to monitor this risk. We think consumer engagement remains limited, due to: i) the cost of contacts considering they must be reordered. Clearly there is the option of yearly lenses, but these are arguably easier to lose/break than glasses; ii) consumer comfort; and iii) the hassle around the product. Additionally we find most consumers who use contacts also have a pair of prescription glasses or prescription sunglasses. Therefore, contacts do not completely cannibalise glasses sales but do extend the replacement cycle of the glasses.
Figure 24: Vision care expected to grow 3% Figure 25: Surgical market expected to grow 4%
2015 industry sales, $bn and projected industry CAGR 2015-2020 2015 industry sales, $bn and projected industry CAGR 2015-2020 28% 9 4% 5% 7 30%
8 4% 6 25% 7 3% 5 6 20% 2% 5 4 1% 15% 4 3 0% 3 10% 2 5% (2%) (1%) 2 3% 2% 5% 1 1 (2%)
0 (3%) 0 0% Contact lenses Lens Care Cataract Vitreoretinal Refractive Glaucoma Industry sales, $bn, lhs Projected industry CAGR '15-'20, rhs Industry sales, $bn, lhs Projected industry CAGR '15-'20, rhs
Source: Meet Novartis Management PPT, Investor presentation Source: Meet Novartis Management PPT, Investor presentation
4. Laser surgery remains a potential threat. Again, similar to contacts, we do not see laser surgery as a significant threat at the moment but will continue to watch for any
Eyewear Industry 13 17 March 2017
change in consumer engagement. We feel consumers still see pricing as too high (varying from £2,500 to £3,200 depending on the type of procedure in the UK, according to lasereyesurgeryhub.co.uk) and are not comfortable with certain aspects of the procedure. Additionally, laser eye surgery is far more established for myopic correction, while presbyopic solutions have struggled to gain significant recognition. EssilorLuxottica would be best placed to capture profits The largest profit pool sits with the lens finishing labs. In this value chain we believe the most lucrative stage is converting the lens puck into a finished prescription lens. This is despite the fact that lens innovation faces considerable pricing pressure. This process involves adding different value-added layers such as anti-reflective coatings and anti UV light coatings that come with significant pricing power and a very limited cost to the manufacturer. In fact, Essilor states the relative margin of selling to an independent optician through a non-owned lab is c50% while through its own lab it is 100% – a 1:2 profit ratio. Profit in the value chain sits with Essilor and the new EssilorLuxottica entity. Using HOLT we assess the current pools of value across the key listed eyewear companies. As separate companies, we find Essilor captures more profit than Luxottica despite Luxottica recording an absolute EBITDA 20% higher than Essilor in FY15 (looking at the areas of the bars in Figure 26). Essilor owns c500 lens labs across the globe and on volume terms finishes c25% of its total lens production volume. Before the launch of the merger, Luxottica had been investing in three centralised lens labs. In Europe this was so the company could offer its wholesale partners lens finishing capabilities for the Ray-Ban brand. Given this analysis of profit pools, we saw this as a positive move for the company to capture more profits of the value chain. As a combined entity, EssilorLuxottica will be able to further increase this exposure and potentially be able to capture the lens finishing profits for all prescription frame sales to wholesale partners.
Figure 26: Essilor holds the largest profit pool of the Figure 27: Lens players have highest margins in the eyewear sector eyewear industry y-axis: CFROI – discount rate, x-axis: proportion of total gross EBITDA margins for the key industry player investment base. (134.33 Yen/€), FY15
20% 31%
15% 24% 21% 22% 10%
15% 5%
8% 0%
-5% Essilor Luxottica Fieldmann Hoya GrandVision Safilo Safilo GrandVision Fieldmann Luxottica Essilor Hoya
Source: Company data, Credit Suisse HOLT®, Credit Suisse research Source: Company data, Credit Suisse HOLT®, Credit Suisse research
Eyewear Industry 14 17 March 2017
Key theme #1: EssilorLuxottica highlights the need for new growth The eyewear industry remains very fragmented. Essilor quotes over 350,000 independent eye care professionals in the retail landscape and 1,500 to 2,000 other distributors and laboratories (see Figure 28). We believe this fragmentation is in part driven by the nature of the business model. Many of the lens labs and independent eye care professionals are run as family businesses and are supported by their strong consumer/client relationships and customer loyalty. But it is also driven by the regulation around opticians, ophthalmologists and optometrists – 'The 3 Os'. Although consolidation has been a longstanding theme, we think there is still plenty of scope for this to continue. Companies have looked to consolidate as they search for new areas of growth. Over the past couple of years we have seen a number of important strategic decisions from the key players, especially more recently with the proposed mega-merger between Luxottica and Essilor. We believe this has been largely driven by the need to find new areas of growth as growth of their traditional businesses arguably starts to roll over (see Figure 29). This is: i) despite the favorable underlying industry growth; and ii) exacerbated by online disruption. Developments online are lowering barriers to entry for new competitors and putting pressure on global brands via increased price transparency.
Figure 28: The eyewear industry remains very Figure 29: Group organic growth for eyewear fragmented with consolidation likely to continue companies has started to roll over Current view of the eyewear industry Constant currency growth of eyewear companies
15%
10%
5%
0%
-5%
-10% 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
Luxottica cc Safilo cc Essilor Group (LFL) GrandVision (org growth)
Source: Essilor FY15 results presentation Source: Company data, Credit Suisse research A wave of eyewear consolidation Both Essilor and Luxottica were making tentative steps into each other’s business areas prior to the merger announcement. In Figure 30 and Figure 31 we summarise the key moves we have seen over the past couple of years by the four eyewear stocks under our coverage. Essilor has diversified the most, building a presence in the frame manufacturing space (although small), retail space and e-commerce. Additionally, the company has looked to build up barriers to entry and gain more pricing power by focusing on branded products via the sunglass category (see Figure 31) and investing in advertising for its branded lenses. The company has picked up a number of sunglass own brands (e.g. Costa in the US and Bolon in Asia) as well as license agreements through the Stylemark acquisition (see Figure 33). We believe this and succession issues at Luxottica triggered the merger. Luxottica, on the other hand, has pushed further into lens labs and lens finishing. The company recently built up its lens finishing capabilities in Europe, centralising its offering so that it could provide lens lab facilities to European wholesale partners. This directly encroaches on Essilor’s business and exposes the company to what we believe is the largest profit
Eyewear Industry 15 17 March 2017
pool along the value chain. We believe that these moves, plus the fact Leonardo Del Vecchio (the founder and majority shareholder of Luxottica) seemed to be struggling to find a CEO to replace him (given the degree of CEO turnover we have seen since 2014 and his return to an executive role in the company at the start of 2016) could have potentially triggered the merger announcement.
Figure 30: Company coverage of the eyewear value chain Dark blue blocks represent established business lines. Lighter boxes with text represent examples of new business moves
Frame manufacture Lens manufacture Lens lab – taking the W/S Retail Online (ex wholesale) puck to finished lens Small exposure through Franchise stores in Asia, Coastal.com,
r Bolon acquisition some standalone stores eyebuydirect.com, o l i in LatAm. framesdirect.com s s E Have always had lens Investing in online and labs attached to digital; sunglasshut.com, LensCrafters stores but rayban.com, looking to expand oakley.com. Plan to a c
i centralised labs and launch more omni- t t
o offer to wholesale channel capabilities. x
u partners L Tech Centers do edging Launching omni-channel n o i and mounting but no capabilities to support s i
V finishing capabilities retail network d n a r G Very limited – started Tried to move into retail Some online capabilities pilot with Smith in the in 2008, following with own brand Smith US financial difficulties sold transactional website the majority of stores. o l
i Today, only have f a Solstice stores in the US S
Source: Credit Suisse research
We believe this was earlier than the market expected. In September 2014, Mr Cavatorta (the interim CEO of Luxottica) said "In terms of Essilor, that was -- that potential deal was explored from both sides more than a year ago. It was least one and a half years ago. And in the end, there was a common thinking between Mr. Del Vecchio, Andrea, myself and the Board, it was shared with them, that there were no -- there were not the right conditions to go ahead with that deal." (source: Thomson Reuters transcript of call on management structure, September 2014). The market therefore knew this deal could be on the table at some point in the future. However, we would have expected it to come at the end of Luxottica’s three-year investment plan detailed in March 2016 as the company arguably would have been in a better position operationally and possibly in a better negotiating position. But if the merger was to happen, we think it needed to happen sooner rather than later. Although these moves were tentative, the companies were clearly investing significantly in capabilities that they could ultimately get from one another. We have mentioned Luxottica’s interest in lens labs, but Essilor also had been expanding its B2C network, especially in the US. This had involved: i) Purchasing three major doctor alliance groups in the US, serving a network of c7,000 optical retail locations (equivalent to Luxottica’s retail network worldwide and almost double Luxottica’s North America store footprint). These are PERC, VisionSource and Opti-Port. Note that c80% of Essilor's business is with independents in the US. ii) Growing its online presence organically and inorganically as a pure-play online retailer.
Eyewear Industry 16 17 March 2017
iii) The acquisition of Photosynthesis Group in China – this company owns multiple retail banners that it franchises out across Asia. It was clear the company was also warming up to retail (note 99% of Essilor’s revenues are from the wholesale channel excluding online) with management commentary becoming increasingly open to the topic, in our view. Therefore the deal needed to happen sooner rather than later to avoid wasted investments or remove potential synergies/benefits from the deal.
Figure 31: Company exposure to branded and unbranded components in the eyewear industry Dark blue blocks represent established business lines. Lighter boxes with text represent examples of new business moves.
Do they sell…(either Own branded lenses Unbranded lenses Own brand sunglass Own brand prescription 3rd party brands through the W/S or frames frames retail)
Essilor Not exactly a new initiative Bought FXI , Xiamen Yarui Expanding some of their Stylemark acquisition came but more emphasis on this Optical (Bolon and Molsion brands into Rx e.g. Bolon with some license via dedicated marketing brands focused on China), agreements e.g. Reebok spend Costa etc. Luxottica
GrandVision
Safilo
Source: Credit Suisse research
GrandVision has also looked to push further into branded lenses. As Essilor has looked to invest more into consumer engagement of its lens brands, GrandVision, one of the largest conglomerates of retail chains, has focused more on its own branded lenses rather than using the lens manufacturers’ brands. According to GrandVision, this is a positive for the suppliers as they no longer need to invest in the merchandising, packaging etc. However, this moves the pricing power and hence profit pool away from manufacturers towards GrandVision. If more retail chains follow suit, we can expect greater margin pressure for the manufactures.
Figure 32: Essilor said it does not want to play in Figure 33: Essilor does not want to increase its the luxury fashion sunglasses segment revenue sensitivity to licensed brands Layout of the sunglass landscape and Essilor brands Essilor split between licensed and own brands and price point exposure for sun and readers division
100% >$120 90%
80% $50-$120 70% Own brands 60%
50%
40%
30% <$50
20% License brands 10%
0% Brand Split Price split
Source: Essilor analyst conference 2014 Source: Essilor US Field Trip, Credit Suisse research
We would note Essilor’s move into mid-tier sun was a clear negative for Safilo – even more so after the proposed merger with Luxottica, as Essilor will be able to leverage Luxottica’s frame knowhow. Safilo has a more balanced portfolio than Luxottica in terms of
Eyewear Industry 17 17 March 2017
price points, with mid/entry tier exposure as well as luxury. By buying brands such as Foster Grant and Mustang, Essilor and now EssilorLuxottica is competing directly with Safilo. This investment does not create significant internal competition between Essilor and Luxottica as Luxottica is more focused on luxury branded frames, which Essilor did not venture into. GrandVision entered the US with ForEyes, but quality of locations is lacking. Further to Essilor’s moves in the US, GrandVision has entered the market through the acquisition of the ForEyes retail chain. This chain consisted of 116 stores at the time of purchase and generated c€83m in revenues in FY15. Although this network is not significant, it gives GrandVision a foothold for further expansion, encroaching on Luxottica’s retail presence and Essilor via the independent ECPs. However, we would note that the locations – largely suburban retail parks – are different from Luxottica’s LensCrafters locations, which are usually in cities.
Figure 34: GrandVision is pushing its in-house Figure 35: Only 9% of the cities where LensCrafters exclusive brands, which have higher margins is present contain a ForEyes store Contribution of in-house exclusive brands by vol for GrandVision Overlap in store network between ForEyes and Luxottica
c95% 24%
75% >70%
c40% 9%
Lenses Contact lenses Frames Sunglasses Total states Total cities
Source: Company data, Credit Suisse research, As of FY16 Source: Company data, Credit Suisse estimates
Offering a different value proposition from LensCrafters with reduced overlap of brands. Notwithstanding the lack of high-traffic locations, we would flag that the GrandVision business model is naturally more promotion-driven. We believe price usually contributes negatively to sales year-on-year. Admittedly this may become more relevant to US consumers, who are increasingly promotion-driven. However, as the company increases its exposure to in-house exclusive brands, we expect the product overlap of For Eyes stores compared with LensCrafters and ECPs to decrease (see Figure 34). We therefore see these developments as a limited threat to LensCrafters at this stage. Safilo and Luxottica expand into pigment capabilities. We have seen Safilo look to expand its lens capabilities by buying back the full amount of LENTI. The company already owned c76% of LENTI, but in September 2016 it bought back the whole amount in order to fully leverage its technology for the design and manufacture of state-of-the-art decorated lenses. Moreover, in a similar vein, in 2Q16 Luxottica purchased a small pigment company for which it will leverage the company’s technology for value-added lens layers in such products as Oakley PRISM and Ray-Ban Chromance. This acquisition gives the company control of the raw material and knowhow around colour contrasts for lenses. Consolidation will continue in the eyewear industry We expect further consolidation given the fragmented nature of the industry. Following the proposed merger of Luxottica and Essilor, we think other industry players would continue to look to consolidate. The sector remains very cash generative and we think M&A remains on the table even for players such as Safilo that have weaker balance sheets. Both Luxottica and Essilor have achieved an average cash conversion of around
Eyewear Industry 18 17 March 2017
100% over the past decade. Therefore even as a combined entity and given the merger is a share-for-share transaction, the balance sheet remains very healthy. In fact, we forecast EssilorLuxottica to turn net cash positive in FY20e.
Figure 36: Luxottica has a lower leverage ratio as it Figure 37: Estimated leverage ratio of the combined has looked to pay off debt over the past 8 years entity Net debt / EBITDA Net debt / EBITDA
3.0x 2.0x
2.5x 1.5x 2.0x
1.0x 1.5x 0.6x 1.0x 0.5x 0.3x 0.5x 0.1x
0.0x 0.0x FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 (0.2x) (0.5x) (0.5x) FY10 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e FY19e FY20e Essilor Luxottica Safilo GrandVision Essilor Luxottica EssilorLuxottica
Source: Company data, Credit Suisse research Source: Company data, Credit Suisse estimates
GrandVision has built up its store network through acquisitions and is likely to continue. We do not believe GrandVision will change its current model and think it will continue to expand its retail footprint. The company had >6,500 stores at YE16 and we expect this to grow further at an average rate of 3% over the next five years. We expect this to be supported by low-single-digit growth from acquisitions. HAL Holdings stakes raise questions around the possibility of a tie-up between Safilo and GrandVision. Given the stakes HAL Holdings has in Safilo and GrandVision, at 42% and 77% of share capital, respectively, we think a potential tie-up between the companies is not out of the question. A combination between these two companies would replicate Luxottica’s current structure, with frame manufacturing and a retail presence. However, we think GrandVision is unlikely to move away from its pure-play retail model and given the degree of self-help/investments Safilo currently requires following the loss of the Kering licenses, we do not think it would be an attractive tie-up for either company. Safilo will continue to look for brands. Safilo continues to look into buying in another brand to support its own brand portfolio. The company’s greatest vulnerability is its overexposure to licencing agreements, which account for 75% of its revenues. In the past, the company's investment plans and basic strategy implementation have been derailed by the company losing large licences. At the end of FY06 it was the Ralph Lauren licence, the end of FY12 it was the Armani licence, and the end FY16 it was the Gucci licence and now the Dior licence appears to be at risk. Finding a strong proprietary brand to help reduce the company’s sensitivity to licences is key, in our opinion.
Essilor/Luxo acquisition history has been strong Traditionally, Essilor has been the largest acquirer among our four eyewear companies. Over the past 10 years, the company has averaged a constant currency growth of 10.5% per annum. Scope has contributed towards 53% of reported growth while underlying organic growth (or LFL as the company calls it) has contributed 38% (see Figure 38). These acquisitions have been associated largely with lens labs (based on number of transactions) and the majority have been bolt on, resulting in the company supporting, on average, 23 acquisitions per year over the past decade. This focus on M&A is exemplified by the CEO remuneration structure with 10% of the bonus dependent on targets around bolt-on acquisitions (as of FY16 remuneration plan).
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Figure 38: Essilor has grown on average at 10.5% Figure 39: Acquisitions have been focused on lens p.a. over the past 10 years labs (based on # of transactions) Essilor growth from LFL, scope and currency. Key strategic Essilor split of acquisitions by type, # transactions acquisitions labelled, %
25% 100%
Transitions Optical Inc, 90% 20% FGXI, Signet Armorlite Intercast, Coastal.com 80% 15% 70% Satisloh 10% 60%
50% 5% 40% 0% 30%
(5%) Shamir Optical, 20% Stylemark Xiamen Yarui Optical Company 10% (10%) FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 LFL Scope Currency Constant currency manufacturer lab distributor retailer
Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research
And the most effective according to our HOLT M&A scorecard. Using the HOLT valuation framework, we are able to assess a company’s ability to carry out successful M&A. The scorecard ranks over 2,200 companies assigning them a percentile based on i) pricing skill, ii) operating skill, and iii) growth ability. These criteria look at i) whether CFROI® increased (cheap) or decreased (expensive) from the acquisition, ii) whether CFROI levels improved over the next 3 years following the transaction, and iii) whether the firm continued to grow in the three years after the acquisition. Under this criteria Essilor ranks in the 82nd percentile while Luxottica ranks in the 46th. (100th percentile = best).
Figure 40: Essilor scores higher than Luxottica on Figure 41: Safilo saw the biggest one-off write- growth ability and pricing skill according to HOLT downs of c€258m HOLT M&A Scorecard Total goodwill write-down from FY05-FY15 for Luxottica and Essilor, from FY07-FY15 for Safilo, from FY11-FY15 for GrandVision, €m
300 82 77 250 64 62
53 200 50 46 48 46 42 150
100
50
Operating Skill Score Growth Ability Score Pricing Skill Score Total Score Total Percentile 0 ESSILOR INTERNATIONAL SA LUXOTTICA GROUP SPA Luxottica Essilor Safilo GrandVision
Source: Credit Suisse HOLT, Credit Suisse research Source: Company data, Credit Suisse research
GrandVision has focused on bolt-on acquisitions, driving c50% of cc growth FY12- 15… Given the fragmented nature of the eyewear industry, GV has tended to increase its retail exposure inorganically through acquisitions of retail chains. Between 2014-2016, the company bought in almost 1,000 stores just through acquisitions, with an average scope growth of 4% from FY12 to FY15. The company states it usually takes 12-18 months to fully incorporate a new store into the GrandVision model, providing a new assortment, training and branding. This varies depending on whether the acquisition is bolt on, or a new market entry. Note, traditionally, the company will rebrand the stores under GV banners if these are already present in the country but, in some instances, it retains the acquiree banner e.g. For Eyes acquisition.
Eyewear Industry 20 17 March 2017
…but has reported a consistent write-down of goodwill since FY10. In order to understand how accurate/good these companies are at assessing the value of their acquisitions outside of HOLT, we crudely assess how often, and to what extent, the companies have had to impair goodwill. Safilo has taken the greatest magnitude of write- downs because of its acquisition of retail chains in FY08 whose growth estimates were considerably revised down in FY09. GrandVision, on the other hand, has reported a steady level of write-downs since the first available data in FY10 although, admittedly, only at low level of <1% of assets.
Figure 42: Growth for GrandVision accelerated in FY15 driven by acquisitions GrandVision growth from LFL, scope and currency, %
14%
12%
10%
8%
6%
4%
2%
0%
-2% FY12 FY13 FY14 FY15 LFL Space contribution Acquisitions Currency Constant currency
Source: Company data, Credit Suisse estimates
Luxottica has been more strategically focused… To recap Luxottica has tended to focus on larger strategic acquisitions buying in key brands such as Vogue (1990), Persol (1995), Ray-Ban (1999) and Oakley (2007). Additionally, the company has bought in some of its largest retail chains including LensCrafters (1995) and Sunglass Hut (2001). It is less obvious how much this has driven growth given the lack of disclosure between scope and organic growth but we estimate, including currency, growth by acquisitions has added c35% to reported growth.
Figure 43: GrandVision has paid the highest Figure 44: The multiple Luxottica has paid for multiple on average for its acquisitions acquisitions since 2001 has increased sharply Average valuation for transactions for each company. Average cost Average cost (net of cash acquired)/ annualised revenue, (x) (net of cash acquired)/ annualised revenue (x)
1.7 3.67
1.31
1.13
1.86 1.64
1.26
0.17 0.26 0.08 0.11
Essilor Luxottica GrandVision SGH OPSM Cole National Oakley MOI Sun Planet Alain Mikli glasses.com
Source: Company data, Credit Suisse research. FX : 1.11 $/€, 1.42 CAD/€, 0.73 £/€, 3,7 Source: Company data, Credit Suisse research. Note some of the earlier transactions were of BRL/€, 1.48 AUD/€ listed companies. Total purchase price taken as of 20-F reports for the transactions
…And been effective at pricing these acquisitions. We look at the average cost (net of cash acquired)/revenue of acquisitions for Essilor (covering 2005 to mid-2016), Luxottica
Eyewear Industry 21 17 March 2017
(2001 to 2014) and GrandVision (2011-2015). This includes c264 acquisitions for Essilor, 9 for Luxottica and c22 for GrandVision. From this analysis, we find Luxottica appears to have paid the lowest multiple while GrandVision, the highest (see Figure 43). However, we would note the multiple paid by Luxottica has increased steadily over the past decade (see Figure 44). Admittedly, the market conditions, type of asset and interest rates will have had an influence on these multiples as well but it is interesting to note that the pricing power appears to have shifted from Luxottica to acquirees.
Figure 45: Luxottica’s most successful brands and Figure 46: Safilo’s acquisition history has been less stores have been bought in straight forward Luxottica key acquisition years Safilo key acquisition years Date Acquistion Type Date Acquistions Type 1990 Vogue brand 1983-1986 Starline Optical Corp distributor 1995 Persol brand 1995 Lenscrafters retail stores 1996 Carrera brand 1998 Eyemed insurer Smith Sport Optics brand 1999 Ray-Ban brand Lenti sun lens Arnette brand 2001 Takeov er big by Chairman Vittorio Tabacchi 2001 Sunglass Hut retail stores 2003 OPSM retail stores 2002 Solstice chain from LVMH (US) retail stores 2004 Cole National (incl Pearle Vision, Sears, Target, & BJs) retail stores 2006 Loop Vision Spain retail stores 2005 Bejing Xueliang Optical Technology retail stores 2008 Sunglass Island Mex ico retail stores Ming Long Optical retail stores Just Spectacles Australia retail stores 2007 Oakley brand Oliver Peoples brand 2009 Sold retail business in Australia and Spain retail stores 2008 David Clulow retail stores Inv estment agreement w ith HAL 2009 Multioptics Internacional retail stores 2012 Tecnol manufacturing plant Safint de Mex ico distributor Sun Planet retail stores 2011 Remaining 66.7% of TBR - real estate other 2013 Alain Mikli brand 2012 Polaroid brand 36.33% of Salmoiraghi & Vigano retail stores 2014 glasses.com online sotre
Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research
Safilo’s acquisitions have led the company in a number of directions. Given Safilo’s more volatile financial history the company has undertaken fewer acquisitions than the other eyewear peers. However, like Luxottica, it has bought its key proprietary brands and tried (with little success) to broaden its direct to consumer access through retail chains. Of note, the company bought two retail chains in Mexico and Australia and subsequently had to sell them as the company fell into financial distress. Today, the company has c100 Solstice stores remaining in the US, down from >300 stores, under a number of banners, globally. Although, arguably, the market believes these are also up for sale (in the FY15 results call management did not rule out the chain’s disposal) as they are not seen as a strategic focus and the stores have reported negative double digit constant currency growth over the past five quarters.
Eyewear Industry 22 17 March 2017
Key theme #2: Online vs Omni channel Omni-channel better placed in developed markets Online to have a growing influence in the optical retail market. The debate around online and the disintermediation of the eyewear market remains a key question. The channel has grown from c3% of total optical retail sales in 2009 to 4% in 2014, a CAGR of 16% (source: Essilor US Field Trip). And has a market value of c€4bn. Sales are still heavily skewed towards the contact lens category as we believe it accounts for c70% of eyewear products sold online. The opportunity therefore lies in both prescription eyewear and sunglasses, in our opinion. These categories remain marginal at only c6% and c24% of the online market respectively, according to our channel checks.
Figure 47: Online penetration of the eyewear sector Figure 48: Essilor expects penetration to reach remains low c14% by 2025e % of total optical retail sold through the internet channel Global online optical retail, lhs, €m. % of online in total optical retail, rhs
18 16% 55% 16 14% 14 12% 12 10% 30% 10 8% 8 20% 6% 6 4% 12% 12% 4 10% 11% 8% 7% 8% 8% 6% 7% 7% 2 2% 5% 4% 4% 5% 4%4-5% 3% 3% 2% 0% 0 0% 2009 2014 2020e 2025e Fragrances Colour Sportswear Footwear Apparel Mobile Phones Wearable Eyewear* Cosmetics Electronics Global online optical retail (lhs, €m) % of online in total optical retail 2008 2013 2015
Source: Euromonitor, *Eyewear data Essilor 2014 Investor day, Credit Suisse research Source: Essilor US Field Trip, Credit Suisse research
Sunglasses are more susceptible to online purchases. We believe, for sunglasses, online could reach a similar level of penetration as apparel and especially so for models with iconic shapes. We do expect some variation across geographies as online for this category is dependent on how familiar the consumer is with the product. For example, we would expect greater penetration in the US vs. China despite both consumer clusters having a high propensity to buy online, with the difference lying in the less mature sunglass market in China. Myopic consumers could more easily shift to online in our opinion. We also expect a greater degree of online penetration for myopic consumers (currently 38% of vision correction needs according to Essilor). Myopic consumers only need simple lenses for vision correction, which once you have your pupillary distance and the right magnifications are easier to buy online. It therefore becomes simple for consumers to get their eyes tested in store and use online sites to search for the best prices. Varifocal lenses give the advantage to omni channel players over pure online. However, the one category we see as truly undisruptable in the eyewear segment is progressive lenses for presbyopic consumers (47% of vision correction needs according to Essilor). These lenses require more accurate measurements and adjustments which need to be made in person for the right fit as they contain a number of points of focus. Additionally these lenses usually come at a higher cost decreasing the likelihood a consumer will buy online. Presbyopic consumers form a larger segment of those requiring vision correction and we assume its relevance should continue to increase as people live longer and ageing populations become larger in the emerging world.
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Online to reach 10% of sales by 2025e in our view. Essilor currently expects the online eyewear market to grow at c18% from 2014 to 2020e reaching €9.7bn and accounting for c10% of total optical retail. But the segment penetration currently still lags behind other consumer goods (see Figure 47). We believe online is important and optical retail will convert to omni-channel but we do believe it will be a slow process. This is because, although we see solutions to headwinds for the channel in the coming years, the nature of the product category (ie, long replacement cycle, higher unit cost vs. traditional fast fashion and higher daily use) means we are not yet at the tipping point for rapid acceleration. We therefore forecast c10% growth p.a. leading to 10% penetration by 2025e.
Figure 50: On average, there is a 30% discount for a Figure 49: Essilor believes the industry is at the pair of iconic aviators on 3rd party websites vs. ray- tipping point for online penetration ban.com Penetration of online sales as % of industry sales Price pull from Google for Ray-Ban RB3025 Aviators in gold, £
Ray-Ban Boots designer sunglasses yoox.com zalando Posh eyes otticanet.com glassesnow Frames center Rxsport opti.fashion Sunglasses save Optical H pretavoir UnitdedShades.com The optic shop JB watches Mister Spex Perfumesclub Sunglass Shop eBay-eyewearexpress eBay withsunglasses.co.uk eBid-shopmyeu Gran Optic Fruugo Red hot sunglasses monnierfreres.co.uk edel-optics visual-click.com bluenty.com £40 £50 £60 £70 £80 £90 £100 £110 £120
Source: Essilor company presentation Source: google.com, Credit Suisse research
The market has become too complacent about the threat online poses as solutions to headwinds appear to be around the corner. ■ Concerns around fakes will not necessarily limit pure online penetration. The number of comments surrounding pure play online websites that are not the mono- brand sites and concern about fakes is still extremely high. Searching on google for the pretavoir website, for example, pulls up ‘pretavoir fake’. However, given consumers' concerns, brands such as Ray-Ban have granted certain sites ‘authorized dealers’ which should help to install some trust. As more brands look to do this and independent online sites gain consumer trust, we expect this headwind to fall away. ■ The process of purchasing is still cumbersome but improving. c69% of US consumers abandon their cart (source Baymard Institute) during check out, and 27% of these state the reason is because of a too long/complicated checkout process. Given the process of ordering lenses takes a considerable amount of time, ie, entering the prescription, choosing the lens and understanding what value the additional layers bring, this could be an important bottleneck for online penetration. However, more advanced sites in the US offer the options of either scanning the prescription or emailing later to try and ease the purchasing process. Moreover, most keep a store of your prescription to promote repeat purchases. ■ Consumer price sensitivity is increasing, reinforcing online sales. For those consumers looking to buy online, the degree of price transparency is now higher than ever. Therefore, online provides an attractive opportunity for cost saving consumers. It is also increasingly important to ensure price harmonization across channels for global brands. For example, for Ray-Ban, competition across online platforms driven by price transparency between third party retailers has led to discounting of products. Luxottica has therefore had to pull back in key regions and look to better control distribution
Eyewear Industry 24 17 March 2017
where online penetration is high such as China (removing third party distributors), the US (using MAP), and Europe (using ARA). This is no doubt the correct strategy but highlights how careful brands have to be as online becomes increasingly important. ■ It takes less effort for consumers to shop around. Moreover, as websites such as camelcamelcamel.com and google launch price comparison cards, the consumer is having to put in smaller amounts of effort to compare prices for products across multiple websites. For example, searching Ray-Ban aviator in google pulls up a price comparison card, this allows you to select a model and then pull up all the websites google has found that model on, and their prices. Prices in the UK vary from £66.36 to £125 (see Figure 50) with the average discount to the Ray-Ban.com store at c30%. ■ Online price variation will hurt frame manufacturers. We compare the price online and offline of Ray-Ban RB5228 prescription glasses with single vision, 1.6 lenses with scratch resistance, AR and anti-UV. The analysis shows the wide variation in online frame prices in the UK but not in the US as we see the impact of MAP. In fact assuming the David Clulow price for this model of £125 is correct (ray-ban.com in the UK does not sell Rx glasses), the average discount is 16%. Surprisingly, in both the UK and US, the biggest source of variation is in the lens pricing with a max price of £134 in the UK vs. min of £25 and a max price of $115 in the US vs. min of $35. This puts the average total cost for the frame and lenses at £165 vs. offline of £278, a c40% saving. We believe the market is underestimating the impact online will have on both frames and lens pricing.
Figure 51: Online lenses have the greatest variation Figure 52: Offline we see a different picture with in prices both frames and lenses facing pricing variation Frame and lens prices, local currency Frame and lens prices, £
smartbuyglasses.com, $ rayban.com glassesusa.com Eyediology Opticians glasses.com framesdirect.com coastal.com Vision Express netzoptiker.de, €
framesdirect.com (uk), £ glassescomplete.co.uk Independent eyewearbrands.co.uk pretavoir.co.uk smartbuyglasses.co.uk misterspex.co.uk David Clulow lensway.co.uk glassesdirect.co.uk 0 50 100 150 200 250 300 0 50 100 150 200 250 300 Frame Lens Frame Lens
Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research
■ Refunds have become easier. In Figure 53 we assess the returns profile for a number of online providers. The vast majority of online providers in the US now offer full refund on purchases and up to 30 days for a return. ■ Barriers to entry are lowered by the online channel. Using the UK market as a proxy, we understand it is relatively easy to set up an online eyewear company given the loose regulation and limited insurance coverage. For unbranded lenses and frames, manufacturers can be found easily at eyewear exhibitions. Once a minimum order of frames is placed, the company only needs to find a lens manufacturer with associated lab to process each of its orders with no need to hold lens stock on its books as well. Although in the UK eyewear retailers should hold copies of customer’s signed prescriptions, we found when buying on any of the European/UK based websites, a copy of the prescription was not requested. Moreover to set up a website that sells branded frames we believe a company needs to i) order a minimum number of products which varies by brand – more widely distributed at c50 pieces while higher end brands at c100 pieces, and ii) complete a profiling of your offering, providing details on either the website or where the retail store is located. For higher end brands,
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we understand the location of the store may limit which brands are offered but for websites it is just a judgement of the quality of website. We understand selling Ray- Ban has become more difficult as the company has started to limit its ARA agreements and requires each unit to be registered in order to stop B2B selling but we believe it is still relatively easy to stock the product legally. However, we think the higher the degree of premiumisation, the lower the level of pure online penetration. We see the trend of premiumisation as an important headwind for pure play online providers. The more expensive the frame and, more importantly, the lens, the less likely consumers are to trust online providers, in our opinion. Lenses quickly reach into triple figures if value added layers such as anti-reflected coatings are added and high quality materials used. This is one headwind which we believe is unlikely to soften in the near term as consumers become more accustomed to buying online given replacement cycles for this type of purchase are relatively long.
Figure 53: Analysis of online returns policies US ONLY Refund Progressive/simple coastal.com 30 days to return or exchange. Call Vision Care center to get prepaid postage stamp. Sun/Rx Both costadelmar.com 30 days to return. Free of charge return. Do not exchange items Sun eyebuydirect.com 14 days to return/exchange. Free shipping for orders >$99 or new customers with orders >$15. Sun/Rx/Rx sun Both Call Customer service for return authorization email. fostergrant.com 30 days to return for refund or exchange, after 30 days can exchange only. Sun/readers framesdirect.com 30 days to return or exchange. For non Rx or contact lenses - free exchange or full refund minus 10% restocking fee. Sun/Rx/Rx sun Both Customer must pay shipping fee. For Rx - free exchange. If new lenses required 50% of original lens price credited towards new lenses. For refunds full price refunded minus 50% of lens price. Customer must pay shipping fee. glasses.com 30 days to return or exchange Call for authorization. Free shipping for return. Sun/Rx/Rx sun Both glassesusa.com 14 days to return. 90 days to process refunds. 100% money back or exchange. must email or call to start return process. Sun/Rx/Rx sun Both Will be given a free return shipping label once emailed or called. Future orders placed using 100% store credit / exchange code are not eligible for another return. oakley.com 90 days to return or exchange. Can return to store for full refund or exchange. Return by mail - get return authorization Sun number and pre-paid return label. rayban.com 45 days to return. Get return authorization number and pre-paid return label. Sun readerglasses.com 30 days of purchase. Need return authorization code. Free of charge return. readers smartbuyglasses.com 100 days to return. Must contact the customer service team to get special returns note. Sun/Rx/Rx sun Both sunglasshut.com 90 days to return since online purchase. Need to print off free shipping label but no need to call. Store purchase cannot be Sun returned by mail. Can return online purchase to store within 90 days of purchase. sunglassesshop.com 30 days to return. Sun warbyparker.com 30 days to return or exchange. Free return shipping for orders within 50 united states. If lenses scratch within 1 year will Sun/Rx Both replace for free. zennioptical.com 30 days to call for a return authorization number. If made a mistake during the order or just don’t like the glasses - 50% Sun/Rx Both refund excl shipping or one-time-due 100% store credit. If feel manufacturing error. return glasses for inspection within 30 days. If made incorrectly will be remade free of charge. Source: Company data, Credit Suisse research Store rationalization will have to happen regardless Warby Parker gives us an interesting example of omni-channel vs. online. Examples such as Warby Parker show that pure online retailers perhaps are at a disadvantage without some brick and mortar retail presence. This is even despite launching the company in one of the most advanced online eyewear markets, the US (5% penetration vs. 4% globally in 2014). Moreover, it shows the potential of omni channel as an attractive opportunity. The startup, launched in 2010, initially as a pure play online retailer has chosen to invest in traditional bricks and mortar store expansion with 30 stores at the start of 2016, 46 at the start of 2017 (from the website store locator) and plans to grow this footprint further in 2017.
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Omni channel provides a better consumer offer than pure play in our opinion. We believe this is because the consumer still likes to go into store to try frames on in person and still has to get their eyes tested in person. Therefore the category need for stores is greater than say for apparel. This purchase has a longer replacement cycle (2-3 years in the US), a higher unit cost than traditional fast fashion and is worn every day; therefore the need for the consumer to ensure the right fit/style is arguably higher. Moreover as product newness increases in the industry it becomes more important for consumers to feel and try the product on in person.
Figure 55: Contact lenses will continue to be the Figure 54: Direct pure players take market share in most accessible to the online channel but the US expectations for sun wear and Rx are high 2015 value share in North America, % y-axis: Proportion of online retail by product as % of total sales, volumes based. X-axis: time since introduction
Marketplaces
Brands
Direct pure players Click & mortar (retailers)
Source: Essilor US Field Trip Source: Essilor US Field Trip
Omni-channel has succeeded in other industries. Sephora and Ulta Salon in the US provide a very persuasive argument that omni-channel can gain market share over pure online or pure retail players. Both sell cosmetics, a different product category to eyewear, but because the eyewear industry lacks a comparable established example of omni- channel, we turn to these retailers to understand if the consumer prefers omni-channel. Ulta Salon reports that multi-channel guests spend 2.4x more than store-only guests and 4.3x more than single channel guests. Moreover, Sephora continues to report double-digit comp growth in its stores despite having a relatively large retail presence with c400 stores in the US (around half of Luxottica’s LensCrafters). We therefore believe omni-channel should have the advantage over pure players and perhaps more so for the eyewear industry than the cosmetics industry seeing as optical retailers can also rely on eye exams to drive traffic into store. Omni-channel players will need to rationalize their store footprint. Although we would prefer omni-channel to pure play online retailers, we admit our companies under coverage with bricks and mortar stores may still have to undergo some store rationalization in certain regions in which they are over-exposed. They will no longer need wide distribution networks to reach the consumer when they have online platforms. Moreover as traffic falls across retail stores whether it be eyewear or apparel, having a wide store base can be costly. Admittedly online purchases can be filled through a store, but as Luxottica and GrandVision centralize their DCs and lens labs, order fulfillment will not come through store doors but the centralized hubs further reducing the need for a wider footprint.
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Figure 56: Number of DOS have grown on average Figure 57: GrandVision has increased its store c1% p.a. over the last decade for Luxottica portfolio by 7% on average each year since FY11 Luxottica, # directly operated stores and franchise GrandVision, # directly operated stores and franchises
8000 7000
7000 6000
6000 5000 5000 4000 4000 3000 3000 2000 2000
1000 1000
0 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY11 FY12 FY13 FY14 FY15 DOS Franchise DOS Franchise
Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research
We believe Luxottica is already starting to do this with its LensCrafters network in the US. Luxottica has its largest retail exposure in the US, the largest online eyewear market. We believe the company understands the implications of online as it has stepped away from its 1,400 LensCrafters store target. It currently has c900 stores and can open up to 500 within Macy’s stores but we expect some store closers at the same time as the company rationalizes its portfolio and makes a shift to smaller stores without bolt-on lens labs. We therefore expect a reduction in the average store size (40/50% size of average store) and a handful of net openings over the next couple of years, improving the quality – e.g. revenue per sq foot of the stores. Moreover the number of Sunglass Hut stores has remained flat this year and we expect some net closures moving forward.
Figure 58: Penetration of online varies across Figure 59: The development of eyewear retail regions networks varies considerably too Penetration rate of online optical retail FY13, in value terms. Includes # inhabitants per optical retail outlet online pure players and click and mortars for spectacles, contact lenses and sunglasses
55,000 10%
8% 7%
6% 29,350
4% 4% 4%
13,300 2% 10,700 10,700 6,650 1%
Latam China France North Australia/NZ Scandinavia Japan Germany UK N.America Europe APAC Developed Latin America APAC Fast-growing Africa-Middle East America markets markets
Source: Essilor 2014 Investor day Source: Essilor 2014 Investor day
GrandVision continues to expand aggressively. The company has increased the number of POS at around 7% per annum since FY11. Although management does not give any guidance around the target number of stores, we do not expect this trend to change over the short to medium term. The company will see some reduction in store size, though, similar to Luxottica, as it looks to lower the average store footprint from 120 sqm to 80 sqm as it centralizes its lens cutting and edging facilities. Online eye exams would add further disruption for retail stores. Essilor believes this could be possible in the next 2-3 years through smart refraction technologies. The company will look to have access to the full purchase cycle from exam to order online,
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either through a technology acquisition or through partnerships. It has already launched an open contest for innovative refraction applications. Competitors such as Zeiss already offer an online eye assessment which can be used to advise consumers if they need an eye test. Opternative is starting to gain traction. Opternative launched the first online eye exam that could provide a prescription in the US in mid-2015. This is a refractive eye exam which allows an ophthalmologist to review the results and make a clinical decision before issuing a prescription. The cost of the eye exam is $40 vs. $79 instore at LensCrafters and £25 instore at Vision Express (GrandVision) for example. 1-800 contacts in July 16 launched, in collaboration with Opternative, the InstaRx which endorses Opternative’s online exam and accepts their prescriptions for contact lens orders. This was the first public endorsement of the exam from a large player in the eyewear industry. Opternative will have more of an impact on the independents. First, an eye examination still requires an authorized ophthalmologists to write the prescription and given we understand the examination does not effectively test for the top 30% of the most severe eye conditions we expect some hesitance from the professional vision care community. Additionally, as independents capture around 69% (on a volume basis) of the eye exam business in the US (a disproportionate amount vs. the retail sales they capture, source: Essilor US Field Trip) there has been a strong amount of pushback in a number of states from these groups. In some states, they have been successful in preventing Opternative from offering its services e.g. South Carolina, by claiming the technology was not accurate enough. We note Luxottica generates a low single digit % of revenue from eye exams while GrandVision generates much less, as most eye exams are given for free. Profit implications are negative for online Margin accretion should come with accelerated growth and leverage of costs... Data from Essilor suggest once a consumer has made a transaction online, (see Figure 61) profit contribution can be higher than the traditional lens business. However, fully understanding the cost of online comes down to; i) how the company splits out centralized costs for this channel, ii) how it thinks of development costs and whether these are charged or capitalized, iii) the cost of initially capturing a purchase i.e. conversion rate and how this is accounted for iv) how the cost of returns and logistics are accounted for, and v) how the costs of checking and authorizing each prescription (in the US – 1 out of 4 prescriptions are invalid according to our channel checks) are accounted for. …But target online margins remain below group margins for industry players. Essilor is currently targeting 10%-12% contribution margin by 2018 vs. group contribution margin at 18%. Therefore we can conclude that although margin accretion should come with scale, there are a number of factors which we highlight below that mean online is overall a drag on industry profit pools for the time being. Moreover, given that, in the apparel industry, online continues to be a drag despite being more established, we can assume further margin upside will take a long time to see and likely be fairly limited. Return costs could be an important drag on profitability, and greater than apparel. Given the size and weight of purchases, logistic costs will be lower for eyewear vs. other categories such as apparel. The cost of returns for contact lenses and sunglasses should also not differ too much as these products can be easily re-sold. However, the important aspect of the profitability of online eyewear is around the returns of prescription glasses. The lenses within these glasses will have been edged, finished and mounted to specific
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frames with a specific shape and prescription. Therefore the likelihood of reselling these glasses is clearly limited – the frames may be re-used but the lenses and the cost of producing them will be unrecoverable. As we found earlier, most online sites now offer full refunds, and so this could be a heavy drag on profitability for this channel if return rates are high and consumers select highly customized products. Although product margins are good, high levels of Rx returns are not sustainable. We understand it is possible, on scale, to buy frames from Asian manufacturers at <$5-10. It is also possible to get single vision stock lenses for $2-5. On top of that there are some labour costs and consumption costs for the process of edging and mounting them in the frame (but this is largely automatized). If we say shipping costs are $5, the total cost of producing the frames and lenses without personalization is c$20-25. Therefore the crude margin on a pair of glasses from Warby Parker for example is c70% (single vision glasses are sold at c$95). If the glasses are returned and re-made, the margin drops to c55% (assuming the same frames are used). Moreover we calculate if the cost of free returns is $5 to the company, it would become loss making if 2.3 pairs are returned and refunded (cost of $30) for every one pair sold (assuming no salvage value from the returned products). Progressive lens sales are the greatest drag on profitability. Our channel checks suggest that the underling profit margins for progressive lenses are lower than basic stock lenses. If basic stock myopic lenses are bought at c£5, we understand the cost of a basic progressive lens is c£55 at wholesale price. Although retailers look to significantly increase the retail price of progressive lenses to preserve the margin, >£200 vs. myopic at c£60 it appears certain online providers do not do that. We find varifocal lenses at £49 on glassesdirect.co.uk for example. Additionally given we believe progressive lenses are harder to fit, with a slight error in the lens center point making them unusable, we would expect higher return rates for these lenses. Both factors lead us to believe progressive glasses will drag the most on online profitability. Sun and contacts should not be as much of a drag on profitability as Rx. As we have mentioned previously in this report, we do not believe contact lenses and sun sales should be as great a drag on profitability as prescription. However, sun prescription will clearly suffer the same dynamics as pure prescription sales. Additionally we would flag personalized products could also have important implications for profitability. Granted these still remain a very small percentage of sales. However, we doubt personalized products made through the ‘Remix’ offering on Ray-Ban.com for example will be kept as inventory or be re-used for other orders. Despite this, ray-ban.com does offer full refunds for remix products.
Figure 60: Online can drive topline according to Figure 61: Margin per consumer is higher online Essilor according to Essilor Average pairs per order and number of purchases over a 3-year Base 1 = Essilor lens business estimated contribution margin per period consumer. US market prescription eyeglasses
4 x5
1.4 x2 ≥1 c.1
x1
EyeBuyDirect Worldwide EyeBuyDirect Worldwide Avg. pairs per order # of purchases over a 3 yr period Essilor Lens Business EyeBuyDirect FramesDirect
Source: Essilor US Field Trip Source: Essilor US Field Trip
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A way to reduce return costs could be to offer a more limited selection of optical lenses. Using the UK market as a proxy, we assess the number of lens options available online and instore. We find there is a considerable range of lenses on offer at the online stores, with the majority offering a number of different thickness of lenses (index 1.5 to 1.74) and additional lens layers such as anti-reflective, UV protection and anti-blue light. At David Clulow, we see a similar offering for single vision lenses with only the additional benefit of choosing between i) bespoke, ii) digital and iii) conventional surfacing for varifocal lens. We also find a similar offering at Vision Express suggesting online retailers do not significantly limit product types to help control costs. Variation in lens prices cannot be explained purely by the supplier. As we have said previously, price transparency afforded by the internet is clearly having knock-on effects on both frames and lenses. Some retailers such as GrandVision do not see these eyewear websites as a threat because of the quality of the lenses on offer. However it appears some websites such as pretavoir.com, lensway.co.uk and smartbuyglasses.co.uk are still supplied by big players such as Essilor and offer some branded options competing directly with the quality of products sold by GrandVision. There could also be a negative mix effect from no one-to-one contract. There is a smaller chance of trading up through additional finishing layers such as anti-reflective given the lack of a salesman and face-to-face interactions. Therefore we do expect some price mix effects from the outperformance of this channel over selling through bricks and mortar stores. Omni-channel could benefit from store banners if they have strong branding. If stores/products have strong brand awareness such as Sunglass Hut or Warby Parker we believe their online platforms will capture more growth than pure online players. This is because the online site benefits from the natural marketing gained from owning bricks and mortar stores. Therefore, we would expect them to see higher conversion rates, reinforcing the advantage of having some retail presence. For Essilor’s highest performing pure play platform conversion is still low single digits and the cost to convert a consumer varies from $25 for the low end website (avg. cost per product of $13) to >$100 for the higher end websites according to our channel checks. Stock implications from our online analysis Essilor and Luxottica have a similar sized presence online... Essilor quotes 5% of Group sales were online in FY15, bringing online revenues to c€340m. Luxottica quotes 4% of Group sales were online in FY15 (and have guided towards finishing the year at 5%) which puts its online revenue between €360m and €450m. Of its online exposure c60% is generated from own online and 40% from wholesale partners. …but we see little scope for internal competition when these two companies merge. Essilor’s online revenues are generated by a number of multi-brand, unbranded and mono-brand owned sites as well as through wholesale partners. The company’s own platforms have been bought in over the past couple of years and include coastal.com and eyebuydirect.com. In North America, for example, where online revenues from its own websites reached 44% of its total online exposure (as of FY16 results), Essilor is heavily exposed to multi-brand pure play offerings. Luxottica does not have as many website banners as Essilor, with a focus primarily on sunglasshut.com, rayban.com, oakley.com and to some extent glasses.com. The company also has websites for LensCrafters and David Clulow, for example, but these are not transactional. Given the varied nature of platforms under Essilor and Luxottica, we see little scope for internal competition with the only clear worry being between glasses.com and Essilor’s multibrand websites. However, Luxottica have been gradually de-emphasizing this platform as the company uses it more as a forum to experiment around omni-channel offerings for LensCrafters. Essilor’s wide online footprint will put the combined company at an advantage. We feel Essilor’s advantage with online sits in its investments across regions, especially
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outside the US. The company has also picked up websites in Asia and areas which have limited optical retail networks and a high propensity for consumers to shop online. We believe this could put the company at an advantage as consumer engagement starts to improve. Although we appreciate leveraging distribution via online in some emerging countries will be difficult given the distribution infrastructure in place, it could be easier than expanding via bricks and mortar stores, in our opinion.
Figure 62: Essilor now has a number of online Figure 63: Essilor’s two multi-brand websites platforms in the US and further afield provide the bulk of online revenues Essilor websites B2C 2015 US online revenue split for Essilor
FGX and Costa branded sites
Coastal.com
Framesdirect.com
Eyebuydirect.com
Source: Essilor analyst conference Source: Essilor US Field Trip. Multi brand – framesdirect.com and coastal.com
Sunglasshut.com plays on omni channel but lenscrafters.com gives away some advantage. As we prefer omni-channel to pure play online stores we see this as a potential advantage for EssilorLuxottica vs. the industry. This is definitely the case for the Sunglass Hut retail banner which has an increasingly integrated channel experience. However Lenscrafters.com is still lagging behind, with only the ability to check stock availability or book an eye exam and no transactional functionality. LensCrafters does have the partnership with glasses.com which allows consumers to order glasses online but get them adjusted in LensCrafters stores (a more omni-channel service). However, we do not feel this is enough and believe the company is losing its competitive advantage by not having a fully integrated omni-channel offering for LensCrafters. This could change more rapidly with the insight from Essilor and we feel would provide a strong competitive advantage over other industry players. GrandVision is leveraging retail locations and launching full omni-channel. We believe less than 3% of Group sales originate from online. These are mostly contact lenses and sunglasses. The company currently only offers a transactional omni-channel service for prescription in Germany, providing online booking, pre selection of frames and the ability to order to home and store. Admittedly, this is a much more omni-channel experience than LensCrafters. Management is using China and Germany to develop the experience before rolling out further afield. But remains too dismissive of disruption. However, the company has a much wider optical retail store footprint in its key region (Europe) vs. Luxottica in its key region (US) and no plans to scale back on expansion as online develops. We are therefore concerned that the company is underestimating the impact digital could have on the need for such a significant sized bricks and mortar network. Moreover, GrandVision only plans to roll out its new online platform over the next two-to-three years, we understand. Safilo’s online presence remains limited. Safilo currently only has a transactional website for Smith out of its own brands. The company lacks websites for Polaroid and Carrera and unlike Luxottica does not own a multi-brand platform. However, online now represents a significant part of the Smith business suggesting the company can
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successfully launch mono brand sites, and including pure internet wholesale partners, online accounts for 5% of Group sales, in line with Luxottica and the industry. Economies of scale will also help to give the advantage to EssilorLuxottica. We believe the primary reason EssilorLuxottica will benefit the most from online or at least be less impacted by the disruption it causes, is because of the company’s size. This size will help reduce costs if integrated fully as the company captures more volumes from the online market and has a greater chance of re-selling returned products. Additionally, by now covering every point of the value chain, the company is exposed to all the profit pools and therefore has the ability to maximize profits in a channel that will potentially see profits squeezed. Proprietary e-commerce survey Google’s ‘Test my site’ assesses speed and mobile friendliness. In order to assess which of these online websites in the US and Europe are best positioned to capture consumer sales, we use Google’s ‘Test my site’. This scores each website based on (i) the mobile friendliness, (ii) the mobile speed, and (iii) the desktop speed. Each of the three assessments are scored out of 100 with the average given in Figure 64 and Figure 65. The criteria the three assessments are based on are detailed in Figure 66. We see little variation between websites on mobile friendliness with the key differentiation between websites coming from mobile or desktop speed. Overall, Luxottica-owned websites outperform Essilor on Google’s ‘Test my site’. This analysis puts Luxottica’s online platforms on average just above Essilor’s in the US, while Essilor sits in line with competition in Europe. This is interesting to note given Luxottica’s strategy, focusing more on omni-channel rather than pure play. It would be reasonable to think, given this strategy, its websites would be of lower quality and perhaps lag behind its competition but this analysis suggests otherwise. Costal.com is still a drag on Essilor’s portfolio. It is also interesting to see that coastal.com scores at the bottom of this analysis despite the fact that Essilor has only just recently launched this platform. Coastal.com was acquired in 2014 and seen as a strategic acquisition that the company could not miss. However, the business it bought was heavily reliant on promotions and the turnaround of coastal.com has taken longer than expected and has not realized the margin potential management had initially guided towards. Issues re-establishing the brand and removing loss-making promotions led in part to the company not reaching management's 2014 expectations of 19% contribution margin by 2016 (contribution margin is the underlying operating margin Essilor guides towards). The company printed 18.6% contribution margin at FY16 results. The relaunch of the website with new branding, exclusive products and MyFit capabilities leave management confident in this turnaround story.
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Figure 64: US based websites total score Figure 65: European based websites total score Average overall score based on (i) mobile friendliness (ii) mobile Average overall score based on (i) mobile friendliness (ii) mobile speed and (iii) desktop speed. blue = Essilor owned, stripes = speed and (iii) desktop speed. blue = Essilor owned, stripes = Luxottica owned, grey = Safilo, red = private Luxottica owned, dotted = GrandVision, red = private
fostergrant.com 83 pretavoir.co.uk 81 readerglasses.com 81 goggles4u.com 79 eyewearbrands.com 78 warbyparker.com 79 sunglasshut.com 77 sunglassesshop.co.uk 75 rayban.com 76 netzoptiker.de 73 glassesusa.com 76 glasses.com 75 misterspex.co.uk 68 oakley.com 72 costadelmar.com 71 lensway.co.uk 68 framesdirect.com 68 glassesdirect.co.uk 67 eyebuydirect.com 67 lenscrafters.com 65 smartbuyglasses.co.uk 63 smithoptics.com 63 smartbuyglasses.com 63 glassescomplete.co.uk 63 zennioptical.com 63 apollo.de 59 coastal.com 62
Source: Testmysite.thinkwithgoogle.com, Credit Suisse research Source: Testmysite.thinkwithgoogle.com, Credit Suisse research
We are concerned there may be a lack of integration. We also note that the scoring for the Essilor-owned websites varied more considerably than the Luxottica-owned sites. This is because Essilor does not tend to integrate its acquisitions and therefore the websites it has acquired still run off their own individual platforms with little synergies/background integration between each other. We wonder with the Luxottica merger whether this will be the case and the ecommerce platforms will be run independently from one another. We believe EssilorLuxottica would benefit more from complete online integration across platforms. Proprietary mobile site scorecard to understand more fully the offering. We build on the work carried out by our US retail team (see CS Fashion Mobile Commerce Analysis: Who is winning the race away from the desktop published 11 October 2016) and assess these websites and their mobile experience according to a 20-step criteria. As our team details, the use of mobile online platform is expected to see even greater growth and penetration than desktop. The 20-step criteria gives us a quantitative mobile platform performance score which we can use to effectively compare across platforms. We look at qualities such as ease of social linking, typeface and readability as well as the use of 'breadcrumbs' (a website navigation technique which allows the user to keep track of how they reached their location).
Figure 66: Testmysite uses a number of criteria for Figure 67: Essilor and Luxottica platforms come top the 3 scores of our proprietary website survey Criteria used in scoring Overall score using our proprietary mobile scorecard Mobile friendliness Mobile speed and Desktop speed zennioptical.com, Ot 19 Avoid plugins Avoid landing page redirects warbyparker.com, Ot 20 Configure the viewport Enable compression fostergrant.com, E 21 Size content to viewport Leverage browser caching costadelmar.com, E 21 goggles4u.com, Ot 23 Size tap targets appropriately Minify CSS framesdirect.com, E 23 Use legible font sizes Minify JavaScript rayban.com, L 23 Minify HTML smithoptics.com, S 24 glassesusa.com, Ot 25 Optimise images glasses.com, L 25 Prioritize visible content oakley.com, L 26 Reduce server response time coastal.com, E 26 smartbuyglasses.com, Ot 28 Eliminate render-blocking JavaScript sunglasshut.com, L 28 and CSS in above-the-fold content eyebuydirect.com, E 29
Source: testmysite.thinkwithgoogle.com Source: Credit Suisse research, E:Essilor owned, L:Luxottica owned, Ot :Other, S:Safilo
Eyewear Industry 34 17 March 2017
Warby Parker underperforms but app provides an advantage. Using this framework, we see that, of the top 6 highest scoring websites, 3 are from Luxottica and 2 are from Essilor. Both score particularly highly on how easy it is to access sizing charts, the typeface/readability of the site and the access at home. However, using this survey, Warby Parker underperforms as it lacks product reviews, sizing detail on the mobile site and, with no scrolling site ID, it is difficult to navigate. However, Warby Parker is one of the only websites to offer an app. On the app store, this scores 4.5 stars from 238 ratings with the only negative comments focusing on the prescription upload. This compares to glasses.com app which scores 1.5 stars out of c200 ratings.
Eyewear Industry 35 EyewearIndustry 36
Figure 68: Proprietary mobile e-commerce survey
Type of eyewear Rx lenses Ability to buy Mobile Suggests Sun/ Branded/ online/pick formatted related/reco Ease of Ease of Easily Typeface/ e t i
s Sun Rx / unbrande Progr Free Integrated up in store browser Scrolling Editorial/Styl mmended Payment navigating Amount of social accessible Readability Access back Filter, sort Customer Product b e Rx d/ both Single essive Postage (excl processing time) lenses inventory within 24hrs website Site ID e content products Beadcrumbs memory homepage Utilities noise linking sizing charts of site home functions Clickability Support reviews W m
o Free shipping 6-7 bd c . l a
t Paid parcel shipping 4-6 bd $8.95 s a
o All Branded Y N Priority shipping 3-5 bd $8.95 Y Y 'low stock' N Y Y Y N Y Y Good Good Good Fair Good Good Best Good Good Fair Poor c l a
c Standard 14-21 d $4.95 i t p o
i Priority 10-14 d $7.45 n m n o e
c All Unbranded Y Y Ex press shipping 7-10 d $18.95 Y NA N Y N Y Y N Y Fair Fair Poor Fair Good Poor Fair Best Good Fair Best z . c
. All shipping free, s e
s Products on fast shipping 1bd s a l
g Frame and Lnes deals 5-6 bd y u b
t Designer sunglasses and frames 5-11 bd r a
m m All Branded Y Y Rx 5-14 bd N NA N Y Y Y Y Y Y Good Best Fair Fair Poor Good Best Best Fair Best Best s o . t c e r i d y u b e m
y o All Unbranded bYar an exYclusiv e premium brand N NA N Y Y Y Y Y Y Best Good Good Good Best Best Best Good Good Fair Poor e c Free shipping 4-5 bd m o
c Premium $4 2-4 bd . t c
e Ex pedited $7 2 bd r i d
s Priority $9 3 bd e m
a Ex press $15 1 bd r All Branded Y Y N NA N Y Y Y N N Y Good Good Fair Fair Fair Fair Best Good Good Good Good f m l e d m Free shipping ov er $50, faster av ailable a o t c s . o r Sun Branded NA NA for an additional price NA N N Y N Y Y N Y Good Good Fair Fair Good Good Fair Fair Good Good Fair c a Free 5-14bd
m Free shipping > $50 3-7bd or $5 o c .
y Free 2 day shipping > $200 or $15 e l k
a Sun Branded NA NA Nex t day shipping $25 NA Y Y Y N Y Y N Y Best Best Good Poor Good Good Fair Good Good Good Good o c . s
e Free 7-10 bd s s a l m All Branded Y Y Ex pedited shipping $9.99 2 bd Y N N Y N Y Y N Y Good Good Good Fair Best Good Fair Best Good Good Poor g o m o c .
n Free shipping on standard and remix a b y
a Sun Branded NA NA orders. 1-2 bd but REMIX 7bd NA N N Y N Y Y N Y Good Good Good Fair Fair Good Fair Good Good Good Good r . a
s Free shipping 7-10 bd u s
e Ex pedited $9.95 5-7 bd s s m a l o All Branded Y Y Ex press $12.95 3-5 bd Y N N Y N Y Y N Y Good Good Fair Fair Good Good Fair Good Good Best Good g c s o a c l . g t n u
u h Sun Branded NA N Free 2 bd shipping and returns NA N N Y Y Y Y N Y Good Best Good Good Good Good Best Best Good Good Poor s s r a m p o y c b . r r a e All Unbranded Y Y Free 10 bd N N N Y N Y Y Y Y Good Fair Good Fair Poor Good Fair Good Good Good Poor w k . u 4 s e l g g m
o o All Unbranded Y Y 12-14 day s for deliv ery Y Y 'instock' N Y N N N Y Y Good Fair Fair Fair Best Fair Fair Good Good Good Good g c m o c . t
n Free standard ground shipping for a r g
r Sun & members. Standard groud shipping $6.50 e t s
o readers Unbranded N N (7-10bd) or 2-day $10 or nex t day $15 NA Y 'instock' N Y N Y Y Y Y Good Fair Fair Poor Fair Fair Fair Good Good Good Good f s c i t p
o Sun & h t i
m sports Branded Y Y 1-2 bd N N N Y N Y N Y Y Best Fair Good Good Fair Good Fair Good Good Good s Good
Source: Company data, Credit Suisse research 17 March 2017 17 March 2017
Key theme #3: The US The US remains the largest optical market and relatively underdeveloped. According to Essilor, the US represents a c$40bn Vision Care industry based on sell-out sales. The largest proportion of this industry at c32% is the lens market, followed by the frame market at c24% (see Figure 69). However, the market still remains relatively underdeveloped with room for growth through i) increased consumer coverage, and ii) increased penetration of value added lenses (see Figure 70).
Figure 69: The US is the largest eyewear market by value… Figure 70: …but remains relatively under developed Sell-out sales. Including; readers, surgery, sunglasses, contact Penetration of total lens industry, % lenses, exams, frames and lenses, ($b)
40 95%
35
30 68%
25 49% 20 39% 39% 15 30%
10
5
- 2009 2010 2011 2012 2013 2014 2015 USA France New Zealand USA Spain China Lenses Frames Exams Contact lenses Sunglasses Surgery Readers Progessive lenses Antireflective lenses
Source: Essilor US Field trip Source: Essilor US Field trip
Recent company commentary suggests a softening of the market. Through 2016, we have seen a deceleration in reported underlying growth for all the key players in the US market. There have been a number of short-term company specific issues (e.g. the impact of MAP on Luxottica W/S North America numbers) and the presidential election towards the end of the year may have had some influence on consumer engagement. Our research has shown that customers postpone purchases more markedly in an election year on a number of items, including eye wear given the uncertainty and focus on a new president. We believe this was compounded by poor weather at the start of the year which impacted the start of the sun season. Therefore there is a lack of transparency as to whether this is a longer term structural downturn or just a small cyclical pause in growth this year.
Figure 71: Growth in North America has fallen this Figure 72: Luxottica has the highest exposure to the year US eyewear market North America growth, % North America/US exposure of Group revenues, %, FY15 data
30% 55% 25% 48% 20%
15% 42%
10%
5%
0%
-5%
-10%
-15% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 c3%
Lenscrafters LFL Safilo cc growth (incl retail) Luxottica (US) Essilor (North America) Safilo (North America) GrandVision (US) Essilor Lens & opt. N.America Luxottica cc N.America w/s
Source: Company data, Credit Suisse research Source: Company data, Credit Suisse estimates
Eyewear Industry 37 17 March 2017
EssilorLuxottica will dominate the US market. Based on company data, we understand the combined EssilorLuxottica will have a c30% market share in North America. Together the combined company has even greater penetration of every part of the value chain compared to the standalone entities. This is because it is i) where Luxottica is the most developed in pure sun and Rx retail, ii) where Luxottica also takes part in the vision insurance market with the second largest provider EyeMed, iii) where Essilor has developed its pure online retailing most extensively and iv) where Essilor also has a significant influence on the independent eye care professionals through the buying groups Vision Source, PERC and Opti-Port. These account for c7,000 locations which we believe account for c30% of the independent market. (March 16 Review of Optometric Business suggested c10,000 locations were signed up to an alliance membership which represented nearly 40% of independent practices). Our channel checks suggest this slowdown was not out of the ordinary for an election year. We have conducted a number of interviews with consultants that have previously worked extensively in the eyewear industry in the US and still have some visibility on market trends. These interviews suggest the trends from this year were not dis-similar to previous trends during a general election year. Moreover given the arguably greater consumer focus on this year’s election it was perhaps not a surprise that shopping and eyewear fell out of focus. This is supported by our OBB data, introduced below, which shows an improvement in independent ECP’s six-month forward expectations in Q4 (see Figure 74). Additionally Luxottica reported 4Q16 wholesale north America organic growth of +5.5% against our expectations of -10% as the company saw strong growth from ECPs towards the end of the year, when consumers focus returned to the category. This more than offset continued MAP weakness. We introduce the Optical Business Barometer of c300 independent ECPs in the US. Collected by Jobson Optical Research, the OBB is an on-going perception study measuring trends in the optical retail business. The data are reported on a quarterly basis, usually around a week before companies in the sector start to report. It covers c300 respondents who consider themselves active at an optical retail location in a group no larger than 3 stores and therefore can be considered as independent ECPs.
Figure 73: Sequential improvement in sentiment Figure 74: Forward looking expectations have with YoY changes improving moved up over 4Q, post the election Question 1: How do you rate the overall optical business trend for the Question 2: How do you think the overall optical business trend will be immediately past month? for the next 6 months?
4.1 12% 4.1 12%
4.0 10% 4.0 10%
3.9 8% 3.9 8%
3.8 6% 3.8 6%
3.7 4% 3.7 4%
3.6 2% 3.6 2%
3.5 0% 3.5 0%
3.4 -2% 3.4 -2%
3.3 -4% 3.3 -4% 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16
Overall index Overall index, % change Future Overall Future overall, % change
Source: Jobson Optical Business Barometer Source: Jobson Optical Business Barometer
The survey shines light on both forward looking and historical changes. The survey covers 9 questions asking respondents to assess the business for the immediate past month as well as the prospects for the next 6 months, therefore giving us some colour on backward and forward looking expectations. The questions are split between the overall optical business, eyeglasses, contact lenses and eye exams. Moreover the data can be
Eyewear Industry 38 17 March 2017
split between broad areas across the US and by annual retail sales categories. The list of questions are: 1. At the location at which you are principally active, how do you rate the overall optical business trend for the immediately past month (eye care products and services)? (from 1 to 5, 5= very positive, 1 = very negative) 2. At the location at which you are principally active, how do think the overall optical business trend will be for the next 6 months? (eye care products and services)? 3. At the location at which you are principally active, how do you rate eyeglass sales for the immediately past month? 4. At the location at which you are principally active, how do think the eyeglass sales trend will be for the next 6 months?
Figure 75: #3: How do you rate the eyeglass sales Figure 76: #4: How do think the eyeglass sales trend for the immediately past month? will be for the next 6 months? From 1-5, 5 = very positive, 1 = very negative From 1-5, 5 = very positive, 1 = very negative
4.0 12% 4.1 12%
3.9 10% 4.0 10%
8% 3.9 8% 3.8 6% 3.8 6% 3.7 4% 3.7 4% 3.6 2% 3.6 2% 3.5 0% 3.5 0%
3.4 -2% 3.4 -2%
3.3 -4% 3.3 -4% 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16
Current EG Current eyeglasses, % change Future EG Future eyeglasses, % change
Source: Jobson Optical Business Barometer Source: Jobson Optical Business Barometer
5. At the location at which you are principally active, how do you rate the number of people having eye examinations for the immediately past month? 6. At the location at which you are principally active, how do think the number of people having eye examinations trend will be for the next 6 months?
Figure 77: #5: how do you rate the number of people Figure 78: #6: how do think the number of people having eye examinations for the immediately past having eye examinations trend will be for the next 6 month? months? From 1-5, 5 = very positive, 1 = very negative From 1-5, 5 = very positive, 1 = very negative
4.1 12% 4.2 12%
4.0 10% 4.1 10%
4.0 3.9 8% 8% 3.9 3.8 6% 6% 3.8 3.7 4% 4% 3.7 3.6 2% 2% 3.6 3.5 0% 0% 3.5
3.4 -2% 3.4 -2%
3.3 -4% 3.3 -4% 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16
Current Exams Current exams, % change Future Exams Future exams, % change
Source: Jobson Optical Business Barometer Source: Jobson Optical Business Barometer
7. At the location at which you are principally active, how do rate contact lens sales for the immediate past month?
Eyewear Industry 39 17 March 2017
8. At the location at which you are principally active, how do think the contact lens sales trend will be for the next 6 months?
Figure 79: # 7: how do rate contact lens sales for Figure 80: # 8: how do think the contact lens sales the immediate past month? trend will be for the next 6 months? From 1-5, 5 = very positive, 1 = very negative From 1-5, 5 = very positive, 1 = very negative
3.9 12% 4.0 12%
10% 3.9 10% 3.8 8% 8% 3.8 3.7 6% 6% 4% 3.7 3.6 4% 2% 3.6 2% 3.5 0% 3.5 0% -2% 3.4 3.4 -4% -2%
3.3 -6% 3.3 -4% 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16
Current CL Current contact lenses, % change Future CL Future contact lenses, % change
Source: Jobson Optical Business Barometer Source: Jobson Optical Business Barometer
9. Across the entire US, how do think the overall optical business trend will be for the next 6 months (retail and eye care services)? See Figure 83. Historically, these data have correlated with eyewear corporate US growth. To understand how effective the data are in providing read through to our companies, we back test the backward-looking indices y-o-y change compared with the relevant reported numbers for each company. For Luxottica, the LensCrafters LFL is c70% correlated to the overall index change while for Essilor there is slightly less of a correlation with the organic growth of its Lens and Optical instruments business in North America. For Safilo the correlation is much lower given the company specific issues that have been relevant since 2009, in our opinion. We do not look at the GrandVision numbers given the small exposure to the US. This suggests some predictive power from these numbers which are published roughly a week before the eyewear companies report, helping to provide some valuable insights.
Figure 81: c70% correlation between overall index Figure 82: c55% correlation between overall index change and LensCrafters LFL change and Essilor N. America Lens growth YoY % change in index vs. Lenscrafters LFL YoY % change in index vs. Essilor Lens and Optical North America
12% 12%
10% 10%
8% 8%
6% 6%
4% 4%
2% 2%
0% 0%
-2% -2%
-4% -4% 1 1 1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 Overall index, % change Lenscrafters LFL Overall index, % change Essilor Lens & opt. N.America
Source: Jobson Optical Business Barometer, Company data Source: Company data, Jobson Optical Business Barometer
Forward looking questions suggest sentiment in the sector is improving. Sentiment among the ECPs for the US Optical environment (question 9) had been decelerating since 4Q14. However, the most recent data set suggests the ECPs have turned more positive, with year-on-year change in sentiment returning to positive growth (see Figure 83).
Eyewear Industry 40 17 March 2017
Figure 83: Sentiment towards the US eyewear market’s future development has turned more positive Figure 84: Contact lenses see no deterioration YoY Across the entire US, how do think the overall optical business trend Across the entire US, how do think the category trend will be for the will be for the next 6 months next 6 months, YoY change
4.0 12% 6%
5% 3.9 10% 4% 8% 3.8 3% 6% 3.7 2% 4% 1% 3.6 2% 0% 3.5 0% -1%
3.4 -2% -2% -3% 3.3 -4% 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16
Future US Optical US Optical, % change Contact lenses, % change Exams, % change US Optical, % change Eyeglasses, % change
Source: Jobson Optical Business Barometer Source: Jobson Optical Business Barometer
Positive correlation between future US optical expectations and key growth drivers... We find there is a positive correlation between the US Optical forward looking index (question 9) and i) 1 quarter-forward LensCrafters LFL, ii) 1 quarter-forward North America wholesale growth, and iii) Essilor North America lens and optical instruments organic growth. This suggests there is some predictive power associated with ECPs' expectations over the next 6 months and numbers reported by our companies in the following quarter. …and between the future US optical expectations and consensus EPS. We also see an interesting correlation between the US Optical forward looking index (question 9) and consensus EPS estimates for both Essilor and Luxottica. If we shift the index forward one quarter (as the question is around the perception of the market over the next 6 months) it is interesting to note the implied reacceleration if this relationship holds.
Figure 85: Essilor consensus EPS has tracked fairly closely to the sentiment towards the optical business trends over the next six months… Figure 86: …and the same can be said for Luxottica Essilor 12mth fwd consensus EPS estimates vs. sentiment of the US Luxottica 12mth fwd consensus EPS estimates vs. sentiment of the optical market over the next 6 months, shifted one quarter forward US optical market over the next 6 months, shifted one quarter forward
6 4 3 4
3.9 3.9 5 2.5 3.8 3.8 4 2 3.7 3.7
3 3.6 1.5 3.6
3.5 3.5 2 1 3.4 3.4 1 0.5 3.3 3.3
0 3.2 0 3.2 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 FY11e FY12e FY13e FY14e FY15e FY16e FY17e FY18e OBB FY11e FY12e FY13e FY14e FY15e FY16e FY17e FY18e OBB
Source: Thomson Reuters, Jobson Optical Business Barometer Source: Thomson Reuters, Jobson Optical Business Barometer
We incorporate the directional trend of the data into our forecasts. This survey and its implications for the North America growth for our companies is important because of the sensitivity of Luxottica and Essilor’s topline to this region. We estimate LensCrafters and North America optical wholesale account for c25% of Luxottica group sales, i.e excluding sun sales, while the optical lens and instrument category in North America
Eyewear Industry 41 17 March 2017
accounts for c39% of sales for Essilor. The 4Q16 data have been more positive than 3Q16 therefore we estimate a reacceleration in North America growth in 1Q17 for both Luxottica and Essilor.
Figure 87: We assume low single digit growth in the early part of FY17, helped by comparables and store Figure 88: Essilor North America organic growth renovation expectation Luxottica LensCrafters LFL, % North America lenses and optical instruments, LFL, %
7% 6% 6% 5% 5%
4% 4% 3% 3% 2% 1% 2% 0% -1% 1% -2% 0% -3% e e e e e 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 6 7 7 7 7 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q -1% 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 Q Q Q Q Q e e e e e e e e e 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 4 1 2 3 4 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 6 7 7 7 7 8 8 8 8 1 1 1 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 LensCrafters LFL 2 yr run rate Q Q Q Q Q Q Q Q Q 4 1 2 3 4 1 2 3 4
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
We find during times of low sentiment Essilor has outperformed Luxottica. We look at the seven periods in which sentiment for the next 6 months deteriorated sequentially. If we look at the LFL numbers, Essilor has outperformed Luxottica in the majority of these occasions. In fact, only when the company relies on building out retail distribution, do we see an outperformance of Luxottica vs. Essilor. This fits with market commentary around retail chains losing market share during 2008 and 2009. Therefore as a combined entity the new EssilorLuxottica will become more resilient to the underlying trends in the US, benefiting when ECPs outperform or when chains outperform. Two warnings signs which suggest that ECPs are starting to feel the pinch. First, Luxottica has seen an increase in interest from the independents in its STARS program in the US. And, second, Essilor has seen high interest from ECPs in their FrameDream program. Both of these initiatives hand control over from the ECP to the corporate and have historically seen resistance from ECPs. This has largely been because independents have wanted to keep control of their business as they are usually run by entrepreneurs or family businesses. Moreover Luxottica and to some extent Essilor, also represent competition with LensCrafters and online platforms. The recent change suggests perhaps the ECPs have struggled this year and are looking for programs to support growth which they may have not usually considered.
Eyewear Industry 42 17 March 2017
Figure 89: We assume the company needs to Figure 90: Essilor has outperformed Luxottica in annualize MAP before seeing a recovery in growth times of low sentiment Luxottica total North America wholesale organic growth, % Key north America growth rates, %
20% 9% 15% 7% 10% 5% 5% 3% 0% 1% -5% -1% -10% -3% -15% e e e e e e e e 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 7 7 7 7 8 8 8 8 -5% 1 1 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 Q Q Q Q Q Q Q Q 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1 2 3 4 1 2 3 4 Lenscrafters LFL Essilor Lens & opt. N.America Luxottica N.America retail
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse research
Luxottica’s upgrade of LensCrafters stores could drive further reacceleration. Luxottica has shown before how it is able to turn around its LensCrafters stores. In 2014 it introduced a two-step plan which involved product segmentation and store refurbishment. The benefits in LensCrafters LFL following the product segmentation and re-assortment was material enough for management to delay the refurbishment as LFL increased to c5%. We note this may have also been partly supported by introducing LensCrafters to VSP and other insurance provider panels. It was only in 2016 the company decided to launch its new store format, removing the lens labs, introducing the Clarify eye exam and making the stores more compact and modern. Given their history of improving LFL through self-help measures, we expect some reacceleration at the start of 2017. We believe this will be helped later in the year by the contribution from the new General manager, Giorgio Candido who joins from the Salmoiraghi retail chain. LensCrafters is over concentrated in the south which has seen more robust sentiment. The data from Jobson can also be split by region. We calculate the greatest number of LensCrafters stores (c315) are found in the south with the lowest number in the northeast (see Figure 91). Looking at the year–on-year change in overall sentiment towards the next 6 months, the south and mid-west record positive changes in forward looking sentiment year on year, which is favourable for Luxottica given its larger concentration of stores in the south. However, in its second largest region, the west, there was a considerable slowdown in sentiment after several quarters of positive momentum.
Figure 91: LensCrafters are over exposed to the Figure 92: …which has seen a good improvement in south of the US… sentiment vs. 3Q15 Distribution of LensCrafters stores across the US, % Y-o-Y change in sentiment for overall sentiment, %
14% 12% 34% 10% 8%
25% 6% 4% 21% 3.4% 20% 2% 0.0% 0% 0.9% (0.2%) -2% -4% -6% -8% 2Q11 4Q11 2Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16
South West Midwest Northeast South West Midwest Northeast
Source: Company data, Credit Suisse research Source: Jobson Optical Business Barometer, Credit Suisse research
Eyewear Industry 43 17 March 2017
Power still lies with the managed care providers in the US… In our initiation of Luxottica we discussed the US managed care market and importance of vision insurers (see ‘Attractive entry point for the long-sighted’ June 2016). The two largest insurers, VSP and EyeMed (owned by Luxottica), dominate the market and through large scale programs with employers have access to a very large pool of consumers. These insurance providers can use member marketing and better discounts to push their consumer clusters into stores – controlling the flow of traffic in the US optical retail landscape. …and they are looking to dictate more of the market. Moreover, in response to increasing competition, vision care insurers have started to also dictate the lens labs used when finishing and processing orders associated with their insurance plan. Initially this required ECPs and approved chains to go to an insurer approved lab but this has developed to specifically dictating insurance orders to insurer owned labs, putting pressure on private lens labs and other manufacturers. From our channel checks, we believe this is done by VSP but not yet done by EyeMed. EyeMed does push retailers to choose one of its third-party approved labs by offering cheaper prices via these labs but this is not compulsory. Interestingly Essilor is currently one of the partners that make up this third- party EyeMed approved network. EssilorLuxottica has a significant advantage in this market if it levered the insurance platform. As well as being more resilient to the US as a combined entity, we also believe the new entity can have a greater influence in the insurance market. According to our channel checks, VSP has become more aggressive with pricing recently as it tries to take market share and differentiate itself. Historically, insurers had relatively different member panels (retail chains/ECPs signed up to the program) but these have converged in recent years, putting the onus on pricing to win employer contracts. Competing on pricing would put pressure on margins but we believe the benefit of being able to push consumers into LensCrafters/other own retail stores, or even the independents under Essilor’s buying Groups, far outweighs the drag on profitability if EyeMed was run at break even, for example. Moreover, we would see it as a positive if following a successful integration of the EssilorLuxottica company, the company looked to expand insurance coverage by buying up another established insurance company such as Superior Vision Insurance.
Eyewear Industry 44 17 March 2017
Europe/Italy Luxury Goods
Luxottica Group (LUX.MI) Rating OUTPERFORM Price (14 Mar 17, €) 50.10 Target price (€) (from 50.00) 58.00 Market Cap (€ m) 24,262.1 Enterprise value (€ m) 25,296.5 Increase target price given merger synergies Target price is for 12 months. ■ Reiterate Outperform and increase target price to €58 from €50. Research Analysts Luxottica’s share price is back towards pre-Essilor merger announcement Catherine Tillson levels and appears to be pricing in little to no synergies for the deal. We 44 20 7888 6052 believe this creates an attractive entry point into a value-generating merger. [email protected] Luxottica now trades in line with the luxury sector vs. a 10-year historical Guillaume Gauvillé, CFA 44 207 888 0321 premium of 21%. EssilorLuxottica ex synergies trades just below its 5-year [email protected] 12-month forward consensus EV/EBIT of 17.3x, and on 15.6x FY18E. ■ Investment story intact. We do not believe the merger timing was a sign the equity story at Luxottica had derailed, and we continue to think the investment plan will run to completion. We believe this merger was driven by i) the synergies of becoming purely vertically integrated, creating a fully independent company with no sacrifice of profits along the value chain; ii) the end to the capital-intensive and lower-return divestment into each other’s businesses; and iii) the need to solve the succession issues at Luxottica. ■ We believe EssilorLuxottica can outperform. With the merger, we believe some of the legacy problems at each company are removed. This includes under penetration of emerging markets, Luxottica’s weakness with the independents, particularly in the US, and the online strategy. See our detailed EssilorLuxottica model in Seeing EssilorLuxottica clearly, also published today. ■ Risks to our investment case: i) the merger does not happen, ii) the eyewear industry experiences a significant slowdown, especially in the US, and iii) the company initiative is executed poorly. ■ New target price of €58. We back out Luxottica’s target price from Essilor’s given the stated exchange rate of 0.461. This target price is derived from a 50:50 weighting of a pro forma DCF for EssilorLuxottica and a Credit Suisse HOLT® Linker including synergies of €540m, in line with company guidance of €400-600m. Share price performance Financial and valuation metrics
7 0 Year 12/16A 12/17E 12/18E 12/19E Revenue (€ m) 9,085.7 9,779.9 10,301.7 10,837.8 6 0 EBITDA (€ m) 1,945.0 2,021.8 2,250.2 2,434.9 Adjusted net income (€ m) 881.70 919.17 1,041.46 1,130.62 5 0 CS EPS (adj.) (€) 1.84 1.91 2.17 2.36 4 0 Prev. EPS (€) 1.75 1.94 2.18 2.39 Ju l- 1 5 Jan - 1 6 Ju l- 1 6 Jan - 1 7 ROIC (%) 13.7 13.3 14.5 15.3 P/E (adj.) (x) 27.3 26.2 23.1 21.3 LUX.M I FT SEURO FIRST 3 0 0 IN D EX P/E rel. (%) 108.0 214.8 224.7 232.1 The price relative chart measures performance against the EV/EBITDA (x) 13.1 12.5 11.1 10.1
FTSEUROFIRST 300 INDEX which closed at 1472.5 on Dividend (12/17E, €) 1.00 Net debt/equity (12/17E,%) 16.7 14/03/17 Dividend yield (12/17E,%) 2.0 Net debt (12/17E, € m) 1,034.4 On 14/03/17 the spot exchange rate was €1/Eu 1.- BV/share (12/17E, €) 13.2 IC (12/17E, € m) 7,225.4 Eu.94/US$1 Free float (%) 27.7 EV/IC (12/17E, (x) 3.5 Performance 1M 3M 12M Source: Company data, Thomson Reuters, Credit Suisse estimates Absolute (%) 0.2 -3.8 0.2 Relative (%) -0.9 -7.7 -9.7
Eyewear Industry 45 17 March 2017
Europe/Netherlands Specialty Softlines
GrandVision N.V (GVNV.AS) Rating UNDERPERFORM Price (14 Mar 17, €) 22.99 Target price (€) 19.00 Market Cap (€ m) 5,848.4 Enterprise value (€ m) 6,514.2 Digital threat too big for now Target price is for 12 months. ■ We initiate on GrandVision with an Underperform rating and €19 TP. Research Analysts GrandVision (GV) is a mass-market player in optical retail. Since its IPO in Catherine Tillson January 2015, it has expanded its store network, which has contributed >60% 44 20 7888 6052 of topline growth. Additionally, through supply chain reorganisation and [email protected] efficiency programmes, the company has expanded margins by 170bps since FY11 leading to a peak adj. EBITDA margin of 16.2% in FY16. ■ The threat of digital on a pure-play retailer seems too great. We see online as a growing disruptor in this industry. GV operates websites for all of its 29 banners, but these vary in quality with only two websites offering the option of buying Rx glasses. We believe the company is underestimating the threat of digital and the need to invest in this channel and remains focused on building out bricks-and-mortar stores. We expect online to limit topline growth and result in downside to margins in the mid-to-long term. ■ Margin expansion initiatives seem to have largely played out. GV has implemented a number of strategic initiatives such as i) supply chain reorganisation and ii) launch of a global ERP system. This has helped to expand margins, but with most initiatives largely complete, we struggle to see further potential for margin accretion. ■ We are just below consensus on EBITDA. We forecast LFL growth of c3% and organic growth ex acquisitions of c4% over the next five years (company guidance of 5% medium term). This leads to peak EBITDA margins of 16.4% by FY19E. This leaves us 2%/2%/4% below consensus on FY17/18/19 EBITDA. With a 25-50% payout ratio, we estimate a TSR of 9% FY16-19E. ■ Valuation does not look supportive; threat of further sell-off by HAL. The shares have rallied >25% since the lows of December 2016, trading on a EV/EBIT of 16x on our FY18e and at a 35% premium to European retailing/specialty retailing sector on consensus 12-month forward EV/EBIT. We note the overhang from a further sell off by HAL, the majority shareholder. Risks include a slower-than-expected transition by consumers to online and deregulation in France boosting LFL by more than we expect. Share price performance Financial and valuation metrics
3 0 Year 12/16A 12/17E 12/18E 12/19E Revenue (€ m) 3,316.0 3,493.0 3,708.1 3,905.4 2 5 EBITDA (€ m) 521.4 567.6 605.3 642.3 Adjusted net income (€ m) 231.00 248.68 269.52 284.94 2 0 CS EPS (adj.) (€) 0.91 0.98 1.06 1.12 1 5 Prev. EPS (€) Ju l- 1 5 Jan - 1 6 Ju l- 1 6 Jan - 1 7 ROIC (%) 14.8 15.0 15.6 15.8 P/E (adj.) (x) 25.3 23.5 21.6 20.5 GVN V.A S A M ST ERD A M EXCH A N GE IN D EX P/E rel. (%) 130.3 145.4 151.7 159.9 The price relative chart measures performance against the EV/EBITDA (x) 12.7 11.5 10.5 9.7
AMSTERDAM EXCHANGE INDEX which closed at 510.1 Dividend (12/17E, €) 0.34 Net debt/equity (12/17E,%) 55.6 on 14/03/17 Dividend yield (12/17E,%) 1.5 Net debt (12/17E, € m) 665.9 On 14/03/17 the spot exchange rate was €1/Eu 1.- BV/share (12/17E, €) 4.4 IC (12/17E, € m) 1,862.8 Eu.94/US$1 Free float (%) 21.0 EV/IC (12/17E, (x) 3.5 Performance 1M 3M 12M Source: Company data, Thomson Reuters, Credit Suisse estimates Absolute (%) 1.7 11.3 -11.7 Relative (%) -1.9 4.0 -27.4
Eyewear Industry 46 17 March 2017
Europe/France Medical Supplies & Devices
Essilor International SA (ESSI.PA) Rating OUTPERFORM Price (14 Mar 17, €) 110.80 Target price (€) 127.00 Market Cap (€ m) 24,201.9 Enterprise value (€ m) 25,583.3 Seeing EssilorLuxottica clearly Target price is for 12 months. ■ We initiate on Essilor with an Outperform rating and a TP of €127. Research Analysts Essilor and Luxottica’s share prices have trended back towards pre- announcement levels and no longer price in management’s guided merger Catherine Tillson 44 20 7888 6052 synergies of €400-600m. We think this has been driven by: a) profit taking; b) [email protected] execution risk; and c) concerns over approvals from competition authorities. We understand the first point given the stock has outperformed the CAC 40 by c25% over the past five years, but we detail in this report why we believe the anti-trust and execution concerns are overstated. ■ The roadmap to EssilorLuxottica. We believe the market is overestimating the execution risk, and in this report we outline the seven key initiatives we think management should implement to harness the full synergies of the merger. These include i) lens insourcing, which we estimate could lead to €150m of cost synergies, and ii) centralisation of lens and frame inventory with lens labs to build the company’s competitive advantage. On anti-trust, we believe the company has some optionality in the US (the market where we believe there could be an issue) through a possible portfolio review. ■ Average EPS growth of 12% out to 2021e. We forecast €540m of EBIT synergies, driven equally by revenue and costs. This supports our >6% growth forecast for EssilorLuxottica over the next five years, along with our forecast for 330bps of contribution margin expansion by 2021. We forecast EssilorLuxottica to turn net cash in FY20e with a 40% payout ratio. We forecast a 15% TSR over the next three years. ■ Risks: We see two key risks, i) the deal does not go through because of competition issues or it is rejected by Essilor shareholders at the AGM on 11 May; or ii) the execution of the merger is poor. ■ Valuation is supportive, opening up an attractive entry point into the name. EssilorLuxottica ex synergies trades on an average historical 12- month forward consensus EV/EBIT of 17.3x. Currently the combined entity is trading at a c10% discount to this on our FY18 estimates, at 15.6x. Our target price of €127 is based on a simple average of our Credit Suisse HOLT® Linker and a pro forma DCF for EssilorLuxottica. Share price performance Financial and valuation metrics
1 3 0 Year 12/16A 12/17E 12/18E 12/19E 1 2 0 Revenue (€ m) 7,115.0 7,770.1 8,312.0 8,881.0 1 1 0 EBITDA (€ m) 1,699.1 1,815.2 1,964.0 2,105.3 1 0 0 Adjusted net income (€ m) 813.00 924.06 1,016.14 1,106.41 9 0 CS EPS (adj.) (€) 3.73 4.24 4.66 5.07 8 0 Prev. EPS (€) Ju l- 1 5 Jan - 1 6 Ju l- 1 6 Jan - 1 7 ROIC (%) 10.6 11.6 12.3 12.8 P/E (adj.) (x) 29.7 26.2 23.8 21.8 ESSI.PA CA C 4 0 IN D EX P/E rel. (%) 194.5 182.9 184.4 184.4 The price relative chart measures performance against the EV/EBITDA (x) 15.3 14.1 12.8 11.8
CAC 40 INDEX which closed at 4974.3 on 14/03/17 Dividend (12/17E, €) 1.50 Net debt/equity (12/17E,%) 18.2 On 14/03/17 the spot exchange rate was €1/Eu 1.- Dividend yield (12/17E,%) 1.4 Net debt (12/17E, € m) 1,381.4 Eu.94/US$1 BV/share (12/17E, €) 26.9 IC (12/17E, € m) 8,962.9 Performance 1M 3M 12M Free float (%) 90.5 EV/IC (12/17E, (x) 2.9 Absolute (%) 1.2 7.0 -1.4 Source: Company data, Thomson Reuters, Credit Suisse estimates Relative (%) -0.5 3.9 -12.5
Eyewear Industry 47 17 March 2017
Europe/Italy Luxury Goods
Safilo Group Spa (SFLG.MI) Rating NEUTRAL Price (14 Mar 17, €) 6.58 Target price (€) 6.00 Market Cap (€ m) 412.3 Lack of brand visibility leaves us cautious Enterprise value (€ m) 439.6 Target price is for 12 months. ■ Potential for a strong self-help story but earnings still at risk from
Research Analysts licence overhang; initiate with Neutral and target price of €6. We like the name because of the 2020 Strategic Plan laid out by current CEO Luisa Catherine Tillson 44 20 7888 6052 Delgado. We believe this has scope to become a strong turnaround story as [email protected] the company removes some of the more basic operational limitations with SAP implementation, improved manufacturing capabilities and insourcing of volumes (70% of global volumes outsourced). Safilo is reducing lead times, rationalising stock keeping units (SKUs) and plans to cut costs by c€25/30m. ■ We remain cautious given licence exposure. The turnaround story looks to be at risk from Safilo’s legacy problem around licences. The first major investment plan in 2011 was derailed by the loss of the Gucci licence and the CEO to Kering. It is likely that the Dior licence and the accompanying LVMH licences will also leave. We estimate Dior is c.€200m of revenues (just under 25% of annual sales) and we include part of its loss in our FY21e sales. ■ Lack of strength in Safilo's own brands. Safilo has been targeting a reversal of its licence to proprietary brand weighting. It currently sits at 75% licences, and targets 60% by 2020. However, outperformance of own brands is yet to materialise. We forecast -11% constant currency (cc) growth in FY17 as the Gucci licence ends and the company guides towards -15%/-20% growth of its 'going forward brand portfolio' in 1Q17. We forecast 5%/6% cc growth thereafter and c160bps of EBITDA margin expansion over FY16-FY20, giving total shareholder return of low single digits over the next 3 years. ■ Risks include i) Dior terminating its contract earlier than expected/or not at all, ii) own brands do not regain momentum, iii) further issues with execution of 2020 Strategic Plan or iv) the company buys in another strong brand. ■ Valuation in line with history. Safilo trades on a normalised EV/EBIT of 20x over the next 5 years, ahead of its 10-year average at c10x, but looks undervalued on EV/Sales of 0.4x vs. history of 0.7x. Our TP of €6 is based on an average of our Credit Suisse HOLT® Linker™ valuation and DCF using a weighted average cost of capital of 8% and terminal growth of c2%. Share price performance Financial and valuation metrics
1 6 Year 12/16A 12/17E 12/18E 12/19E 1 4 Revenue (€ m) 1,252.9 1,130.1 1,202.2 1,264.6 1 2 EBITDA (€ m) 86.7 28.6 60.8 86.9 1 0 Adjusted net income (€ m) 13.68 -16.00 1.10 14.97 8 CS EPS (adj.) (€) 0.22 -0.26 0.02 0.24 6 Prev. EPS (€) Ju l- 1 5 Jan - 1 6 Ju l- 1 6 Jan - 1 7 ROIC (%) 5.0 -1.2 0.7 2.2 P/E (adj.) (x) 30.2 -25.8 376.6 27.6 SFLG.M I FT SEURO FIRST 3 0 0 IN D EX P/E rel. (%) 119.4 -211.7 3664.2 300.7 The price relative chart measures performance against the EV/EBITDA (x) 5.3 15.4 6.8 4.5
FTSEUROFIRST 300 INDEX which closed at 1472.5 on Dividend (12/17E, €) 0.00 Net debt/equity (12/17E,%) 3.1 14/03/17 Dividend yield (12/17E,%) 0.0 Net debt (12/17E, € m) 27.3 On 14/03/17 the spot exchange rate was €1/Eu 1.- BV/share (12/17E, €) 13.9 IC (12/17E, € m) 903.9 Eu.94/US$1 Free float (%) 48.6 EV/IC (12/17E, (x) 0.5 Performance 1M 3M 12M Source: Company data, Thomson Reuters, Credit Suisse estimates Absolute (%) 0.1 -17.5 -17.4 Relative (%) -2.0 -22.1 -28.4
Eyewear Industry 48 17 March 2017
Companies Mentioned (Price as of 14-Mar-2017) Dixons Carphone Plc (DC.L, 304.1p) Dufry (DUFN.S, SFr149.2) Essilor International SA (ESSI.PA, €110.8, OUTPERFORM, TP €127.0) Fielmann (FIEG.DE, €71.66) GrandVision N.V (GVNV.AS, €22.98, UNDERPERFORM, TP €19.0) HOYA (7741.T, ¥5,424) Hennes & Mauritz (HMb.ST, Skr246.5) Inditex (ITX.MC, €31.39) KappAhl (KAHL.ST, Skr46.4) Kingfisher (KGF.L, 341.1p) LVMH (LVMH.PA, €198.35) Luxottica Group (LUX.MI, €50.1, OUTPERFORM, TP €58.0) Marks & Spencer (MKS.L, 330.5p) Matas (MATAS.CO, Dkr99.0) Next (NXT.L, 3929.0p) OVS Spa (OVS.MI, €5.48) Pets at Home Grp (PETSP.L, 188.3p) Safilo Group Spa (SFLG.MI, €6.58, NEUTRAL, TP €6.0) Sports Direct (SPD.L, 297.1p) ULTA Salon, Cosmetics & Fragrance, Inc. (ULTA.OQ, $285.38) XXL ASA (XXLA.OL, Nkr93.0)
Disclosure Appendix Analyst Certification Catherine Tillson and Guillaume Gauvillé, CFA, each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.
3-Year Price and Rating History for Luxottica Group (LUX.MI)
LUX.MI Closing Price Target Price Target Price Closing Price LUX.MI Date (€) (€) Rating 55 15-Jun-16 44.82 52.00 O * 07-Oct-16 40.85 50.00 50 * Asterisk signifies initiation or assumption of coverage.
45
40 01- Jul- 2016 01- Sep- 2016 01- Nov- 2016 01- Jan- 2017 01- Mar- 2017
O U T PERFO RM The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products.
Eyewear Industry 49 17 March 2017
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:
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Target Price and Rating Valuation Methodology and Risks: (12 months) for Essilor International SA (ESSI.PA)
Method: Our target price of €127 is based on a simple average of our HOLT Linker and a DCF (WACC of 6%, long-term growth of 3%) based on our pro forma EssilorLuxottica model. We rate the shares Outperform as we believe the stock looks attractive on most metrics and has a stronger competitive positioning than its peers as the eyewear industry faces increasing disruption from online. Risk: Key risks to our Outperform rating and €127 target price include: The merger with Luxottica falls through. Further deceleration and weakness in the US optical market. Increased competition from other lens manufacturers. Bad weather affecting the sun season. Resistance from independent opticians in the US to take on Essilor-branded products. Acquisitions of overpriced or poor-quality assets. Target Price and Rating Valuation Methodology and Risks: (12 months) for GrandVision N.V (GVNV.AS)
Method: Our Underperform rating and €19 target price is based on a simple average of our HOLT Linker and our DCF valuation. We believe the stock looks less attractive than peers and expect further earnings downgrades. Risk: Key risks to our Underperform rating and €19 target price are; i) the company manages to effectively launch omni channel which allows them to capture more market share and drive top line. Ii) online disruption is less than expected. Iii) The company manages to expand aggressively in the US and take market share. Iv) The company's exclusive brands gain market traction and drive volumes into store. Target Price and Rating Valuation Methodology and Risks: (12 months) for Luxottica Group (LUX.MI)
Method: Our target price of €58 and Outperform rating is based on applying the guaranteed exchange ratio of 0.461 Essilor shares for each Luxottica share. The Essilor share price is a simple average of our DCF and a HOLT Linker model (using a 15-year competitive advantage period window) and the EssilorLuxottica proforma. With the stock having de rated signficantly post deal and valuation coming back in line with its the 5yr consensus 12mth fwd EV/EBIT of EssilorLuxottica ex synergies, we think current levels represent an attractive entry point and rate the stock Outperform.
Eyewear Industry 50 17 March 2017
Risk: Key risks to our target price of €58 and Outperform rating include: (i) the merger deal falls through (ii) broad macro weakness (iii) a significant decline in US domestic purchases (iv) loss of key licenses such as Prada (v) key proprietary brand Ray-Ban loses brand equity. Target Price and Rating Valuation Methodology and Risks: (12 months) for Safilo Group Spa (SFLG.MI)
Method: Our target price of €6 is based on a simple average of our Credit Suisse HOLT(R) Linker (TM) and our DCF valuation. We believe the stock should look more attractive despite the risk associated with the name as the company looks to implement its 2020 Strategic Plan. Given the stock is trading close to our target price, we rate the shares Neutral. Risk: Key risks to our Neutral rating and €6 target price are i) one of the key licences such as Dior terminates their agreement early or does not renew their agreement. ii) broader slowdown in the eyewear sector especially in the US. iii) the proprietary brands fail to gain market share and consumer traction, and iv) the business sees significant disruption as it implements its IT transformation.
Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures/view/selectArchive for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (LUX.MI, SFLG.MI, ESSI.PA, LVMH.PA, MKS.L, OVS.MI, ULTA.OQ, XXLA.OL, DUFN.S, KGF.L, DC.L) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (SFLG.MI, DUFN.S, KGF.L, DC.L) within the past 12 months. Credit Suisse has managed or co-managed a public offering of securities for the subject company (DC.L) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (SFLG.MI, DUFN.S, KGF.L, DC.L) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (LUX.MI, SFLG.MI, ESSI.PA, LVMH.PA, MKS.L, OVS.MI, ULTA.OQ, XXLA.OL, DUFN.S, KGF.L, DC.L) within the next 3 months. As of the end of the preceding month, Credit Suisse beneficially own between 3-5% of a class of common equity securities of (DUFN.S). For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit- suisse.com/disclosures or call +1 (877) 291-2683. 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Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.credit- suisse.com/sites/disclaimers-ib/en/canada-research-policy.html. Credit Suisse Securities (Europe) Limited (Credit Suisse) acts as broker to (KGF.L). The following disclosed European company/ies have estimates that comply with IFRS: (HMb.ST, ITX.MC, MKS.L, NXT.L, DUFN.S, KGF.L, DC.L). Credit Suisse has sent extracts of this research report to the subject company (GVNV.AS, SFLG.MI, ESSI.PA) prior to publication for the purpose of verifying factual accuracy. Based on information provided by the subject company, factual changes have been made as a result. Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (OVS.MI, XXLA.OL, DUFN.S, DC.L) within the past 3 years. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. This research report is authored by: Credit Suisse International ...... Catherine Tillson ; Guillaume Gauvillé, CFA To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the FINRA 2241 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse International ...... Catherine Tillson ; Guillaume Gauvillé, CFA Important Credit Suisse HOLT Disclosures With respect to the analysis in this report based on the Credit Suisse HOLT methodology, Credit Suisse certifies that (1) the views expressed in this report accurately reflect the Credit Suisse HOLT methodology and (2) no part of the Firm’s compensation was, is, or will be directly related to the specific views disclosed in this report. The Credit Suisse HOLT methodology does not assign ratings to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and warranted value calculations, collectively called the Credit Suisse HOLT valuation model, that are consistently applied to all the companies included in its database. Third-party data (including consensus earnings estimates) are systematically translated into a number of default
Eyewear Industry 51 17 March 2017 algorithms available in the Credit Suisse HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. The adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national borders. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes the baseline valuation for a security, and a user then may adjust the default variables to produce alternative scenarios, any of which could occur. Additional information about the Credit Suisse HOLT methodology is available on request. The Credit Suisse HOLT methodology does not assign a price target to a security. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes a warranted price for a security, and as the third-party data are updated, the warranted price may also change. The default variable may also be adjusted to produce alternative warranted prices, any of which could occur. CFROI®, HOLT, HOLTfolio, ValueSearch, AggreGator, Signal Flag and “Powered by HOLT” are trademarks or service marks or registered trademarks or registered service marks of Credit Suisse or its affiliates in the United States and other countries. HOLT is a corporate performance and valuation advisory service of Credit Suisse. Important disclosures regarding companies or other issuers that are the subject of this report are available on Credit Suisse’s disclosure website at https://rave.credit-suisse.com/disclosures or by calling +1 (877) 291-2683.
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