Consumer Durables US: an Emerging Market?

INDEPENDENT RESEARCH Consumer Durables 23rd May 2013 US: an emerging market? Consumer Durables

ESSILOR BUY FV EUR96 vs.85 In our first report on emerging Optics markets last December, we forgot to Bloomberg EF FP Reuters ESSI.PA include one: the US! It is remarkable to note that all optics players consider Price EUR89.7 High/Low 89.7/67.51 Market Cap. EUR19,261m ZV EUR19,329m the US as a genuine emerging market, both in prescription eyewear and PE (2013e) 29.5x EV/EBIT (2013e) 21.0x sunglasses. This is another example of the outstanding growth potential

LUXOTTICA BUY FV EUR44 vs. 41 harboured in the global Optics market. In this report, we have increased Bloomberg LUX IM Reuters LUX.MI our Fair Values for Essilor (EUR96 vs. EUR85) and Luxottica (EUR44 vs. Cours EUR42.65 High/Low 42.65/24.77 Capi. boursière EUR20,303m EV EUR21,745m EUR41) after updating our market assumptions. PE (2013e) 30.5x EV/EBIT (2013e) 19.2x  The US market paradox: the leading global Optics market, but also an SAFILO BUY EUR15 Bloomberg SFL IM Reuters SFLG.MI emerging market. Indeed, the US market remains under-penetrated in Price 13.89EUR High/Low 13.9/4.2EUR technologies for corrective lenses (penetration rate for anti- Market Cap. EUR858m EV EUR1,43m advanced PE (2013e) 32.5x EV/EBIT (2013e) 14.5x reflection lenses: 37% vs. 95% in China!) due to technological delays at

prescription laboratories which have not invested sufficiently in state-of-the- art equipment such as digital surfacing. The sunglasses market is also emergent in the US since 80% of sunglass purchases carry price tags of around USD50 (vs. EUR100 in Europe), given that distribution is dominated

23/5/13 by mass retailing and customers are still fairly insensitive to brands. 130

125  The US is set to become the largest contributor to growth at our groups 120 alongside emerging markets. Although it is already the leading market for

115 Essilor (~40% of sales) and above all, Luxottica (58% of sales), growth

110 potential remains significant. Essilor is trying to catch up the technological lag

105 by buying and then updating prescription labs in order for them to offer the

100 latest innovations, while Luxottica is developing upscale retailing either via its

95 own banners (LensCrafters, Sunglass Hut), or via department stores and travel M J J A S O N D J F M A M STOXX EUROPE 600 CONSUMER GDS E - PRICE INDEX STOXX EUROPE 600 E - PRICE INDEX retail. These strategies contribute to the value effect in the US market and to Source: Thomson Reuters Datastream boosting growth levels at our groups.

 After a mixed Q1 13 in terms of sales performance, an acceleration is likely as of Q2 for Essilor and Luxottica. In addition to the demanding comparison with the year-earlier period that we were expecting, the two leaders also suffered from disadvantageous weather conditions and a negative calendar effect. In contrast, the two groups both confirmed a sharp recovery in April, confirming less demanding comparison and still very positive momentum in emerging markets. Essilor is also set to benefit from certain major innovations (Varilux S series, Crizal Prevencia…) whereas Luxottica can rely on Giorgio Armani and Oakley to ensure that 2013 is just as dynamic as 2012.

Analyst: Consumer Analyst Team: Cédric Rossi Loïc Morvan 33(0) 1 70 36 57 25 Peter Farren

[email protected]

r r

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Table of contents

1. The US: an emerging market ...... 3

1.1. The leading global market… ...... 3

1.1.1. The US is the leading ophthalmic market in value terms...... 3 1.1.2. … but still under-developed in sunglasses ...... 3 1.2. …despite a technological lag that still needs to be caught up ...... 4

1.2.1. Significant potential for high value-added corrective lenses ...... 4 1.2.2. Sunglasses: more selective retailing in order to step up "premiumisation" of the offering 6 2. A buoyant US optical market despite current volatility ...... 9

2.1. A still beneficial macro-economic environment ...... 9

2.1.1. Consumer sentiment is changing in line with negotiations on the sequester ...... 9 2.1.2. Optical product consumption is still holding up well ...... 9 2.2. The US market is a major catalyst for the stocks we cover...... 11

2.2.1. Essilor still has extensive untapped potential… ...... 12 2.2.2. … but so do eyewear groups Luxottica and Safilo ...... 13 3. Our 2013-2014 forecasts ...... 16

3.1. A flat Q1 2013 performance for our groups...... 16

3.2. … but the best to come as of Q2 2013! ...... 17

3.2.1. Essilor: a dual-paced year in 2013 ...... 17 3.2.2. Luxottica: Wholesale division in honour ...... 18 4. Re-rating justified by excellent fundamentals ...... 21

4.1. Healthy stockmarket performance continuing in 2013 ...... 21

4.2. Change in EV/EBIT n+1 ...... 21

4.3. DCF valuation ...... 24

Price Chart and Rating History ...... 26

Bryan Garnier stock rating system ...... 27

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1. The US: an emerging market 1.1. The leading global market…

1.1.1. The US is the leading ophthalmic market in value terms... Within the global ophthalmic market, which accounts for an annual total of 1,140bn lenses, the US market alone represents almost 18%, or around 200m lenses. As the table below shows, the US market has been exceeded by China in volume terms (around 226m lenses) although in value terms China is still lagging considerably, remaining five times smaller than the US market.

In 2012, the US corrective lens market grew by around 3% in volume terms. As shown further on, this growth was driven by an advantageous macro-economic backdrop, fairly robust demographic growth (+0.9% in 2012) as well as marketing initiatives launched by the main players in the market (innovations, campaign to favour anti-reflective lenses etc.).

Fig. 1: The US: a strategic market in size terms

Population Eyeglass wearers Size of the market Weight in the Country/Region (m) (m) (m lenses) worldwide market (%) US 311 199 ~200 ~18 China 1,354 330 226 ~20 India 1,210 ~140 ~100 ~9 Brazil 193 ~90 ~60 ~5 European Union 502 ~266 ~200+ ~18 Total worldwide 7,100 1,700 1,140 -

Source: National Eye Institute, Essilor

1.1.2. … but still under-developed in sunglasses The sunglasses segment is a genuinely emerging segment, harbouring outstanding development potential for Luxottica and Safilo. Two main statistics underpin this fact: (i) in 2012, the US sunglass Retail market represented around USD3.5bn whereas that of corrective lenses totalled USD10.6bn, according to Vision Monday and (ii) almost 80% of sunglass purchases are made on average prices of USD50 whereas the average price in Europe stands at EUR100.

Fig. 2: Sunglasses are an emerging segment in the US:

Source: Luxottica This emerging market status is found in both Italian groups' exposure, with Europe remaining the leading region as shown in the chart below. At the two main global eyewear manufacturers, North

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America accounts for 37% of sales at Safilo (adjusted for Latin America) whereas it accounts for 25% of Wholesale sales at Luxottica.

While this breakdown could seem surprising at first glance for Luxottica, given the presence of a number of US brands (Ray-Ban and Oakley as well as licences such as Coach, Ralph Lauren, etc.), note that a significant share of production is sold in the group's optical chains (LensCrafters, Sunglass Hut, etc.), thereby explaining the dominant weighting of Retail sales, accounting for 61% of group sales and 83% of sales in North America.

Fig. 3: Luxottica and Safilo's North American exposure:

Luxottica (2012 Wholesale sales): Safilo (2012 sales):

North America North America 25% 37%

Western RoW Europe RoW (o/w 12% 40% LatAm) 6% Western Europe Asia-Pacific 40% Emerging 17% markets 23% Source: Company Data

Note that this segment also concerns Essilor, which is now one of the major players in the US sunglasses market thanks to its readers business. This leadership was bolstered by the 2011 acquisition of Stylemark, which merged with FGX last year. In 2012, the new pairing generated sales of EUR344m, more than 80% of which in North America, and sold around 130m units.

1.2. …despite a technological lag that still needs to be caught up

1.2.1. Significant potential for high value-added corrective lenses Although the US market is already the leading global market in value terms, growth potential remains high as shown by the three charts on the following page, with penetration rates of high value-added products remaining fairly low, and even lower than those in certain emerging markets.

The most remarkable example is that of anti-reflective lenses. In the US, only 37% of lenses have an anti-reflective treatment, vs. 100% in Japan and even 95% in China! This was the main reason underlying the partnership between Luxottica and Essilor to provide 400 LensCrafters' stores with anti-reflective treatment machines (see further on), in order to expand the technology and increase the market in value terms. The same goes for high-index lenses (see right-hand chart), which only account for 6% of the US market, way behind China (14%) and South Korea (60%).

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Fig. 4: A lagging product-mix in advanced technologies:

Penetration rate of progressive lenses… … Anti-reflective lenses… … and “thin” lenses (index >= 1.6)

60% 49% 95% 100%

31% 26% 37% 24% 14% 6% 2% 2%

China U.S. France New Zealand India U.S. China Japan Brazil U.S. China South Korea Source: Essilor

This technological lag has stemmed from independent prescription laboratories. The lag has primarily been caused by the structure of the US ophthalmic market, particularly at prescription laboratories, which are virtually unavoidable intermediaries between opticians and lens manufacturers. Note that these labs are responsible for transforming semi-finished lenses (one side completed) into finished lenses (both sides completed), surfacing (moulding and polishing) and applying lens treatments (anti-reflective, anti-scratch, anti-UV etc.).

Contrary to the European market where manufacturers have in-house prescription laboratories, the US market has almost 600 laboratories in North America, more than 50% of which are still independent. As seen in Fig. 15 on page 12, the large majority of these laboratories still belong to families which, even recently, were reticent to invest in ultra-modern equipment (digital surfacing, anti-reflective machines etc.) and in complicated R&D since the high growth in standard products (uni-focal lenses, 1.5 index lenses etc.) was enough to expand their business. Note that this technological lag only concerns the US since the large majority of Canadian labs are at the same technological level as their European equivalents.

A recent example was provided by the Varilux S series: the roll-out of this new progressive lens requires very modern equipment both at laboratories and opticians (Visioffice measurement system, digital surfacing technology etc.). However, according to Essilor, only 10% of the independent laboratories are equipped with this advanced technology, and until now this has limited the penetration of high value-added products and made the roll-out of the Varilux S series longer in the US than in Europe.

Faced with this trend, the optics chains that integrate their labs such as LensCrafters (Luxottica) and Wal-Mart have a competitive edge since their laboratories are often very well equipped, thereby enabling them to offer exclusive products and/or services, and stand out from other independent opticians and chains which work with independent laboratories that do not have modern equipment. As such, LensCrafters is one of the only chains to be able to offer an anti-reflective treatment within an hour.

Fig. 5: Structure of US ophthalmic market:

Raw material suppliers Chemist groups & glass makers

Lens producers Integrated manufacturers (plants + Non-integrated manufacturers (Vision Ease, Polycore…) prescriptions labs) ex: Essilor Independent labs Prescription labs/lens finishing Integrated chains (store + labs)

Retail Independent opticians Non-integrated chains Ex: LensCrafters (LUX), Wal-Mart

Consumers Eyeglass wearers

Source: Essilor, Bryan Garnier

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The acquisition of laboratories by Essilor is a means of moving them and the market upscale The laboratory acquisition policy started in the US in 1996 is therefore doubly strategic for Essilor since it is a means of: (i) growing market share by increasing the penetration of brands at the laboratories, and (ii) equipping laboratories in state-of-the-art technology in order to enable them to move upscale by offering the group's latest innovations (Varilux S series, Crizal Prevencia, etc.) to consumers. As such, out of the 10 largest independent laboratories listed by the US optics site Vision Monday in 1992 (below), Essilor has bought six of them!

Fig. 6: Listing of top 10 independent prescription laboratories in 1992:

Name 1992 net sales (USDm) Comments 1 The Omega Group 90 Acquired by Essilor (1996) 2 Walman Optical 55 Independent 3 Twin City Optical 45 Acquired by Essilor (1998) 4 Duffens Optical 40 Acquired by Essilor (1996) 5 Southern Optical 40 Acquired by Essilor (1996) 6 Soderberg Ophtalmic 32 Independent 7 Dynoptic (Icare Labs) 25 Independent 8 DBL Management 20 Acquired by Essilor 9 Associated Optical 19 Acquired by Essilor 10 Classic Optical Labs 16 Independent

Source: Vision Monday

Thanks to this aggressive laboratory acquisition strategy, at the end of 2012, the French group owned around 150 prescription laboratories across the US. As the table below shows, Essilor was therefore by far the largest integrated manufacturer, with sales exceeding USD1bn and a network virtually five times larger than that of its two main rivals Hoya and Zeiss. This leadership in prescription laboratories should therefore provide Essilor a better position to make the most of moves upscale in the US market.

Fig. 7: Listing of five major integrated manufacturers in the US:

Rank Name 2012 Rx Qholesale sales* (USDm) 1 Essilor 1,058 2 The Hoya Free-Form Company 193.5 3 Carl Zeiss Vision Laboratories 145.8 4 VPSOne Optical Technology Centers 112.8 5 Nassau Vision Group Laboratories (Essilor) 22.0

* Rx sales for the 12 months ending August 31, 2012 / Source: Vision Monday

1.2.2. Sunglasses: more selective retailing in order to step up "premiumisation" of the offering The lag in value terms also concerns the sunglasses market since Luxottica estimates that almost 80% of sunglass purchases are made for prices of less than USD50, whereas the average price of a pair of sunglasses in Europe fluctuates at around EUR100. This has been confirmed by Vision Council, which estimates the average price of a pair of sunglasses in the US market at just USD36! In our view, two reasons explain this difference: (i) retailing channels remain dominated by mass merchants and this does not favour an increase in value, and (ii) brand awareness remains weak on the part of consumers.

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Upscale retailing still under-represented in volume terms The left-hand chart below shows indeed that in 2012, mass retailing again accounted for 63% of the 76.9m pairs of sunglasses sold in the US, whereas, so-called specialised retailing (such as Sunglass Hut at Luxottica and Solstice at Safilo) only represented market share of 15% in volume terms. Finally, department stores accounted for around 7% of market volumes.

In contrast, market share in value terms in this upscale distribution chain is significant since specialised retailing already accounts for 42% of the market, given the exclusive presence of luxury and/or premium brands (Ray-Ban, Oakley, Hugo Boss…) and above all, by a better trained sales force in terms of orienting customers towards upscale products.

Department stores also boast significant market share (14%) since this circuit is already a reference for well-off clients in terms of other luxury segments (leather goods, ready-to-wear etc.). As discussed on page 13, department stores harbour huge development potential for Safilo and Luxottica, thereby explaining why Luxottica signed an exclusive contract with Macy's which houses 670 SGH sales points since 2010.

Fig. 8: Breakdown of US sunglass market by retail circuit:

Units sold (%) Retail value (%)

Optical Other Sport Department Optical chains independents 4% 5% stores 9% 3% Optical 14% Optical chains independents 3% 7% Sport Department 5% stores Other 7% 1%

Sunglass specialty 15% Drug/Mass Sunglass 63% specialty Drug/Mass 42% 22%

Source: Vision Council

Premiumisation also involves educating consumers Paradoxically, while the US is the leading Luxury market in the world consumers spend very little on their glasses frames (53% of purchases in the USD100-149 price-range vs. an average of EUR133 excluding lenses in France), and on their sunglasses (average price of USD36) as we have just seen. In our view, this lag relative to Europe is still linked to the Retail segment, which has not played its role in educating and making customers aware in order to convince them to invest in more upscale sunglasses.

The issue is therefore the same for the ophthalmic segment: manufacturers and associations such as Vision Council need to: (i) better train independent opticians in order for them to convince their clients to move upscale and to attract new clients, (ii) extend the network of specialised banners in order to improve the shopping experience, and (iii) communicate on the benefits of innovations such as polarised and photochromic lenses and new materials that decrease the weight of frames.

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Solutions: more selective innovation and distribution As for prescription lenses, innovation in sunglasses has been driven by the use of new materials that are more resistant and lighter, which offer better protection from UV rays while helping to improve vision. The challenge for manufacturers such as Luxottica and Safilo is therefore to combine the various innovations in frames and lenses in order to considerably improve the price/mix. Indeed, as the table below shows, the price difference between a basic Aviator model (metal frame with non- polarised lenses) and an upscale model (titanium frame and polarised lenses) can reach up to 50%.

The polarised lens segment (lenses blocking polarised light and therefore blinding reflections) is a good example in view of the huge development potential in the US given that these lenses are increasingly used by manufacturers for their numerous advantageous: anti-glare (contrary to standard sunglasses), a better contrast of colour and depth and lighter-coloured lenses that nevertheless offer 100% protection against UV rays. These polarised lenses are therefore recommended for outdoor activities, water activities (high reflection) and for driving.

Fig. 9: Price range for Aviator model at Ray-Ban:

Selling price (USD) 145 175 195 225 Frame material Metal Titanium Metal Titanium Polarised lenses? No No Yes Yes Source: Ray-Ban.com

Manufacturers such as Luxottica and Safilo have similar strategies to luxury groups in opening directly-operated stores in order to be nearer consumers and control sales. As in the Luxury market, this specialised retailing format is a means of participating in the market "premiumisation" since the purchase experience is improved by a better trained sales force, exclusivity in certain ranges and products and locations often close to major Luxury shopping areas (see photos below). These factors prompt consumers to buy upscale frames and sunglasses more easily. Indeed, LensCrafters, SGH and Solstice have all opened stores on 5th Avenue in New York.

Fig. 10: Favouring specialised retailing to step up "premiumisation":

Sunglass Hut store in West Palm Beach Solstice store in Los Angeles

Source: Company data

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2. A buoyant US optical market despite current volatility 2.1. A still beneficial macro-economic environment

2.1.1. Consumer sentiment is changing in line with negotiations on the sequester As illustrated in the chart below, the Conference Board index, which tracks consumer confidence, rose to 68.1 in April from 61.8 the previous month. The level remains relatively high, despite certain grey areas that are a concern for consumers: (i) tax uncertainties linked to negotiations on the sequester, (ii) budget cuts and the increase in income tax.

Consumer confidence is holding up fairly well, thanks to a brighter employment picture (114,000 jobs created in April), with the jobless rate reduced by 0.1 points to 7.5%, its lowest in four years. The US administration has also revised upwards its job creation figures for February (332,000) and March (165,000). The steady decline in unemployment is bolstering consumer confidence and, consequently, benefitting consumer spending.

Fig. 11: Performance of the Conference Board US consumer confidence Index (100 = 1985)

120

100

Source: Conference Board

2.1.2. Optical product consumption is still holding up well Despite the volatility in macro-economic indicators since the start of the year, the environment clearly remains more favourable to consumer spending in the US than in Europe, where both the economy and unemployment rates have yet to stabilise. In our view, US retail figures continue to rise because the two key vehicles for wealth creation in the US are performing well: (i) US stockmarket indices are at historically high levels (with the Dow Jones hitting a record high of over 15,000 points!), which has a beneficial impact on household savings and (ii) the real estate market has bounced back, with the S&P/Case-Shiller index up 1.2% in February (+1% in January) and 9.3% year-on-year, the highest level since June 2006!

The macro-economic environment therefore remains favourable to consumer spending, particularly for optical products, as highlighted in the chart below. Retail sales of optical products (corrective

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lenses and contact lenses) remain at historically high levels, which should automatically benefit Luxottica, given its position as the leading optical retailer (~9% market share).

Fig. 12: US GDP growth and US retail sales (% change)

-5

-10

-15

U.S. GDP growth U.S. total retail sales U.S. retail - corrective eyeglass & contact lenses Source: Datastream

Another indicator of this market’s sound health is the business barometer presented below, based on surveys among independent eye-care professionals (optometrists, opticians, labs, etc.). After a slight downturn in February, the index returned to the January level in March (3.8), confirming the optimistic stance of independent opticians/optometrists, which make up almost 50% of the Retail market for optical products in the US.

Fig. 13: Barometer of trends among independent eye care professionals

Optical business barometer and OBB 4,0 attitudes: 3,9

3,8

3,7

3,6 2010 3,5 2011 3,4 2012 3,3 2013

3,2

3,1

3,0

Source: Jobson Optical Research

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Encouraged by this healthy start to the year, The Vision Council, a US association of optical product manufacturers and distributors, is optimistic for 2013 for two main reasons: (i) macro-economic data should continue to drive optical product sales and (ii) numerous initiatives by the sector’s key players (e.g. the anti-glare campaign launched by LensCrafters, innovative products marketed by Essilor, etc.) are set to boost the replacement rate in the market. 2.2. The US market is a major catalyst for the stocks we cover The US remains the biggest market for the three stocks in our universe and, as its regular outperformance of the European market since 2007 shows (see table below), it is clearly one of the main growth drivers for our groups, after emerging markets.

Since 2009, Essilor’s organic growth has accelerated constantly in North America, reaching +4% in 2012. This performance was achieved on the back of both volumes and the value effect, with a price/mix enhanced by the latest innovations, particularly Crizal UV. The key contract with LensCrafters for the supply of anti-reflective coating machines for an additional 200 stores provided new impetus at the year-end and should continue to do so in 2013 as the machines are delivered. Finally, the strong performance of the readers business, with more than 80% of sales generated in North America, reflects the vigour of the under-50-dollar sunglasses segment in the US and the success of Essilor’s other key contract with the Dollar General chain.

Luxottica generates 58% of its sales in North America, of which 82% in the Retail activity (LensCrafters and Sunglass Hut being the two main stores), while the Wholesale division contributes the remaining 18%. In the Wholesale business, the sunglasses segment is the main growth driver, as illustrated by the performance of the luxury portfolio (mainly sunglasses) and same-store growth at Sunglass Hut (+10.1% in 2012).

Although 2012 got off to a sluggish start for Safilo in the Americas region (42% of sales, of which ~37% in North America), Q4 saw a more dynamic performance, with same-currency growth of 9.4%, allowing the Italian group to report sales up slightly for the year (+0.5% same-currency in 2012). Solstice, the specialist sunglasses chain, did better with same-currency sales up 5.6%.

Fig. 14: North America continues to drive growth at all groups in the industry

2007 2008 2009 2010 2011 2012 Essilor Europe – LFL 6 2 -3 0 2 3 Essilor North America – LFL 8 5 -0.4 1 4 4 Essilor Readers – LFL N/A N/A N/A 7 5 7 Luxottica – Europe (Wholesale Div) – same-currency 19 11 -6 7 6 3 Luxottica N/A (Wholesale Div) – same-currency 28 57* -3 6 15 15 Safilo Europe – same-currency 9 -4 -17 2 1 25** Safilo Americas – same-currency 10 7 -9 8 8 1 * Impact from the integration of Oakley // ** Impact from the integration of Polaroid Source: Company Data

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2.2.1. Essilor still has extensive untapped potential… In 2012, the global leader in ophthalmic lenses had around 40% of the US market in value terms, slightly below its global market share of around 45%. According to management, this leadership position is not likely to attract the attention of the US competition authorities (FTC) since: (i) the market remains highly fragmented with 500-600 independent players and (ii) Essilor has adopted an open model, whereby newly integrated labs are required to generate at least 20% of their sales with rival brands. Very often, Essilor’s labs are leading clients of Zeiss and/or Hoya. The FTC has clearly realised that the French group has been key to structuring the US market, rather than aiming to close or control it.

The group will therefore continue its quest for market share without making changes to its historic strategy, which combines organic growth with acquisitions. Apart from demographic growth, which should naturally filter through to the optical market, innovation is set to remain a key motor for volume growth (increased replacement rate, benefiting new entrants, etc.) and especially for growth in value terms, since the market stands to benefit from a catch-up effect as it closes the technology gap with other regions.

Acquisitions should not be neglected, because, as shown in the table below, the majority of the 500- 600 independent players are still family-owned. Such companies tend to be willing to join the “Essilor system” for various reasons: (i) they lack the resources to invest in new lab equipment, (ii) their labs stand to benefit from Essilor’s expertise (in terms of sourcing, the supply chain and at the commercial level) and (iii) the family owners can enjoy their new wealth while continuing to work at the labs.

In practice, Essilor often seeks to limit its acquisitions to a majority stake in order to allow the family owners to remain at the helm of their company, with the aim of pursuing its development. This strategy is the best way to guarantee seamless integration and, above all, to ensure that the new addition creates value. Essilor therefore boasts further substantial untapped potential in the US market, thanks to the extensive choice of targets and the technological catch-up involved (value effect).

Fig. 15: Top 10 independent prescription labs

Rx* sales Rx* sales Net sales Name Founded State Owner (USDm) (% of net) (USDm) 1 Walman Optical 1915 Minnesota Employee-owned 111.0 46 240.0 2 Luzerne Optical 1973 Pennsylvania The Dougherty family 32.0 97 33.0 3 Rite-Style Optical 1948 Nebraska The Lee family 24.7 95 26.0 4 US Optical 2008 New York The Cotran family 22.0 100 22.2 5 Digital Eye Lab 2007 New York Optical Distributor Group 20.2 100 20.2 6 Expert Optics 1979 Illinois The Ruden family 20.0 95 21.0 7 Three Rivers Optical 1969 Pennsylvania The Seibert family 17.8 96 18.5 8 Icare Labs 1968 Florida The Payne family 17.4 85 20.5 9 Robertson Optical 1958 Georgia The Robertson family 16.9 96 17.6 10 Classic Optical 1970 Ohio The Friedkin family 16.5 100 16.5 * Rx stands for prescription Source: Vision Monday

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2.2.2. … but so do eyewear groups Luxottica and Safilo The volume growth drivers discussed for Essilor are, of course, set to be the same for Luxottica and Safilo. These two groups should also benefit from several catalysts for value growth: (i) the development of specialised retail (especially for Luxottica), which enhances the price mix thanks to a higher average spend than in mass-market retail, (ii) the penetration of new distribution channels such as department stores and travel retail outlets and (iii) the impact of US consumer education, i.e. encouraging buyers to choose premium or upmarket eyewear brands over cheaper models.

1/ Specialised retail: independent opticians should not be overlooked In terms of glasses frames, the chart below shows that independent opticians have the biggest slice of the market in the over-USD150 price range, which makes up 31% of their sales. Optical chains come next, with 26% of sales in the upscale segment, thanks to their specialised sales staff. Department stores lag behind with just 14%. In our view, this is because their customers are looking for brand- name sunglasses rather than frames for corrective lenses.

There tends to be a correlation between the price of glasses frames and their lenses, such that independent opticians probably generate a substantial share of sales in high value-added lenses. This backs up Essilor’s choice to use independent optometrists and opticians as its main distribution channel (~60-65% of sales in North America). Frame manufacturers such as Luxottica and Safilo have also forged closer relationships with independent players, which provide a distribution channel that complements their optical chains.

Fig. 16: Breakdown of corrective lens sales by distribution channel

6% 12% 14% 26% 24% 31% 27% 29%

52% Price over $150

53% Price $100-$149 32% Price under $100 60% 71% 67%

34% 23% 68% 8%

Drug/Mass Optical chains Department Independent Online Total market stores opticians

Source: VisionWatch, Vision Council

2/ Targeting department stores and travel retail outlets While department stores are already established among customers’ favourite venues for luxury purchases, curiously, accessories and especially sunglasses have so far been sidelined, representing barely 1% of department store sales, versus around 25% for perfume & cosmetics or clothing & apparel. This situation is changing now that manufacturers have made these new distribution channels their prime targets.

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Although Luxottica and Safilo have long been working with these chains (since 1994 for Safilo), the real breakthrough came at the end of 2009 when Luxottica strengthened its exclusive partnership with the Macy’s chain (over 800 department stores throughout the country), opening 430 new Sunglass Hut sales points, on top of the existing 240. Since then, eyewear groups have benefited from a catching-up effect and sunglasses now rank no. 10 in terms of space allocated in department stores, up from the no. 20 position three years ago.

The chains are well aware of the opportunities created by sunglasses: (i) product diversification, (ii) a complementary product range that is more accessible than other luxury segments and enables department stores to attract a new type of clientele and (iii) higher sales per square metre compared with perfumes or clothing, as shown in the chart below. The chart shows that it was a sound decision to allocate these spaces to specialised brands, since sales per square metre have risen from EUR4- 8,000 /m² to EUR18-30,000/m².

Fig. 17: Department stores: sales per m² by product category

Source: Luxottica

Travel Retail, with a global market of EUR49.4bn (of which EUR8bn for accessories), is another important new development area for sunglasses manufacturers. Sunglasses are very popular purchases among the travelling public: light and easy to carry, they have lower price tags than other luxury items and are useful for holidays.

Although Luxottica and Safilo clearly stand to benefit from the global boom in tourism driven by emerging countries, the US is also a strategic market for travel retail since it is the leading market for air travel and home to four of the world’s top 10 airports in terms of passenger traffic (Atlanta, Chicago, Los Angeles and Dallas). The two groups are set to step up openings of SGH (Luxottica) and Solstice (Safilo) airport outlets in the US and worldwide.

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3/ Consumer education: increasing brand awareness via directly-owned stores

Like luxury goods groups, Luxottica and Safilo realised that to increase consumer awareness of their brands, the most effective strategy was to open directly-operated stores under their specialised retail banners. The two groups’ specialised stores are designed and laid out to mirror luxury goods boutiques and have more highly trained sales staff. This enhances the shopping experience and brings it more in line with the exclusive image connected with luxury sunglasses.

Specialised boutiques, particularly those dedicated exclusively to sunglasses such as SGH or Solstice, are becoming favourites with customers shopping for sunglasses. As shown in the chart below, same- store growth for SGH in the US market was higher than its global figure in 2012 (+10.1% vs. +9.8%). Retail sales of sunglasses in this market should therefore remain a major catalyst for the two Italian manufacturers.

Fig. 18: Sunglass Hut same-store growth (US and Worldwide)

4 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12

Sunglass Hut - U.S. Sunglass Hut - Worldwide

Source: Luxottica

With its various specialised stores in the premium/upscale segment (see the table below), Luxottica is better placed than Safilo to tap growth in the sunglasses market. However, given this market’s vast potential, there is plenty of room for both of the leading sunglasses stores, SGH and Solstice.

Fig. 19: Main specialised brand and store networks in North America (31/12/2012)

Luxottica (brand & store network) Safilo (brand & store network)

Sunglass Hut: 1,927 Solstice: 136 Ilori: 21 Oakley: 148 Oliver Peoples: 8 Optical Shop of Aspen: 18 Total: 2,122 Total: 136

Source: Company Data

Consumer Durables

3. Our 2013-2014 forecasts 3.1. A flat Q1 2013 performance for our groups... For several months, investors were indeed aware that Q1 2013 would be a challenging period, in view of very demanding comparison with the year-earlier period, both at Essilor (Q1 2012 sales up 8.5% lfl) and Luxottica (+11.1% lfl). This theme was expected by the market and helped limit profit-taking moves on both shares following their publications, especially since the two groups confirmed their 2013 guidance for sales growth.

Essilor's Q1 earnings affected by exceptional items. In addition to demanding comparison with the year-earlier period that was well identified by the market, the French group suffered from a negative calendar effect (fewer shopping days than in Q1 2012 given that 2012 was a leap year and that Easter fell in April and not in March this year), and (ii) clearly disadvantageous weather conditions in Europe and the US which took a toll on opticians (less footfall in stores) and sales of sunglasses, (readers, polarised and photochromic lenses). The group's deputy CEO Laurent Vacherot, stated that the calendar effect alone dented organic sales growth by 1.9 points, with Q1 sales coming in flat whereas the consensus was forecasting a 1.5% increase.

Q1 sales growth at Luxottica (+5.6% same-currency) in line with estimates. The Italian group nevertheless showed a slight acceleration relative to Q4 2012 (+5.1%) despite identical comparison with the year-earlier periods. As expected, the contribution from the Giorgio Armani licence was very low in Q1 (around EUR13m out of a full-year sales target of EUR130m) since the licence was only launched in early March, although momentum was buoyant for the other brands, especially Oakley which continued to post double-digit growth. Like Essilor, the Retail business was affected by fewer shopping days during the period and disadvantageous weather conditions, as shown by the performance at the sunglass banner Sunglass Hut (+5.5% on a same-store basis vs. +10% in Q4 2012).

Fig. 20: Easier comparison bases as of Q2:

Essilor (organic growth): Luxottica (growth at constant FX):

10 14 8,5 12 11,2 11,1 8 10,0 9,5 6,4 10 9,2 6 8 4,8 7,0 6,7 4,5 4,5 4,4 5,6 4,0 6 4 3,6 5,1

4 2 2 0,0 0 0 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13

Source: Company Data

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3.2. … but the best to come as of Q2 2013!

3.2.1. Essilor: a dual-paced year in 2013 We are still forecasting pure organic growth of 4.7% in 2013. Although this shows a slight decline relative to the 5.2% reported in 2012, it actually masks a dual-paced performance over the year with 1/ low organic growth in Q1 2012 (+0%) and 2/ a gradual acceleration over the coming three quarters as comparison with the year-earlier periods becomes more attractive (average growth of 3.8% in Q2, Q3 and Q4 2012), thereby enabling Essilor to report average organic growth of 5.5-6% over the coming three quarters.

In our view, the group boasts one or more significant catalysts:

(i) Varilux S series: in addition to the successful roll-out of the new progressive lens in Europe, Essilor launched the Varilux S series in Asia and Latin America as of Q1 2013. Note that its distribution in the US is taking longer than expected, due to the technological lag at prescription laboratories (discussed earlier in this report), which do not yet have the suitable equipment for surfacing new generation progressive lenses.

(ii) A rich innovation pipeline: during the conference call on Q1 2013 earnings, management again confirmed that this year would be rich in new launches: Crizal Prevencia (blue anti- light filter), Optifog 2.0 (second-generation of anti-fog lens) and a new range of polarised lenses, Xperio, which is getting off to a strong start.

(iii) Emerging markets: Sales in the four BRIC markets are expected to rise in double digits. The group should also benefit from high growth in new markets recently penetrated, especially Colombia or Turkey.

(iv) Easier comparison with the year-earlier period after Q1: the next three quarters should enjoy fairly beneficial comparison levels since growth in Q2 2012 (+4.8%), Q3 (4%) and Q4 (+2.8%) point to an average of 3.8%, which is even easier than the 5% average quarterly growth reported in 2011.

For 2014, we consider our 5.5% organic growth forecast fairly cautious since it takes account of very poor visibility, especially in Europe. Interestingly, our assumptions for Europe (+1.5%) remain lower than the 2004-2008 average of 4%. Momentum should remain fairly robust for the US and this table also shows that the main source of acceleration is set to stem from emerging markets.

Fig. 21: Organic growth forecasts by region (2010-2014e):

% LFL change 2010 2011 2012 2013e 2014e Europe 0.4 1.9 2.6 1.5 1.5 North America 1.4 3.8 4.0 3.5 4.5 Asia-Pacific & Africa 8.4 13.0 12.3 10.5 11.5 Latin America 16.5 10.4 13.0 8.5 9.0 Total lens & optical instruments 2.4 4.6 5.3 4.5 5.3 Equipment 21.4 18.2 1.4 7.5 7.5 Readers 0.0 1.3 5.9 6.0 6.5 Total Group 3.0 5.0 5.2 4.7 5.5 Source: Company Data; Bryan, Garnier & Co ests.

Consumer Durables

Essilor's margins could widen further in the absence of a strategic acquisition Whereas in recent years, Essilor management's priority was to maintain buoyant sales growth and step up development in emerging markets at the expense of improving operating margin, during the conference call on Q1 2013 earnings, Hubert Sagnières stated that the board of directors was considering allowing an increase in profitability since the integration of acquisitions was going ahead better than expected.

Indeed, we continue to believe that Essilor has the ability to steer changes in its profitability depending on its top-line growth:

(i) In the event of robust sales growth: Essilor can allow itself to post stable EBIT margin by increasing marketing spend and the pace of acquisitions once the group posts sales growth as strong as it was in 2012 (lfl growth of 14.5%, well ahead of medium-term guidance for at least 7%), without counting the positive currency impact (+4.6%), which helped post a 14.8% increase in EPS.

(ii) In the case of "weaker" sales growth: In 2013, lfl sales growth should stand at 8.3% (including changes in the scope of consolidation of 3.6%), although the impact from currencies is likely to be slightly negative. Essilor could therefore stabilise marketing spend as a percentage of sales (as well as operating expenses) in order to slightly increase margins and enable it to maintain double-digit growth in EPS (+10%e).

Consequently, we are maintaining our assumption for a slight increase in EBIT margin in 2013 (+20bp to 18.1%), bearing in mind that this forecast could be at risk in the event of: (i) a strategic acquisition that would have a significant dilutive impact, (ii) a fresh increase in marketing spend as a % of sales in order to accompany the new launches planned for 2013.

3.2.2. Luxottica: Wholesale division in honour For 2013, the Wholesale division houses a large number of catalysts to sales growth, the main one being the launch of the new Giorgio Armani licence. We have factored in sales of EUR90m for the first year, which is more cautious than the full-year target of EUR130m set by management in early March and lower than the sales generated by Safilo from the licence in 2012 (around EUR130-140m also).

Thanks to the production platform in Brazil, Tecnol should also play a significant role in 2013 with the start of production for the Ray-Ban and Oakley collections destined for the Brazilian and South- American markets. This local productions means Luxottica can: (i) improve lead time (thereby favouring orders from opticians), (ii) cut selling prices since the brands will no longer pay customs duty and (iii) reship some of this production to South America, especially to the Multiopticas stores. Tecnol should therefore help improve the local penetration rate and market share of Vogue, Ray-Ban and Oakley.

We have also factored in Alain Mikli (2011 sales of EUR60m). We have assumed that the Alain Mikli brand accounts for half of sales whereas licences (J-P Gaultier and Starck) account for the other half. Finally, Luxottica should continue to make the most of Oakley's international expansion (11.7% of sales vs. 10.8% in 2011) in Europe and emerging markets, with the group set to post further double- digit growth in 2013, as in Q1 2013.

Consumer Durables

As shown by the table below, the own-label brands now account for more than 70% of Luxottica's sales vs. 57% in 2008! This shows: (i) the success of Ray-Ban, which is generally the first brand to set up in a new market, (ii) the global roll-out of Oakely in Europe and in emerging markets (around 12% of 2012 sales) and (iii) the faster unlocking of synergies with the Retail banners. The main advantage lies in minimising the risk of non-renewals of licences, which cost the group dearly in 2003, like Safilo in 2011, both times due to the loss of the Giorgio Armani licence.

Fig. 22: Rising momentum of own-label brands

% of total sales 2008 2009 2010 2011 2012 Ray-Ban 15.8 17.8 19.9 21.7 23.1 Oakley 10.2 11.5 11.9 10.8 11.7 Total Proprietary brands 57.2 64.2 67.6 69.5 70.3 Source: Company Data

In view of the group's guidance for high single-digit growth in same-currency sales, we are maintaining our forecast for an 8.4% increase in 2013.

Luxottica should again post significant operating leverage in 2013 For the fourth year in a row, Luxottica has reiterated its target to increase EBIT twice as quickly as same-currency sales growth, thereby pointing to further high leverage to profitability at the Italian group. Note that in the past three years, Luxottica has reached or exceeded its initial guidance. The sources behind this increase are:

(i) In Wholesale: 1/ Since Tecnol is now integrated and on the point of producing the Ray- Ban and Oakley brands (after Vogue in 2012), the subsidiary is set to boost margins in the division, 2/ Giorgio Armani should also contribute (positive volume and price/mix impact), and 3/ optimisation of industrial facilities, as shown by the table below which highlights uninterrupted productivity gains since 2009.

(ii) In Retail: 1/ Australia-NZ: The Italian group is making the most of the recovery at its main banner OPSM after restructuring work undertaken in 2012, which led to same store sales growth of almost 10% last year. 2/ US: although the margin has been restored to the peak levels seen prior to the 2008 crisis, management confirmed that this could widen further, especially at Sunglass Hut and LensCrafters, 3/ catching-up effect, especially in China, Latin America and the Iberian Peninsula (120 stores taken over in 2012, i.e. the European part of Multiopticas).

Fig. 23: Productivity constantly rising in Luxottica's plants:

2008 2009 2010 2011 2012 Total frames produced (m) 50.1 48.7 56.6 64.5 75.0 % change - -2.8 16.2 14.0 16.3 Number of frames produced daily (000) 207.7 208.0 235.0 263.3 275.5 % change - 0.1 13.0 12.0 4.6 Source: Company Data; Bryan, Garnier & Co ests.

As such, we are forecasting an 80bp widening to 14.7% in 2013, nevertheless following the 90bp improvement seen in 2012.

Consumer Durables

Still robust momentum for 2014

For 2014, we are looking for same-currency sales growth of 7.5% at the group level. In the Wholesale division (+9.5% same-currency), momentum should again be driven by the roll-out of Giorgio Armani and Oakley, as well as the Alain Mikli brand in the prescription segment, which is not particularly well developed on a global scale. We will also watch out for the rising momentum of local collections of Ray-Ban, Oakley and Vogue produced in Brazil by Tecnol since after Brazil, Luxottica should clearly supply other neighbouring markets.

In the Retail segment (+6%), the majority of growth is set to stem from emerging markets, with generalist banners such as Multiopticas in Latin America and LensCrafters in China, but above all SGH, which should continue its development in high growth markets. As an example, in Brazil, SGH already has 25 stores and intends to double the network this year. Note that Brazil is a strategic market for the group (around 4% of sales), especially since the country is preparing to welcome firstly the World Cup football tournament in 2014 and then the summer Olympic Games in Rio de Janeiro in 2016.

We have increased our 2014-15 EBIT estimates by 2% but remain more cautious than the consensus with our 2014 and 2015 figures respectively 3% and 4% lower. Catalysts should be the same as in 2013, namely for the Wholesale segment, the impact of volumes on organic growth, a better price/mix (G. Armani, Alain Mikli, price hikes implemented in 2013) and Tecnol, whereas the Retail division should benefit from: the roll-out of SGH in emerging markets, travel retail and department stores (beneficial regional and distribution mixes) and a catching-up in China. In this backdrop, we are forecasting EBIT margin of 15.3% (+60bp vs. +40bp initially).

Fig. 24: 2010 sales and EBIT margin estimates by business:

EURm 2010 2011 2012 2013e 2014e Wholesale business Net sales 2,236.4 2,456.3 2,773.1 3,110.5 3,406.0 Lfl change (%) 9.1 11.2 10.0 12.2 9.5 EBIT 461.9 529.1 604.5 697.8 783.4 % of sales 20.7 21.5 21.8 22.4 23.0 Change (bp) 250 80 30 60 60 Retail business Net sales 3,561.6 3,766.1 4,313.1 4,571.9 4,850.7 Lfl change (%) 5.9 9.1 5.8 6.0 6.1 EBIT 424.4 436.9 552.7 613.6 669.4 % of sales 11.9 11.6 12.8 13.4 13.8 Change (bp) 40 -30 120 60 40 Intra-group EBIT restatements -174 -159 -175 -180 -191 Group total Net sales 5,798.0 6,222.6 7,086.1 7,682.4 8,256.7 Lfl change (%) 7.1 9.9 7.5 8.4 7.5 EBIT 712.2 807.1 982.0 1,131.4 1,262.0 % of sales 12.3 13.0 13.9 14.7 15.3 Change (bp) 110 70 90 80 60

Source: Company Data; Bryan, Garnier & Co ests.

Consumer Durables

4. Re-rating justified by excellent fundamentals 4.1. Healthy stockmarket performance continuing in 2013 Despite the high share-price gains made in 2012 by Essilor (+39%) and Luxottica (+43%), these healthy performances continued at the start of 2013 driven by higher-than-expected full-year figures and above all, confirmation that 2013 is set to resemble 2012 despite the global slowdown, which was clearly reassuring for investors. As such, the French group's share price has risen by 17% since 1st January 2013, while Luxottica's has gained 34%.

The clear outperformance by the two shares nevertheless provides a downside that plenty of other companies would love to have: namely their valuations, which a number of investors now consider strained. In the short-term, this fact could also prompt the two stocks to underperform their respective indices due to: (i) a risk of disappointment: market expectations were raised at the beginning of the year after 2013 guidance was welcomed by the market, thereby limiting potential in terms of good news, while the groups are not sheltered from a temporary air pocket (re. disadvantageous weather conditions in Q1 2013), despite very low execution risk for both groups, and (ii) possible sector rotation: with a slightly more beneficial market backdrop, investors could be tempted to switch into cyclical stocks in order to find more performance and more beta. We nevertheless believe that these two threats only have a limited impact (see following section).

An alternative for investors: Safilo! Indeed, the global no. 2 and leading rival to Luxottica offers a number of themes sought after by the market: (i) a recovery stock since Safilo's outlook is brightening after several difficult years, (ii) a growth stock, our estimates prompt us to forecast a CAGR in 2012-15 EBIT and EPS of 17.6% and 32.7% respectively and (iii) an attractive valuation in view of 2013 PEG of 0.7x vs. 2.5x for Essilor and 1.7x for Luxottica.

Fig. 25: Stockmarket performances in Consumer sample:

3 months : 6 months : 4 5 NIKE 'B' NIKE 'B' A DIDA S (XET) LUXOTTICA ESSILOR INTL. A DIDA S (XET) LUXOTTICA ESSILOR INTL. HENNES & MA URITZ 'B' SEB INDITEX HENNES & MA URITZ 'B' PUMA ( XET) BOSS (HUGO) (XET) BOSS (HUGO) (XET) PUMA ( XET) BIC INDITEX SEB BIC - 10,0 - 5,0 0,0 5,0 10,0 15,0 20,0 25,0 - 20,0 - 10,0 0,0 10,0 20,0 30,0 40,0

Source: Bryan, Garnier & Co ests. 4.2. Change in EV/EBIT n+1 In our recent sector study of December 2012, we already underscored the re-rating enjoyed by the two global leaders in the Optics market. Indeed, in terms of forward (n+1) EV/EBIT, Essilor was trading at a 17% premium relative to its historical average, whereas the Italian group was valued in line with its historical average.

Consumer Durables

This uptrend has continued since the French group is now trading at a record premium of 24%. As discussed in the previous section, Essilor reported higher-than-expected 2012 earnings and despite disappointing Q1 2013 organic growth (flat vs. consensus forecast for +1.5%), due to exceptional items (negative impact due to fewer shopping days and disadvantageous weather conditions), the share only suffered very limited profit-taking moves.

Fig. 26: Change in n+1 EV/EBIT (2005-2013) at Essilor:

EV/EBIT 1yr forward 2005-13 average

Source: Bryan, Garnier & Co ests.

The re-rating was even higher at Luxottica since the share is currently trading at a 12% premium in terms of forward EV/EBIT, whereas it was trading in line with its historical average last December. These valuation levels remain lower than Essilor's despite a number of joint catalysts (defensive Retail business, increasing weight of emerging markets etc.), as well as specific drivers: exposure to the US market (58% of sales) and higher operating leverage over 2013-15 compared with Essilor (2012-15 CAGR in EBIT of 12% at Luxottica vs. 9.6% for the French group).

Fig. 27: Change in n+1 EV/EBIT (2005-2013) at Luxottica:

EV/EBIT 1yr forward 2005-13 average

Source: Bryan, Garnier & Co ests.

Consumer Durables

Reasons for a lasting premium on these two shares Historically speaking, Essilor and Luxottica were sought after by investors for excellent fundamentals including global leadership, a strategy to conquer market share combining organic growth and acquisitions and strong innovation. These enabled the two groups to widen the gap over their respective rivals and this lead should remain intact.

In our view, the genuinely new theme for the past two years and which is now the focus of the market's attention is that of emerging markets. These are at the root of the acceleration in the global Optics market since they harbour the greatest potential in terms of volumes (demographic growth, urbanisation of populations etc.) and value (training of opticians, catching up trends, emergence of middle classes etc.).

The market is aware that this theme is only just beginning at Luxottica (13% of overall sales, but 23% of Wholesale sales) and Essilor (18% of sales), especially since these exposure levels compare with those of luxury groups (on average 35-40% of sales) and L’Oréal (40% of sales). Consequently, even when a publication is used as a pretext for profit-taking (re. Essilor and Luxottica after their Q1 2013 publication), thr impact remains very limited since the market has a more medium-term perspective for playing rising exposure to emerging markets which should help accelerate organic growth.

Fig. 28: Exposure to emerging markets, 2015 guidance:

Name % of total 2012 sales 2015 guidance Essilor 18 25% Luxottica – Total group 13 ~18-20% o/w Wholesale Division 23 ~27-30%

Source: Company Data, Bryan, Garnier & Co ests

Sector rotation is only a short-term threat: Indeed, the chart below shows that while the Essilor share could temporarily underperform the CAC40 index (as in H2 2012 for example), it performs far better over a long period, even during bullish market periods. Consequently, even if investors revisit cyclical and/or recovery stocks, we do not consider sector rotation a sustainable threat, again in view of robust fundamentals and emerging markets.

Fig. 29: Essilor performance relative to CAC 40 (base 100 = 02/01/2012):

160

Essilor share

140

120 CAC 40 index

100

Source: Datastream

Consumer Durables

4.3. DCF valuation In order to take account: (i) of excellent visibility on coming years thanks to an acceleration in the global Optics market (Essilor and Luxottica are highly likely to renew their guidance for 2013 sales growth in coming years), (ii) fundamentals, which have never been so solid for both groups, especially with a global leadership that has increased over their respective rivals, we have decided to update our five-year beta estimates which were previously more cautious than the market's.

Essilor: Concerning 2013, we are forecasting reported growth of 8.3% including organic growth of 4.7%, slightly below the group's guidance for "at least 5%". We are forecasting slightly faster growth in 2014 and 2015 sales, driven by organic growth (+5.5% in 2014 and +6% in 2015) and recurring structural effects of around 3% until 2015. We have then assumed gradually lower rates until reaching our growth to infinity estimate of 2.5%.

Our theoretical FV of EUR96 is obtained by taking into account EBIT margin to infinity of 18.5% as of 2019. This assumption implies low upside potential in margins even if management recently declared that Essilor could post a slight widening in EBIT margin as of 2013 given the smooth integration of acquisitions.

In view of the slight decrease in our beta from 0.75 to 0.7, we obtain a cost of capital of 7.2% (risk- free rate of 3% and risk premium of 6.1%) and a cost of debt of 3%, pointing to WACC of 7.2%.

Fig. 30: DCF valuation:

EURm 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e Net Sales 5,405 5,871 6,413 6,959 7,550 8,154 8 725 9 248 9 711 10 099 % change 8.3% 8.6% 9.2% 8,5% 8,5% 8,0% 7,0% 6,0% 5,0% 4,0% EBIT 918 1,014 1,114 1,232 1,351 1,484 1,614 1,711 1,796 1,868 EBIT margin (%) 17.0% 17.3% 17.5% 17,7% 17,9% 18,2% 18,5% 18,5% 18,5% 18,5% Income taxes -243 -271 -299 -326 -358 -393 -428 -453 -476 -495 Tax rate (%) 26% 26% 26% 27% 27% 27% 27% 27% 27% 27% Operating profit after taxes 676 744 814 905 993 1,091 1,186 1,258 1,320 1,373 +Depreciations 243 264 289 348 340 367 393 416 437 454 -Change in WCR 80 90 105 49 53 57 61 65 68 71 -Investments in fixed assets 245 265 290 313 340 367 393 416 437 454 Operating cash flow 594 653 708 891 940 1,034 1,125 1,193 1,252 1,303

PV of terminal value 14,133 +PV of future cash flows (2011-20) 6,410 = Enterprise Value 20,543 Net debt (2013e) -68 Other liabilities 359 Minority interest 305 Financial assets 353 Theoretical value of equity 20,163 Number of shares (m) 211 Theoretical FV per share (€) 96

Source: Bryan, Garnier & Co ests

We are therefore reiterating our Buy recommendation and have increased our Fair Value from EUR85 to EUR96, pointing to upside of close to 8%.

Consumer Durables

Luxottica: We are forecasting sales growth of 8.4% in 2013, primarily driven by the launch of the new Giorgio Armani licence and thanks to emerging markets that should be at the root of the high growth expected between 2014 and 2016. Note that the Retail segment also benefits from traditional medium-term and long-term catalysts specific to the global Optics market, namely the ageing population, trading-up trends in emerging markets etc.). As of 2017, we have assumed a gradual decline in our sales growth estimates to reach our growth rate to infinity estimate of 2.5%.

After a further sharp widening in EBIT margin expected in 2013 (+80bp to 14.7%), our estimates for 2014 (+60bp) and 2015 (+40bp) are in line with management's guidance for medium-term growth in EBIT margin of 50-70bp. We have then assumed a normal average EBIT margin of 16% as of 2016.

In view of our new beta assumption (0.75 vs. 0.8 previously), the cost of capital now stands at 7.6% (risk-free rate of 3% and risk premium of 6.1%), and the cost of debt at 4%, pointing to WACC of 7.1%.

Fig. 31: DCF valuation:

EURm 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e Net sales 7,682 8,257 8,876 9,542 10,257 10,975 11,689 12,390 13,010 13,530 % change 8.4% 7.5% 7.5% 7,5% 7,5% 7,0% 6,5% 6,0% 5,0% 4,0% EBIT 1,131 1,262 1,394 1,527 1,641 1,756 1,870 1,982 2,082 2,165 EBIT margin (%) 14.7% 15.3% 15.7% 16,0% 16,0% 16,0% 16,0% 16,0% 16,0% 16,0% Income taxes -366 -412 -463 -511 -550 -588 -627 -664 -697 -725 Tax rate (%) 35.5% 35.0% 35.0% 33,5% 33,5% 33,5% 33,5% 33,5% 33,5% 33,5% Operating profit after taxes 765 850 930 1,015 1,091 1,168 1,244 1,318 1,384 1,440 +Depreciations 379 407 438 477 513 549 584 620 650 677 -Change in WCR 63 60 65 67 72 77 82 87 91 95 -Investments in fixed assets 384 413 399 477 513 549 579 613 644 670 Operating cash flow 698 784 904 948 1,020 1,091 1,168 1,238 1,300 1,352

PV of terminal value 15,274 +PV of future cash flows (2011-20) 7,066 = Enterprise Value 22,339 Net debt (2013e) -1,442 Other liabilities 364 Minority interest 12 Financial assets 170 Theoretical value of equity 20,691 Number of shares (m) 472.7 Theoretical FV per share (€) 44

Source: Bryan, Garnier & Co ests

We are therefore reiterating our Buy recommendation and have raised our Fair Value from EUR41 to EUR44, representing upside of close to 6%.

Consumer Durables

Price Chart and Rating History Essilor

22/5/13 90

40 2010 2011 2012 2013 ESSILOR INTL. Source: Thomson Reuters Datastream

Ratings Target Price Date Ratings Price Date Target price 27/10/08 BUY EUR33.545 01/03/13 EUR85 06/06/08 SELL EUR40.38 16/01/13 EUR80

30/04/07 BUY EUR44.3 04/12/12 EUR78 03/09/12 EUR72 25/04/12 EUR70 20/04/12 EUR67 02/03/12 EUR64 01/03/12 Under review 29/11/11 EUR59

20/04/11 EUR61

Luxottica

22/5/13 45

15 2010 2011 2012 2013 LUXOTTICA Source: Thomson Reuters Datastream Ratings Target Price Date Ratings Price Date Target price 13/10/11 BUY EUR20.35 30/04/13 EUR41 29/09/08 SELL EUR16.56 04/03/13 EUR38

27/06/07 BUY EUR28.58 16/01/13 EUR35 04/12/12 EUR34 09/05/12 EUR31 01/03/12 EUR29 20/01/12 EUR26.5 13/10/11 EUR23 26/10/10 Under review 13/03/09 EUR9 30/10/08 EUR12 29/09/08 EUR17 18/02/08 EUR24 30/10/07 EUR31

27/06/07 EUR33

Consumer Durables

Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a BUY recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to NEUTRAL be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a SELL recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Distribution of stock ratings

BUY ratings 51.4% NEUTRAL ratings 29.7% SELL ratings 18.9% Research Disclosure Legend 1 Bryan Garnier shareholding Bryan Garnier & Co Limited or another company in its group (together, the “Bryan Garnier Group”) has a No in Issuer shareholding that, individually or combined, exceeds 5% of the paid up and issued share capital of a company that is the subject of this Report (the “Issuer”). 2 Issuer shareholding in Bryan The Issuer has a shareholding that exceeds 5% of the paid up and issued share capital of one or more members No Garnier of the Bryan Garnier Group. 3 Financial interest A member of the Bryan Garnier Group holds one or more financial interests in relation to the Issuer which are No significant in relation to this report 4 Market maker or liquidity A member of the Bryan Garnier Group is a market maker or liquidity provider in the securities of the Issuer or No provider in any related derivatives. 5 Lead/co-lead manager In the past twelve months, a member of the Bryan Garnier Group has been lead manager or co-lead manager No of one or more publicly disclosed offers of securities of the Issuer or in any related derivatives. 6 Investment banking A member of the Bryan Garnier Group is or has in the past twelve months been party to an agreement with the No agreement Issuer relating to the provision of investment banking services, or has in that period received payment or been promised payment in respect of such services. 7 Research agreement A member of the Bryan Garnier Group is party to an agreement with the Issuer relating to the production of No this Report. 8 Analyst receipt or purchase The investment analyst or another person involved in the preparation of this Report has received or purchased No of shares in Issuer shares of the Issuer prior to a public offering of those shares. 9 Remuneration of analyst The remuneration of the investment analyst or other persons involved in the preparation of this Report is tied No to investment banking transactions performed by the Bryan Garnier Group. 10 Corporate finance client In the past twelve months a member of the Bryan Garnier Group has been remunerated for providing No corporate finance services to the issuer or may expect to receive or intend to seek remuneration for corporate finance services from the Issuer in the next six months. 11 Analyst has short position The investment analyst or another person involved in the preparation of this Report has a short position in the No securities or derivatives of the Issuer. 12 Analyst has long position The investment analyst or another person involved in the preparation of this Report has a long position in the No securities or derivatives of the Issuer. 13 Bryan Garnier executive is A partner, director, officer, employee or agent of the Bryan Garnier Group, or a member of such person’s No an officer household, is a partner, director, officer or an employee of, or adviser to, the Issuer or one of its parents or subsidiaries. The name of such person or persons is disclosed above. 14 Analyst disclosure The analyst hereby certifies that neither the views expressed in the research, nor the timing of the publication of Yes the research has been influenced by any knowledge of clients positions and that the views expressed in the report accurately reflect his/her personal views about the investment and issuer to which the report relates and that no part of his/her remuneration was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report. 15 Other disclosures Other specific disclosures: Report sent to Issuer to verify factual accuracy (with the recommendation/rating, No price target/spread and summary of conclusions removed).

A copy of the Bryan Garnier & Co Limited conflicts policy in relation to the production of research is available at www.bryangarnier.com

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Important information This independent investment research report (the “Report”) was prepared by Bryan Garnier & Co Limited and is being distributed only to clients of Bryan Garnier & Co Limited (the “Firm”). Bryan Garnier & Co Limited is authorised and regulated by the Financial Services Authority (the “FSA”) and is a member of the London Stock Exchange. This Report is provided for information purposes only and does not constitute an offer, or a solicitation of an offer, to buy or sell relevant securities, including securities mentioned in this Report and options, warrants or rights to or interests in any such securities. This Report is for general circulation to clients of the Firm and as such is not, and should not be construed as, investment advice or a personal recommendation. No account is taken of the investment objectives, financial situation or particular needs of any person. The information and opinions contained in this Report have been compiled from and are based upon generally available information which the Firm believes to be reliable but the accuracy of which cannot be guaranteed. All components and estimates given are statements of the Firm, or an associated company’s, opinion only and no express representation or warranty is given or should be implied from such statements. All opinions expressed in this Report are subject to change without notice. To the fullest extent permitted by law neither the Firm nor any associated company accept any liability whatsoever for any direct or consequential loss arising from the use of this Report. Information may be available to the Firm and/or associated companies which are not reflected in this Report. The Firm or an associated company may have a consulting relationship with a company which is the subject of this Report. This Report may not be reproduced, distributed or published by you for any purpose except with the Firms’ prior written permission. The Firm reserves all rights in relation to this Report. Past performance information contained in this Report is not an indication of future performance. The information in this report has not been audited or verified by an independent party and should not be seen as an indication of returns which might be received by investors. Similarly, where projections, forecasts, targeted or illustrative returns or related statements or expressions of opinion are given (“Forward Looking Information”) they should not be regarded as a guarantee, prediction or definitive statement of fact or probability. Actual events and circumstances are difficult or impossible to predict and will differ from assumptions. A number of factors, in addition to the risk factors stated in this Report, could cause actual results to differ materially from those in any Forward Looking Information. Disclosures specific to clients in the United Kingdom This Report has not been approved by Bryan Garnier & Co Limited for the purposes of section 21 of the Financial Services and Markets Act 2000 because it is being distributed in the United Kingdom only to persons who have been classified by Bryan Garnier & Co Limited as professional clients or eligible counterparties. Any recipient who is not such a person should return the Report to Bryan Garnier & Co Limited immediately and should not rely on it for any purposes whatsoever. Notice to US investors This research report (the “Report”) was prepared by Bryan Garnier & Co. Ltd. for information purposes only. The Report is intended for distribution in the United States to “Major US Institutional Investors” as defined in SEC Rule 15a-6 and may not be furnished to any other person in the United States. Each Major US Institutional Investor which receives a copy of this Report by its acceptance hereof represents and agrees that it shall not distribute or provide this Report to any other person. Any US person that desires to effect transactions in any security discussed in this Report should call or write to our US affiliated broker, Bryan Garnier Securities, LLC. 750 Lexington Avenue, New York NY 10022. Telephone: 1-212-337-7000. This Report is based on information obtained from sources that Bryan Garnier & Co. Ltd. believes to be reliable and, to the best of its knowledge, contains no misleading, untrue or false statements but which it has not independently verified. Neither Bryan Garnier & Co. Ltd. and/or Bryan Garnier Securities LLC make no guarantee, representation or warranty as to its accuracy or completeness. Expressions of opinion herein are subject to change without notice. This Report is not an offer to buy or sell any security. Bryan Garnier Securities, LLC and/or its affiliate, Bryan Garnier & Co. Ltd. may own more than 1% of the securities of the company(ies) which is (are) the subject matter of this Report, may act as a market maker in the securities of the company(ies) discussed herein, may manage or co-manage a public offering of securities for the subject company(ies), may sell such securities to or buy them from customers on a principal basis and may also perform or seek to perform investment banking services for the company(ies). Bryan Garnier Securities, LLC and/or Bryan Garnier & Co. Ltd. are unaware of any actual, material conflict of interest of the research analyst who prepared this Report and are also not aware that the research analyst knew or had reason to know of any actual, material conflict of interest at the time this Report is distributed or made available.