Luxottica

Equity report

April 6th, 2017

Luxottica: Equity Report

Executive Summary Luxottica (“LUX” or the “Company”) is a global leader in the design, manufacture and distribution of fashion, luxury and sport eyewear (see Appendix Market Information for further information on the industry). Among its core strengths are a strong and well-balanced brand portfolio (see Appendix Brands) which is composed of iconic proprietary brands (such as Ray-Ban and Oakley) as well as prestigious licensed brands (such as Giorgio Armani and Michael Kors). Through a number of acquisitions of independent distributors (see Appendix Acquisitions) as well as the opening of new subsidiaries and joint-ventures in major foreign markets the Company has expanded internationally and developed a global geographic footprint. Its wholesale distribution network covers more than 150 countries and is complemented by an extensive retail network of approximately 8,000 stores (such as LensCrafters in North America, Salmoiraghi&Viganò in Italy and Sunglass Hut worldwide, among others). LUX’ competitive advantage is the vertically integrated business model built over the years (for a more detailed background of the Company’s development since its foundation, please refer to the Appendix History). The path followed so far will now culminate in the announced merger with Essilor, the world’s largest lens maker, which is expected to be completed by year-end 2017. This report, however, will analyze LUX as a stand-alone business and therefore not include any implications related to the transaction.

In the following analysis, we examined LUX’ investment, financing and operating decisions and carried out a ratio analysis as well as a valuation of the Company’s price per share. Our main findings suggest that, in the context of a growing eyewear market, the Company is well positioned to further penetrate the industry and continue to outpace its peers. Predominantly, we found that the Company is effectively managing its working capital in combination with the excellent maintenance of funds from highly rated long-term financing instruments. Its financial discipline with regards to short- and long-term liquidity in combination with strong profitability is supported by increasing retained earnings despite a continuous dividend payout. The revenue mix is approximately 60% retail and 40% wholesale and even though revenue growth has slowed down slightly, the Company has shown a positive trend in its net income margin which suggests achievements in cost efficiency. Extraordinary management of returns on LUX’ employed capital is reflected in the advanced Du Pont Analysis.

The valuation of LUX’ stock has been carried out with a Discounted Cash Flow Model on the basis of market consensus and several own assumptions, which derived a value range between €47.00-€53.20. The sensitivity analysis was carried out with respect to WACC and growth rate. This has been accompanied by a multiples valuation using several different parameters which yield an overall price range from €46.1 to €60.1. In light of the proposed merger, our estimated price range might certainly be highly sensitive to any new information that becomes available in this context. Hence, we advise to take caution in interpreting this figure and are eager to observe where the Company is heading in the years to come.

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Luxottica: Equity Report

Financial Analysis The following analysis will examine the Company’s financial statements in the context of LUX’s business strategy (see Appendix Business Strategy), competitive advantage and trends in profitability. We decided to compare LUX mainly with its closest competitor Safilo (see Appendix Comparison of Business Models for an analysis of peers) as their business models are most similar. Investment Decisions With reference to the common-sized balance sheet of LUX (see Excel Financial Analysis), the main accounts on the asset side are: among current assets, Cash & Cash Equivalents with a three-year average1 of 10.6% of total assets (TA), Accounts Receivables with 9.5% and Inventories with 8.2%; among non-current assets, Property, Plant & Equipment with 32.4% (gross), Goodwill with 36.1% and Other Intangible Assets with 14.9% of TA.

The main investing activities in the past three years were related to the acquisition of tangible as well as intangible assets (primarily related to IT infrastructure) in combination with the acquisition of Alain Mikli in FY13 for €71.9mn, the e-commerce platform glasses.com in FY14 for €30.1mn, and Sunglass Warehouse (SGW) in FY15 for €21.0mn as part of the Company’s expansion strategy.

Cash & Cash Equivalents have increased substantially in FY14 from (7.6% to 15.2% of TA). The main underlying reasons are the issuance of new bonds in the amount of €500mn in FY14 as well positive effects of exchange rate changes. LUX holds cash predominantly to manage its debt repayments, execute its payout ratio and pay for acquisitions (more than 90% of the Company’s deals in its history where payment type is disclosed were paid in cash). The level of and movements in Cash & Cash Equivalents are not unusual in LUX’ market as peers need to continuously invest in growth opportunities to maintain their competitive advantage. Safilo, in comparison, maintains an average of roughly 5% of TA throughout the same period (see Safilo_BalanceSheet (CS)).

Accounts Receivable (A/R) have remained fairly stable during FY13-FY15 as well as A/R turnover (three-year average of 10.73) and Days Sales Outstanding (DSO) (three-year average of 34.02) as can be seen in the Excel sheet LUX_WC. In comparison, Safilo is relying much more on A/R (three- year average of 16.5% of TA) even though LUX reports much higher sales than Safilo. It’s A/R turnover lies at an average of 4.67 with an average of 78.51 in DSO (see Safilo_WC), which highlights LUX’s superior credit sales management. Concerning the allowance for doubtful accounts, LUX reported an average of ~5% in the past three years and the Company was not significantly exposed to credit risk.

Inventories (Inv) also remained fairly stable in the analyzed period. However, the ~15%- increase in FY15 inventory was due to an effort to improve the quality of customer experience by having inventory levels in line with customer demand and thereby decreasing the delay of order. Inv Turnover

1 The three-year period covers FY13 to FY15.

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Luxottica: Equity Report and Days Inventory Outstanding (DIO) are on average 3.59 and 101.64 (see LUX_WC), which is quite similar to Safilo’s average Inv Turnover and DSO of 2.05 and 177.75 (see Safilo_WC) even though Safilo is holding a higher level of inventory (average of 15.3% of TA as opposed to 8.2% for LUX). This reflects LUX’ more stable sales patterns which the Company can more easily predict. LUX clearly benefits from a lower inventory level as this means that less cash is tied up.

Property, Plant & Equipment is primarily composed of land and buildings, including leasehold improvements and machinery and equipment. Its share of TA did not change a lot between FY13 and FY15 but has nevertheless been affected by additions through acquisitions. Accumulated depreciation also did not move a lot. LUX allocated depreciation on a straight-line basis over the estimated useful live of the assets (10-40 years for buildings, 3-20 years for machinery and equipment, 20 years for aircraft and 2-10 years for other equipment). Capital expenditure (Capex) has been increased by 23% every year and in the observed period was primarily related to the enhancement of IT infrastructure, opening of new stores and the remodeling of older stores. LUX estimates that, going forward, approximately 60%+ of Capex will be invested in growth and 40% or less in maintenance.2

Investments in Intangible Assets are primarily related to IT infrastructure and LUX’ proportions are similar to Safilo’s. The accumulated account consists mainly of the Company’s investment in goodwill and trademarks as a result of acquisitions over the years. Increases in goodwill and intangible assets due to business combinations in the period under review refer primarily to the acquisition of SGW in FY15, and glasses.com in FY14 as well as Alain Mikli in FY13. In the case of the glasses.com acquisition, goodwill was mainly due to the synergies the Company expects will be generated. Annual tests on impairment of goodwill have not resulted in any major reductions. Hence, there is no risk associated with these accounts. Trademarks are amortized on a straight-line basis over periods ranging between 15 and 25 years.

Financial Decisions LUX’ main sources of financing are Accounts Payables with 12.7% of total liabilities and equity (TL&E) on average, Long-Term Borrowings with 21.1% and Retained Earnings with 51.2%. The Company’s financing structure fairly matches with investments: current assets comprise 30.9% of TA on a three-year average and current liabilities average 21.4% of TL&E in the period under review. Fixed assets comprise 13.9% (net) of TA, while Long-Term Debt makes up 21.2% of TL&E.

Accounts Payable (A/P) in proportion to TL&E stayed rather constant throughout the three years and only increased slightly from FY14 to FY15 due to overall business growth in combination with improved payment terms and conditions as well as strengthening of the foreign currencies in which the Company operates. The exposure to exchange rate risk derives from its Australian subsidiary OPSM Group and its dominant presence in the US as well as manufacturing facilities in China. These

2 Earnings Call March 02, 2016

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Luxottica: Equity Report currencies have strengthened over the recent years, increasing LUX’ net sales but also A/P. According to the financial reports, the carrying value of A/P is approximately equal to the fair value of these accounts. Hence, there is no major credit risk originating from this liability. Furthermore, LUX has steadily reduced its cash conversion cycle (CCC) from 37.9 days in FY13 to 30.13 in FY15 (see Excel Sheet LUX_WC), while A/P Turnover has averaged at 36.1 and Days Payables Outstanding (DPO) were continuously increased from 99.8 in FY13 to 103.8 in FY15. This shows that the Company is able to maintain short-term liquidity. When comparing the relative share of A/P on LUX’ balance sheet with that of its closest peers, there is no significant variation. Its closest competitor Safilo records ~13.2% of TL&E as A/P. Safilo’s DPO, however, is significantly higher at 157.8 on average, exhibiting a downward trend. This reflects LUX’ bargaining power due to its high market penetration.

The main sources of Long-Term Debt (LT Debt) are shown in the Appendix Outstanding Debt. LUX mainly received funds from private placements and the bond market with coupon rates ranging from 2.6% to 7%. The Company’s credit rating is "A-" reflecting a favorable position in terms of solvency and liquidity (also see Ratio Analysis later in this report). In FY15, the Company repaid €649.3mn of its LT Debt which left it with an outstanding amount of €1,715.1mn of which €21.8mn mature in FY16. LUX’ LT Debt financing is mainly used to finance long-term business operations and acquisitions. The covenants associated with current debt have not been violated in the past three years which suggests low risk of default. In order to compare LUX’ debt position with that of its peers, Debt- to-Equity (D/E) ratios were calculated (see Excel Peer Liquidity Comparison). We found that, in fact, Luxottica's D/E ratio is in line with the peer average: .32 in 2015 and averaging .43 from FY13-FY16 as compared to .28 average for the peer group in FY16 and .38 over FY13-FY16 despite a major outlier from Fielmann, which hardly uses any LT Debt to fund its activities as it places high value on internal growth, avoids takeovers and funds expansion mainly through cash. However, one should notice that Fielmann is a much smaller company with assets totaling just under €900mn (FY15) compared to LUX’ €9.6bn (FY15). Hence, Fielmann is not the best benchmark for comparing financing. In comparison to Safilo, LUX’ share of LT Debt financing is higher (~21% of TL&E compared to Safilo's ~10%). Safilo has reduced its debt substantially over the years and prefers to rely more on internal financing while LUX maintains its debt financing to fund increasing capital expenditures, numerous acquisitions and further business expansion. Nevertheless, the fact that LUX’ debt has been decreased over the past five years shows that the company is becoming progressively less dependent on that source of financing. Instead, the Company more strongly relied on Retained Earnings which comprise ~45% of TL&E during FY13-FY15. While LUX has continued to pay regular dividends at a constant payout ratio of 50%, the proportionate share of TL&E has been maintained due to LUX’ strong profitability.

LUX recognizes leases as operating when a significant portion of the risks and rewards of ownership is retained by the lessor. Related payments are charged to the consolidated statement of income. Leases are characterized as financial when the lessee bears substantially all the risks and

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Luxottica: Equity Report rewards of ownerships. Such leases are capitalized at the lower of the fair value of the leased property and the present value of the minimum lease payments. The corresponding rental obligations are included in “long-term debt” in the consolidated statement of financial position, while the associated interest payments are shown in the consolidated statement of income. Financial leases amounted to €25.2mn in FY14 and €25.2mn in FY15, while future minimum operating lease obligations amount to €1,447.8mn as of year-end 2015 (see Excel Contractual Obligations) with rental expenses of €463mn, €488mn and €559mn in FY13, FY14 and FY15, respectively. The Company leases various retail stores, plants, warehouses and office facilities as well as certain of its data processing and automotive equipment under operating lease arrangements. Taking into account the change in accounting standards with IFRS 16 (applicable from January 1, 2019) which requires all leases to be recorded on the balance sheet as assets and liabilities, we recommend to take caution with respect to the impact of the change in accounting regulation. A reclassification of operating leases as finance leases could significantly deteriorate LUX’ long-term liabilities as well as long-term liquidity ratios. However, in comparison with Safilo’s finance lease obligations, LUX’ treatment of its leases does not seem untypical.

Operating Decisions3 Revenues The sales of Luxottica are divided into two different categories which are represented by the Optical Retail and the Wholesale divisions. In FY16, 61.2% of the total revenues were generated by Retail while Wholesale accounted for the remaining 38.8%. The higher proportion of the retail division in FY16 is mostly attributable to the increased number of retail stores opened in the North American market. Sales growth in this division is mainly generated from opening new stores and amounted to 6% in total from which only 0.6% was from same store sales growth. The Company does not disclose the sales split among the brands it produces, but Ray Ban is reported to be the strongest contributor. On the other hand, Oakley, one of the company's main sellers, has been struggling in recent years.

Geographically, the vast majority of LUX’ sales are derived from the North American market and this was represented by a total figure of 59.1% in FY16. The proportion of the North American market of the total revenues has been stable for the last five years (avg. 57.6%), and has had a positive trend during this time. The second biggest market is Europe with 18.7% (5-year avg. 19%) of total revenues and third is Asia Pacific with 12.7% (5-year avg. 13%). The fastest growing market for the Company in 2016 was Latin America (LATAM) which grew by 10% with constant currency exchange rate and the corresponding share of the total revenues amounted to 6.1% (5-year avg. 6.3%). The fast strong demand in LATAM is caused by significant growth especially in Mexico and a positive performance in Brazil, where the company's market penetration is still relatively low. LUX expects LATAM to be the fastest

3 Please refer to Excel Ratios & Margins from IS for this analysis.

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Luxottica: Equity Report growing market in the foreseeable future as its is absorbing more market share in accordance with its long-term strategy.

Comparing the Company’s sales development during the years 2012 to 2016 with its peers, we can see that the overall development has been fairly similar. The average growth rate for Luxottica has been 8.05% during the last five years, whereas it has been 7.84 % for its peers. Furthermore, we can see a trend of slowing revenue growth for Luxottica, having the highest y-o-y growth of 13.88% in 2012, and the slowest y-o-y growth of 0.83% in 2016. A similar trend is not observable with its peer group on average, which experiences a high volatility of sales growth during the period.

In 2017, LUX expects its total revenues to grow on a scale of low to mid-single digit. The biggest market, North America, is expected to grow 1-2% as the large scale market penetration limits the growth potential. On the other hand, the fastest growing market LATAM is expected to perform strong in 2017 with a growth between 8-9%. Correspondingly, the European market is expected to grow at 6-8% and Asia-Pacific by 5-6 %. In 2016, the Asia-Pacific region was temporarily affected by restructuring of the distribution channels in Mainland China, but the positive effect of these changes are already expected to be seen in 2017. Furthermore, e-commerce is seen as the driver of growth for LUX’ retail division, posting a growth of 24% in 2016.

The global eyewear industry is worth about €100 billion and the Company expects it to grow by 19 % by 2021.4 The expected increase can be caused by demographics, such as ageing population and under- penetration which is caused by lacking awareness on vision health. Furthermore, the global economic development and rising standards of living will drive the increase in demand for LUX’ premium brands. Luxottica sees its revenues at €15 billion at 2024, which implies a yearly growth rate of 6.5 % for the next eight years.

Expenses LUX has similar cost of sales as its peer group. From FY12 to FY16, the Company averaged a gross profit margin of 65.84%, which is slightly better than the peer average of 63.58%. On the other hand, LUX is more efficient in terms of operating costs relative to revenues. The Company's operating costs averaged at 50.78% of total revenues in the last five years, whereas the relative number of the peers was 57.06%. Moreover, the Company has been able to reduce the proportion of the operating costs slightly, which is not the case for its peers on average. One reason for this is LUX´ strategy of strong vertical integration, which sets it apart from its industry peers.

The biggest portion of LUX’ operating costs (OC) are Selling & Marketing costs, which have averaged 71.27% of total OC between 2012 and 2015. The proportion has been relatively stable but jumped to 75.63% in 2016 which was caused by a charge of about €87mn of adjusting items mainly related to the

4 Luxottica Annual Report 2016

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Luxottica: Equity Report reorganization projects the company undertook in 2016. LUX´ peers have a fairly similar cost structure with regards to operating expenses, as the industry average also experiences high selling & marketing costs as part of the business profile.

The depreciation LUX records has not seen a lot of variability during the last five financial years, averaging about 4 % from 2012 to 2015. In 2016, the figure jumped to 5.6%, due to a 16% net increase in fixed assets and lower than expected revenues for the year. The depreciation policy does not seem to have a big impact on the bottom line.

Profit LUX’ net income grew by 5.77% in 2016, which was much lower than its five-year average of (13.79%). This was mainly due to the lower than expected sales of 2016. Compared to its peers (Safilo excluded due to deep losses), the Company’s net income has not grown as fast. During the last five years, the peer group has grown at an average rate of 14.09%, hence slightly outperforming LUX. The same trend is observable when looking at the net income margin. The Company’s net income margin averaged at 8.32% in the last five years compared to 8.85% of its peers'. LUX’ net income margin has been on a positive trend though (unlike that of its peers) and the Company has been able to improve its net income margin yearly topping at 9.36% in 2016 (comp. peers: 6.75%). Hence, LUX has made its operations more cost-efficient even though its sales growth has slowed down. One cause for this is the decrease in interest costs, which has decreased from €121.1mn in 2012 to €81.5mn in 2016 (-40.98%), due to decreased financial debt. The Company’s overall cost structure has remained fairly similar during the last five years.

Losses and Gains LUX has not experienced serious operating losses during the years 2012 to 2016. The abnormal losses have ranged between €9mn in in 2013 to its highest of €86mn in 2015, which was caused by a €64mn acquisition expense in relation to SGW during the financial year. In 2016, the abnormal loss amounted to €34mn, which also included a payment of €54mn received from the Essilor deal and a €69mn restructuring expense related to the China supply chain restructuring. During the last five years, the abnormal losses occurred have not had a big impact on the company's bottom line, amounting to an average of 0.41% of the total revenues. Furthermore, the foreign exchange hedging losses have ranged between a loss of €8mn in 2013 to a gain of €0.7mn in 2014, serving as evidence of a low risk in currency hedging.

Pensions LUX has both defined benefit and defined contribution plans. The pension plans expose the Company to actuarial risks, such as longevity risk, currency risk, and interest rate risk as well as market (investment) risk. In FY2013, the Company recorded an actuarial gain of €63.2mn, which represents ~20% of total comprehensive income in that year. However, we do not believe that the risks associated with LUX’ employee benefit obligations constitute a major issue as its pension plans have been

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Luxottica: Equity Report adequately funded (never have the pension assets made up less than 90% of pension obligations) throughout the period FY13-FY15 and the proportion of pension liabilities over TL&E has been rather low.

Taxes LUX’ effective tax rate ranged from 36.9% in FY15 to 42.6% in FY13, which does not exhibit major volatility. In the adjusted figures, the Company decided to exclude the tax effects of the accrual for tax audits in FY07 and subsequent periods, the reorganization of the acquired Alain Mikli business (in FY13), the termination of the former CEOs (in FY14) as well as the tax effect of the reorganization of Oakley and other minor projects (in FY15). This seems reasonable as those effects can be regarded as non-recurring.

Ratio Analysis5 Comparing the ROE, ROA, operating margin and leverage of LUX to its peers, fairly similar numbers are observed for the last five years. From 2012 to 2016, the Company’s average ROE has been 14.48% (vs. 14.68% for peers), ROA has been 7.40% (vs. 7.08% for peers), operating margin has been 14.73% (vs. 12.55 % for peers) and total debt to total assets has averaged 23.94% (vs. 23.73% for peers). As mentioned earlier in the report, LUX has achieved higher cost efficiency compared to its peers and this is also observable in the 2016 figures. The Company`s ROE has increased to 15.2% (vs. 6.95% for peers), ROA was 8.53% (vs. 2.11% for peers), operating margin was 14.81% (vs. 7.03% for peers) and leverage was 19.84% (vs. 18.56% for peers). Furthermore, we can observe that LUX has been able to increase its profitability and efficiency ratios systematically every year, a trend that is not observable for its peers.

Looking at the Z-scores of LUX and its peers, we can observe a fairly similar risk of bankruptcy. LUX’ current Z-score is 7.03, whereas the average of its peer group is 7.59. The high figure of the peer group is mainly caused by Fielmann's score of 19.09 as, if left out, LUX has a higher Z-score than all its other peers. We can conclude that the Company has an extremely low probability of financial distress and bankruptcy which is in line with its strategic pillar of financial discipline.

Short term liquidity We compared LUX’ short-term liquidity ratios with those of Essilor, Safilo, Cooper, Grandvision and Fielmann.

Compared to its peer average, LUX has a slightly higher current ratio of 1.36 in 2016 (vs. 1.25 for peers) which it improved over the years, while the current ratios of peers went down. Also, LUX’ quick ratios have been above the peer average almost throughout the whole period, signaling the huge inventory the Company has, which it has purposely increased over the last three years in order to

5 Please refer to Excel Ratio Peer Comparison, Peer Liquidity Comparison as well as Reformulated Statements and DuPont Decomposition for this analysis.

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Luxottica: Equity Report improve the quality of the customer experience by having finished product inventory ready at all times and in line with the rising consumer demand.

LUX’ cash conversion cycle is conspicuously lower than the peers’ average with 33 days (four-year average) as compared to 95 days (four-year average) among the peer group. While the difference is definitely attributed to its great exposure to the Retail business which is associated with low levels of average day of sales. Nevertheless, LUX has to be given credit for its superior management to have such a high gap in the cash conversion cycle, which reflects the efficiency with which the Company is being able to generate cash through its short-term assets and liabilities despite its business expansion and cyclical nature of sales.

To conclude, when compared to its peers, LUX definitely comes out on top by quite a margin in almost every aspect of short-term liquidity, making it a superior company when compared to its most competitive peers, despite the numerous acquisitions and related integration procedures, making the management of the company all the more impressive.

Long-term liquidity As far as the long-term liquidity is concerned, we can see that LUX’ long-term D/E ratio is on average in line with the industry in the last three years (2014 to 2016). However, the total liabilities to equity ratio was comparatively higher than peers’, suggesting that it is the short-term liabilities and not the long-term borrowings bringing about such a gap and indeed it is the sharp rise in A/P from €681mn to €944mn from 2013 to 2016 due to the growth of business and strengthening of the foreign currencies in which the group operates that has caused the increase in this ratio. At the same time, LUX seems to be getting closer to the industry average. Interest rate coverage ratio (IRCR) is one aspect in which the Company is behind its peers, but that is mainly due to an outlier in Fielman, whose IRCR is extraordinarily high given its scarce use of debt to finance its operations. However, this should not be seen as a bad sign for LUX as Fielmann is a much smaller company. Since we have not included the Fielmann figures for 2016, this year gives a better representation of the peers' IRCR which is higher but not quite as drastically as the previous years in which Fielmann’s IRCR figures are included. LUX’ relatively high IRCR ratio is because, given its continuously increasing business expansion into the US as well as emerging markets along with the vertical integration strategy, the Company has been using and continues to use substantial debt financing to raise financial resources. While, in absolute terms, the IRCR is not a cause for liquidity concern for the Company, this is one area it could improve.

Du Pont Decomposition For the advanced Du Pont analysis, we used the financial statements of the recent three years from 2013-2015. Thereafter, the return on operating assets, financial leverage and the spread were calculated, which are the three main components of Return on Capital Employed (ROCE), the metric that reflects the level of efficiency with which a company generates profits from its capital employed. We can see

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Luxottica: Equity Report that LUX’ ROCE improved at an incredible rate from 2013 to 2014 from 7.85% to 20%. More frequently than not, when companies experience such a high level of growth, they are not able to support this in the following years. However, LUX was able to successfully sustain the improved ROCE in 2015 as well. One can see the zeal of the Company to dominate the industry looking at the rise in total assets from €8bn in 2013 to €9.6bn in 2015 and indeed the company is finding success with its return on net operating assets more than doubling from 6.3% in 2013 to 13.4% in 2015. What makes this even more impressive is that the Company’s financial leverage decreased from .64 in 2013 to .48 in 2015, partly attributed to the repayment of debt in 2015. But since the Company has not raised more debt, it seems that it is beginning to progress towards internal financing and reduce its reliance on that source of funding. Furthermore, the net borrowing costs have remained stable around 3%-3.7% over the three years despite the lowered financial leverage, which would normally reflect debilitated contribution of FLEV to boost ROCE due to lower costs of financing. However, this has clearly not been the case as the Company’s ability to persistently improve the RNOA has not been hindered, thereby improving the overall ROCE. The company actually managed to improve its spread substantially from 2.5% in 2013 to 11% in 2015 to offset the reduced contribution of FLEV to the ROCE. To conclude, the impressive rise in the LUX’ ROCE and the further analysis of this profitability metric strengthens our belief that the company’s aforementioned strategic moves and financial investments have indeed been fruitful.

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Luxottica: Equity Report

Valuation In order to estimate the fair value of LUX, we applied the two most common valuation methods: the discounted cash flow (or “DCF”) and the multiples. DCF analysis uses future free cash flow projections and discounts them to arrive at a present value estimate. The discount rate used is generally the appropriate weighted average cost of capital (WACC), which, in its simplest version, consists of two components: the cost of debt and the cost of equity.

The former component reflects both the time value of money (risk-free rate) and the risk premium, and these factors can change substantially from one economy to another. As LUX operates globally, we decided to compute a weighted average of the cost of equity in its two major markets, the US and Europe, where the weights are given by the percentage of sales realized in each market. In detail, the US cost of equity accounts for 76% of the total, and the Europe for 24%. For the risk-free rate, we opted for the latest ten-year government bond yield. As in the Eurozone there does not exist one unique government yield, we relied on the Euro area yield curves provided by the ECB, which takes into account only AAA-rated government bonds. Lastly, for the equity risk premium we relied on Damodaran’s estimations.

For the calculation of the Beta, we regressed LUX’s monthly stock returns against the MSCI World index for the last five years. Again, the choice of this last index reflects the company’s global presence. The results of these computations give us a total cost of equity of 5.74%.

Regarding the cost of debt, LUX has only two types of publicly traded bonds. We chose the bond with a seven-year maturity (02/10/2024) and a current yield of 0.425% as the most representative indicator of cost of debt. Lastly, for the computation of the WACC, we used the average value of the effective tax rate over the last years and the leverage ratio. The resulting WACC is 5.2%.

Once we had the appropriate discount rate, we had to project the free cash flows. One of the most important assumptions of this stage is the competitive-advantage period, which represents the number of years the management believes the firm can sustain its competitive advantage, given the present strategies. We were suggested to choose a period between three and five years. We opted for the longer period, given that the company is a mature stage which allows cash flows to be forecast quite accurately.

The consensus estimates figures, based on the combined estimates of the analysts covering LUX, provided a useful starting point. Estimates from 2017 to 2019 were reliable, as they roughly correspond to the guidance from the management or, at least, tend to follow a similar trend. On the other hand, FY20 estimates seemed less reliable, probably because of the lower number of analysts providing forecasts. Thus, we decided to keep estimates in the first three years mostly unchanged, while adjusting figures for FY20. Lastly, we had to estimate financials for FY21 independently. In this case, we assumed that many items would remain at a fixed percentage of sales, calculated as the average of the

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Luxottica: Equity Report previous three years. More in detail, annualized 2017-2021 revenue growth rate is expected to be 5.3% due to product quality, strong brands and increasingly direct relationship with the end-consumer through retail and e-commerce. EBIT margin is expected to increase from 15.7% to 16.3%, due to strong focus on cost control. Tax rate is constant at 38.7%, as per 2012-2015 average. Depreciation, capex and change in WC are expected to be stable at, respectively, 5.5%, 5.7% and 0.9% of revenue.

Given the estimated cash flows, we were also able to project the value of the total net investment (“TNI”). We then used the 2017-2021 average expected growth of this latter, which is 1.24%, as a proxy of the growth rate (“g”) needed for the calculation on the terminal value. Other alternatives could have been the expected GDP growth or the luxury sector expected growth. However, both figures seemed too high, considering the mature stage of the company.

Given our assumptions, we obtained an enterprise value of €25,273.3mn, which implies a target share price of €50.17 (see Appendix DCF Model). As this result is extremely sensitive to the WACC and the growth rate, we also decided to run a sensitivity analysis, which provides us with a €47-€53 range. Furthermore, major risks to the target price on the downside are the correction of consumer confidence, notably in the US, loss of key licenses, increase in competition, notably from mass-market retailers, and a possible overhang from main shareholder (see Appendix Ownership Structure). On the upside, main opportunities are: stronger top-line momentum leading to faster margin progression than expected, lower-than-expected operating expenses thanks to tighter discretionary cost control, and faster-than- anticipated penetration of emerging markets.

On the other hand, the multiples analysis (see Appendix Multiples) consists of identifying comparable companies and applying the valuation multiple to the key statistic of the firm being valued. For the selection of the peers, we opted for picking only the companies that operate internationally in the same industry and have a similar size. This selection resulted in the following companies: Fielmann, Grandvision, Safilo and Essilor. For the choice of multiples, we used the most common ones: EV/Revenue, EV/EBITDA, EV/EBIT, P/E, Price-to-FCF and Price-to-Book. All these multiples refer to historical figures for the fiscal year ending in December 2016, and estimated figures for the year ending in December 2017, if available. The average result is a target share price of €51.20.

According to our DCF and multiples analysis (see Appendix Football Field), the company thus appears fairly priced, compared to the current share price of €50.9 (as of 4 April 2017). However, our analysis might have to be reconsidered once we could fully assess the impact of the merge with Essilor, especially in the medium/long run. As managers explained during the last earnings call, “it is still early days and hence they would not be able to comment further on the progress made so far towards this combination”.

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Luxottica: Equity Report

Appendices Market Information According to the Market Report “Global Eyewear Market with Focus on Luxury Sunglasses: Industry Analysis & Outlook (2016-2020)” from www.marketreportsonline.com, the eyewear market remains strong due to increasing myopia and an ageing population. It is forecasted to rise in the next five years. Regionally, Latin America and Asia Pacific are structural and volume growth markets with improving access to healthcare and education deregulation and an emerging middle class with strong awareness for luxury products. Some of the noteworthy trends and developments of this industry are the growth of the contact lens category, an emerging online eyewear market, scale benefits of optical retailers, a shift to higher value eyewear products and increasing demand for quality sunglasses. The main growth drivers of the global eyewear market are an aging population, urbanization, the rise of middle income, an increasing number of people requiring vision correction as well as the use of eyewear as fashion statement, according to “Global Eyewear Market with Focus on The Premium Eyewear: Size, Trends & Forecasts (2016-2020)” from www.marketreportsonline.com. Threats come from the price differences between branded and non-branded products. The report “Eyewear Market Analysis by product (Contact Lenses, Spectacles, Plano Sunglasses) and Segment Forecasts to 2024”, published in August 2016, on www.grandviewresearch.com states that the contact lenses segment is expected to witness considerable growth driven by the need for elimination of spectacles and the adoption of plano sunglasses to enhance aesthetic appearance. The plano sunglasses segment is projected to grow the fastest: increasing sale of high-end luxury and branded sunglasses. The Asia Pacific region is anticipated to emerge as key market for global eyewear manufacturers (30% of global eyewear demand in 2015). Furthermore, vendors increasingly adopt modern ways of distribution (online retailing, exclusive online stores and other e-commerce and aggregator websites). Brands Propietary Brands: - Ray-Ban (one of world’s bestselling brands of sun and prescription eyewear) - Oakley (leader in sport and performance category - Persol - Oliver Peoples - Alain Mikli (high-end market) - Arnette (sport market) - Vogue Eyewear (fashion market)

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Luxottica: Equity Report

Licensed Brands (>20): Giorgio Armani, Emporio Armani, Armani Exchange, Brooks Brothers, Burberry, Bulgari, Chanel, Coach, D&G, DKNY, Michael Kors, Paul Smith Spectacles, Prada, MiuMiu, Raph Lauran, Polo Ralph Lauren, Ralph, Starck Eyes, Tiffany & Co., Tory Burch, Valentino, Versace

Acquisitions Deal Announce Announced Total Value Payment Target Name Acquirer Name Seller Name TV/EBITDA Deal Status Type Date (mil.) Type M&A 2/7/2017 Orange County Participacoes SA Luxottica Group SpA 117.61 Cash Completed M&A 1/30/2017 Oticas Carol Luxottica Group SpA 117.62 Cash Pending M&A 1/16/2017 Luxottica Group SpA Essilor International SA Delfin Sarl 16,608.75 Stock 13.29 Pending M&A 1/16/2017 Luxottica Group SpA Essilor International SA 9,507.64 Stock 12.68 Pending M&A 11/25/2016 Salmoiraghi & Vigano SpA Luxottica Group SpA N/A Undisclosed Pending M&A 5/16/2014 Inveroptic SAU Luxottica Group SpA N/A Undisclosed Completed M&A 1/7/2014 Glasses.com Inc Luxottica Group SpA Anthem Inc N/A Cash Completed M&A 8/5/2013 Revo SQBG Inc Luxottica Group SpA 20.00 Cash Completed INV 11/27/2012 Salmoiraghi & Vigano SpA Luxottica Group SpA 58.23 Cash Completed M&A 11/2/2012 Alain Mikli International SASU Luxottica Group SpA N/A Undisclosed Completed M&A 5/17/2012 120 stores/Spain & Portugal Luxottica Group SpA SUN Planet SA N/A Undisclosed Completed M&A 12/1/2011 Grupo Tecnol Ltda Luxottica Group SpA 79.55 Cash Completed M&A 8/5/2011 Erroca International Ltd Luxottica Group SpA 28.49 Undisclosed Completed M&A 5/23/2011 Multiopticas Internacional SL Luxottica Group SpA N/A Cash Completed M&A 2/17/2011 Stanza High Tech Luxottica Group SpA 23.11 Cash Completed M&A 8/13/2010 Optifashion Group Luxottica Group SpA HAL Holding NV 26.90 Cash Completed JV 2/8/2010 Eyebiz Pty Ltd N/A Undisclosed Completed INV 5/27/2009 Multiopticas Internacional SL Luxottica Group SpA 55.69 Cash Completed M&A 9/16/2008 Sunglass Hut UK Ltd Luxottica Group SpA Banco Santander SA 75.01 Cash Completed M&A 7/28/2008 Ray Ban Sun Optics India Pvt Ltd Luxottica Group SpA 23.75 Cash 16.85 Completed M&A 6/20/2007 Oakley Inc Luxottica Group SpA 2,193.24 Cash 18.8 Completed M&A 3/23/2007 2 Sun Chains Luxottica Group SpA 13.29 Cash Completed M&A 11/2/2006 DOC Optics Luxottica Group SpA 110.00 Cash Completed Bruckmann Rosser Sherrill & Co LLC M&A 9/29/2006 Things Remembered Inc Gordon Brothers Group LLC 200.00 Cash Completed (Fund: Bruckmann Rosser Sherrill & Co II LP) M&A 6/23/2006 Modern Sight Optics Luxottica Group SpA 17.50 Undisclosed Completed M&A 5/18/2006 Shoppers Optical Luxottica Group SpA King Optical Group Inc 60.29 Undisclosed Completed M&A 10/4/2005 Ming Long Optical Luxottica Group SpA 35.84 Cash Completed M&A 7/7/2005 Xueliang Optical Luxottica Group SpA 25.25 Undisclosed Completed INV 1/5/2005 Pearle Europe BV HAL Trust Luxottica Group SpA 191.26 Cash Completed M&A 11/26/2004 OPSM Group Ltd Luxottica Group SpA 81.00 Cash 48.72 Completed M&A 10/30/2003 Ray Ban Sun Optics India Pvt Ltd Luxottica Group SpA 6.46 Cash 59.25 Completed M&A 10/8/2003 Cole National Corp Luxottica Group SpA 705.62 Cash 16.39 Completed M&A 4/30/2003 OPSM Group Ltd Luxottica Group SpA 276.40 Cash 11.31 Completed M&A 1/16/2003 IC Optics Srl Luxottica Group SpA Gianni Versace SpA N/A Undisclosed Completed M&A 12/11/2001 Face-It sunglass business Luxottica Group SpA OPSM Group Ltd N/A Undisclosed Completed M&A 2/26/2001 First American Health Concepts Inc Luxottica Group SpA 24.32 Cash 39.92 Completed M&A 2/22/2001 Sunglass Hut International Inc Luxottica Group SpA 669.20 Cash 8.25 Completed M&A 4/28/1999 Ray-Ban Sunglasses Luxottica Group SpA Bausch & Lomb Inc 640.00 Cash Completed M&A 10/1/1995 WOMENS SPECIALTY RETAILING GR Retail Brand Alliance Inc Luxottica Group SpA N/A Undisclosed Completed M&A 3/3/1995 US Shoe Corp Luxottica Group SpA 1,301.70 Cash 10.45 Completed

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Luxottica: Equity Report

History

Business Strategy Competitive Advantage: vertically integrated business model (which entails reduced costs of supply chain) built over the years, covering the whole value chain: design, product development, manufacturing, logistics and distribution

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Luxottica: Equity Report

Long-term Strategy

Continue expand in eyewear and eye care sectors by growing its various businesses (organically or through acquisitions)

Focus on strategic pillars: - Vertical integration - Design and technological innovation - Brand portfolio management - Market expansion - Financial discipline - Development of talented and committed employees (improvement of organizational efficiency)

Plans to sustain its business in the future through building strong brands that create enduring relationships with consumers. Therefore, need to invest to strengthen and balance portfolio with acquisition of new brands and addition of new licensing agreements.

Committed to maintain and strengthen position in markets in which it operates.

Evaluates opportunities to further penetrate emerging markets (long-term growth strategy).

Aim at increasing market expansion through - stronger retail distribution - consolidating its wholesale network - further growing in e-commerce, department stores and travel retail

Comparison of Business Models Luxottica Luxottica covers all aspects of the value chain (design, manufacturing, distribution…) which allows it to directly control production and monitor quality. Luxottica’s products are distributed through retail, wholesale and e-commerce. The success of Luxottica started with the acquisition of Ray Ban in 1999. At that time, Ray Ban had financial issues, was close to bankruptcy. Luxottica decided to lower the price, and brought the production facilities in Italy. The result was higher than expected, and the success of the brand became worldwide. Success of Luxottica can mainly be explained by its vertical integration which is upward (control of the suppliers and the distribution) and downward (control of the retailers). This vertical integration permitted Luxottica to have a fluid coordination between all the steps of the value chain, and in this way, reduce the cost. Safilo is the biggest competitor of Luxottica.

Luxottica is very similar to Safilo. High competition between the two, with licenced brand which switched between the two brands (Armani switched from Luxottica to Safilo in 2006, but Ralph Lauren switched from Safilo to Luxottica). The only main difference between these two brands are the licensed brand that they own.

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Luxottica: Equity Report

Safilo Safilo is an Italian company which provides a large variety of glasses, some of them are proprietary brands and the other are licensed brands (Fendi, Dior). Safilo puts a lot of emphasize on the importance of its research and development department which is divided into the product creation and the product development (new materials, technologies…) which aims to improve the efficiency of the manufacturing process. Safilo’s products are partly produced by third parties but also by Safilo facilities. The raw materials used for the production are delivered by selected suppliers which are chosen in terms of their quality standard and their delivery time. Concerning the marketing part, Safilo uses digital media, print media, sponsorships and public relations in order to promote its products. In addition to that, each brand has its own marketing plan in order to reflects the core characteristics of each brands. Safilo is present in nearly 130 countries, and sells its products through owned shops and independent distributors.

Cooper Cooper is operating in a different sector than Luxottica. Indeed, it has two main divisions, one is Cooper Vision which offers different kinds of contact lenses that corrects several vision problems. This division represents 80 % of Cooper revenue. The other division is Cooper Surgical which represent 20% of Cooper revenue. Due to the difference of the service provided between Luxottica and Cooper, the business strategies of the two company are not comparable. Concerning the marketing and distribution of Cooper surgical products, they are marketed by “sales representative, independent agents and distributors”. The company also use e-commerce, social media, educational programs and tradeshows.

Concerning Copper Vision, the products are marketed through field sales representatives (optometrists, ophthalmologists, opticians…). It also uses distributors to sell the products, where some of them have an exclusive partnership with cooper to market the products in specific demographic area.

Concerning the products of Cooper Vision, Cooper company manufactures its own products (it does not sell any other brand, only Cooper’s products which own some patents concerning the product’s name but also the product itself). The brand is composed of a large variety of products which responds to the largest number of customers as possible. Concerning the raw materials used during the manufacturing process (packaging materials…), Cooper company relies on sole suppliers, but the raw materials are usually available from different sources.

To resume, Cooper company aims to offer the most differentiated lens products portfolio as possible. The products are patented and owned by the company. The main source of expenses will be directed to the research and development department. The company is always trying to expend its activities in other geographic areas. Concerning the manufacturing, Cooper makes acquisitions to develop its distribution (the company recently bought Sauflon pharmaceuticals for 700 million, which is a European distributor and manufacturer of contact lenses).

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Luxottica: Equity Report

Essilor Essilor handles everything from research to manufacturing, but mainly distributes its products through retailers. The proposed merger with Luxottica will vertically integrate the distribution process to the combined business model.

Fielmann Fielmann, like Luxottica, covers the whole value chain from manufacturing products to distribution. The company owns the largest optical retailer in Germany, which gives it a strong market position in its home market (40 % of total market).

Contrary to Luxottica and Essilor, Fielmann is present only in Germany, Austria, Switzerland with only a small exposure to Italy and no market exposure outside of Europe.

Outstanding Debt

DCF model

Today 2017 2018 2019 2020 2021 2022 31/03/2017 31/12/2017 31/12/2018 31/12/2019 31/12/2020 31/12/2021 31/12/2022 FCFF 762.2 888.9 962.2 1,008.6 1,057.7 1,070.9 % Growth 16.6% 8.2% 4.8% 4.9% 1.2% Terminal Value 27,017.6 FFCF + TV (0.0) 762.2 889.1 962.2 1,008.6 28,075.3

Share Price Calculation In EURm EV 25,273.3 - Net Debt 2016 1,177.0 Market Cap 24,096.3

In million Total number of shares (m) 480.3

Target Share value (EUR) 50.17 Current Share value (EUR) 50.90 Premium on current price (1.43%)

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Luxottica: Equity Report

Ownership Structure

The Company founder, Mr. Del Vecchio has been Chairman of the Board of Directors since LUX’ incorporation. Delfin S.à r.l., controlled by Mr.Del Vecchio, is the largest shareholder of the Company with a 61.90% holding of the outstanding ordinary shares.

Multiples method

Revenue EBITDA EBIT Price / Earnings P/FCF P/Book Dec-16A Dec-17E Dec-16A Dec-17E Dec-16A Dec-17E Dec-16A Dec-17E LTM LTM EV 26,481 26,814 27,580 27,324 26,452 26,075 25,214 24,492 18,549 28,686 Market Cap 25,304 25,637 26,403 26,147 25,275 24,898 24,037 23,315 17,372 27,509 Share Price 52.69 53.38 54.98 54.44 52.63 51.84 50.05 48.55 36.17 57.28

Summary statistics Min 36.17 Max 57.28 Average 51.20 Median 52.66

Average 51.20 Current Price 50.9 Premium 0.59%

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Luxottica: Equity Report

Football Field

Luxottica - Football Fields

P/Book LTM € 54.4 € 60.1

Price / Earnings Dec-17E € 46.1 € 51.0

Price / Earnings Dec-16A € 47.5 € 52.6

EBIT Dec-17E € 49.3 € 54.4

EBIT Dec-16A € 50.0 € 55.3

EBITDA Dec-17E € 51.7 € 57.2

EBITDA Dec-16A € 52.2 € 57.7

Revenue Dec-17E € 50.7 € 56.1

Revenue Dec-16A € 50.1 € 55.3

DCF € 47.0 € 53.2

€ 40.0 € 45.0 € 50.0 € 55.0 € 60.0 € 65.0

Series1 Series2

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