1 Diamond Stock Set To Shine Brightly

Coty (NYSE:COTY) is a company many investors have likely never heard of, even though it owns several extremely well-known brands.

As the parent company of leading beauty and luxury brands, Coty owns subsidiaries such as Gucci, Calvin Klein, Tiffany, Vera Wang, Covergirl and Burberry, to name just a few.

Like many luxury goods companies, Coty share price has been turbulent this year. COTY stock is up 16.1 percent YTD, slightly outpacing the S&P 500’s overall performance of 13.9 percent.

While the S&P has fallen just 4 percent over the last three months, though, Coty has underperformed considerably, dropping over 20 percent.

These drastic share price swings may have investors wondering whether Coty is now undervalued and how much shares of the company’s stock are really worth.

Is Coty a Good Stock to Buy Now?

Looking at Coty’s most recent earnings report, investors will find several positives in the overall financial performance.

Quarterly revenues increased by 16 percent on a year-over-year basis, reaching $1.35 billion. Net income, meanwhile, rose to $29.6 million after a loss of $286 million in the year-ago quarter.

For the full fiscal year, net income skyrocketed from $55.5 million last year to $495 million this year, reflecting a strong business recovery from just a few years prior.

Over the past year, the company has regained what appears to be a solid, sustainable level of profitability. Net margin has improved to 9.2 percent, while gross margin rose to nearly 64 percent. Coty’s return on equity during this period has been a respectable 12.7 percent.

Thanks to improving margins, Coty is expected to enjoy significant forward earnings growth. Over the next five years, analysts project compounded growth of 28.5 percent.

During the coming 12-month period, earnings per share are expected to grow at 26.1 percent. Assuming Coty can achieve these growth numbers, shareholders will likely see very strong returns from the stock over several years.

Top Line Is Topsy Turvy

For all of its appealing aspects, Coty’ revenue growth has been volatile. After going public in 2013, the company’s annual revenues gradually declined from a starting point of $4.65 billion to $4.28 billion in 2015.

By 2017, revenues had spiked dramatically to briefly exceed $9 billion. The turn of the decade, however, once again clipped Coty’s revenues to a low of $4.16 billion in 2020.

For the full year of 2022, Coty’s revenues recovered to $5.27 billion, but the company is still far from regaining the high water mark it achieved prior to the pandemic.

It should be noted that Coty is still executing a new long-term growth strategy that could improve its fundamentals. This strategy, originally outlined in 2021, involves prioritizing prestige brands, cutting costs to improve earnings, accelerating the growth of skincare brands and expanding the use of direct-to-consumer sales channels.

Combined, these efforts are designed to drive Coty’s growth to steady, sustainable levels through and beyond 2025.

Coty Is Saddled with a Good Deal of Debt

A notable risk to Coty shareholders at the moment is its high debt load. With a debt-to-equity ratio of 1.05, Coty is currently carrying more debt than is generally considered healthy for most companies.

This has caused the company to incur higher interest expenses as rates have gradually risen. In the most recent quarter, for instance, Coty paid $72.2 million in interest, compared to just $40.4 million a year ago.

As such, debt reduction will be a key measure of the company’s financial success going forward.

Is Coty Stock Undervalued?

Coty currently trades at a forward P/E ratio of 21.2, a price-to-book ratio of 2.1 and a price-to-sales ratio of 1.5. These ratios are somewhat below the broader market, suggesting Coty may be attractive to bargain hunters.

The company’s low price-to-cash-flow ratio of 9.3, however, may indicate more significant undervaluation. This is especially true in light of the growth rate that analysts expect from Coty’s earnings over the next few years.

So what’s the deal, is Coty stock undervalued? According to 18 analysts, Coty share price is undervalued by 32.8%. In their view, fair value for the stock sits at $12.94 per share. The highest price target for Coty is $15 per share.

Even the lowest price forecast suggests that the stock will reach a target of $10, indicating that Coty currently has much more upside potential than downside potential.

A discounted cash flow analysis using the 28.5 percent growth expected over the next five years and the company’s most recent full-year EPS of $0.57 strongly suggests that the stock is undervalued.

Assuming a discount rate of 10 percent that tracks the historical performance of the S&P 500, Coty shares would have a net present value of around $17.

While it is very likely unwise for investors to assume the best-case scenario of nearly 30 percent growth compounded reliably over five years, DCF analysis provides further support for Coty being undervalued at today’s prices.

Where Will Coty Stock Be in 5 Years?

Using the expected rate of earnings growth, it’s also possible to come up with a rough idea of where Coty shares could be several years from now. Assuming EPS grows at 28.5 percent, Coty would earn roughly $2 per share five years from now. Using a P/E ratio of 20, this would imply a price of about $40.

This, however, is an exceptionally bullish case that requires a very high rate of sustained growth. Using a more modest 15 percent as the compounded rate of earnings growth and making the same P/E assumption, the stock would be worth just under $23 in five years.

This is almost certainly a more realistic view than the bull case presented above, as it leaves room for periods of lower growth and provides investors with a decent margin of safety.

With its growing focus on prestige brands, Coty could also benefit from a winding down of inflationary pressures and renewed economic growth over the coming five years. The recent drop in both Coty shares and the broader luxury goods market may present a buying opportunity, as high-end brands are likely to rebound as the economy gradually improves. Such upward pressure may lend additional support to higher share prices for Coty.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.