INDEPENDENT RESEARCH Optical & Eyewear Sector · Louis Vuitton. sunglasses are located in France and Italy, while American manufacturer . Marchon Eyewear. expanded its Italian manufacturing

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INDEPENDENT RESEARCH Optical & Eyewear Sector 24th June 2015 Confluence of favourable factors in the optical sector!

Optical & Eyewear Sector

ESSILOR BUY FV EUR124 Bloomberg EF FP Reuters ESSI.PA

Price EUR106,25 High/Low 114,9/71,49

Market cap. EUR22,825m Enterprise Val EUR24,419m PE (2015e) 28.0x EV/EBIT (2015e) 19.8x

LUXOTTICA BUY FV EUR63 Bloomberg LUX IM Reuters LUX.MI Price EUR60,15 High/Low 61,85/35,7 Market Cap. EUR28,827m Enterprise Val EUR29,860m PE (2015e) 32.8x EV/EBIT (2015e) 20.6x

SAFILO BUY vs. NEUTRAL FV EUR15

Bloomberg SFL IM Reuters SFLG.MI Price EUR12,91 High/Low 16,35/9,13 Market Cap. EUR810m Enterprise Val EUR946m PE (2015e) 17.9x EV/EBIT (2015e) 10.1x

Price and data as at close of 19th June

We maintain our ‘buy’ rating and our FV for EI (EUR124) and LUX (EUR63), although with a slight preference for EI given its upside potential (+17%). We upgrade SFL from ‘neutral’ to ‘buy’ with an FV of EUR15 as we expect a gradual improvement in the momentum. Of note, 2016e PEG ratios for EI (1.6x) and LUX (1.7x) are more attractive than in June 2014 thanks to accelerated organic growth and, more importantly, currency impact! Despite the impact from Gucci in 2017, SFL exhibits a 2016e PEG ratio of 1.2x.

An exceptionally favourable combination of positive factors in the optical sector! While the companies in our coverage universe already enjoyed excellent fundamentals and the optical sector showed strong structural catalysts, it is now among the major beneficiaries of a weaker euro, as demonstrated by the impact on Q1 sales (LUX: +14.6%, EI: +12.7% and SFL: +9.8%).

2015-2017: almost all the signals are on green for EI and LUX. They intend to step up growth during the period 2014-17 (CAGR: 11.1%e, EI+LUX average) as they own industry leading brands (Ray-Ban, Varilux…), increase marketing expenses to stimulate demand in mature countries, and expand quickly in emerging markets. This growth will be profitable as we expect a 14.8% CAGR (EI+LUX average) over the period, fuelled by operating leverage, productivity gains and by the rising contribution of the sunglasses and online segments for EI.

Safilo: towards more enabling conditions in the coming quarters: Although some projects from the strategic plan for 2020 are painful to implement (e.g. Q1 Asian sales: -23% due to a change in the distribution model), they are key to achieving accelerated sales and margin growth. Q1 negative factors will gradually wear off and the relaunch of Carrera (March 2015) will be a major catalyst. Excluding the impact from Gucci in 2017, our estimates imply 14-17 CAGRs of 8% and 18%, for sales and EBIT, respectively.

M&A: no large transactions ahead in our opinion. Following the failed merger talks between EI and LUX in 2013, we believe the same obstacles still exist (leadership conflicts, great operational complexity, and governance issues at Luxottica), especially as both groups have other significant, less risky medium-term growth drivers. In addition, we do not believe in the acquisition of SFL by EI since the licencing business does not seem to be of interest to EI and since this move would be a declaration of war on LUX. Therefore, we expect smaller acquisitions.

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STOXX EUROPE 600 CONSUMER GDS E STOXX EUROPE 600

23/06/15

Source Thomson Reuters

Analyst: Consumer Analyst Team: Cédric Rossi Nikolaas Faes 33(0) 1 70 36 57 25 Loïc Morvan [email protected] Antoine Parison

Virginie Roumage


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Table of contents 1. State of the global optical market in 2014 .............................................................................. 3

1.1. A market growing at a 4% rate ........................................................................................................ 3 1.2. The sunglasses market is still enjoying strong momentum! ....................................................... 4

1.2.1. The “Made in Italy” label is in good shape! .................................................................... 4

1.2.2. Solid medium-/long-term catalysts .................................................................................. 6

1.2.3. Essilor is also contributing to the premiumisation of the sunglasses segment ....... 10

1.3. Prescription lenses: a slightly more enabling environment ...................................................... 11 1.3.1. Economic conditions are gradually improving ............................................................. 12

1.3.2. Significant increase in marketing expenses to reinvigorate the high-end segment…13

1.3.3. … and the business in mature markets .......................................................................... 13

2. Lessons learned in Q1 15 ........................................................................................................ 15

2.1. US: still the main driver of the sector .......................................................................................... 15 2.2. Europe: the improvement that started in 2014 is taking hold ................................................. 16 2.3. Emerging countries: surprise in Latin America! ......................................................................... 17

3. Our estimates for 2015-17 ...................................................................................................... 19

3.1. Towards solid organic growth in 2015-17 ................................................................................... 19 3.1.1. Essilor’s strategy is firmly in place! ................................................................................. 19

3.1.2. Luxottica: the virtues of vertical integration ................................................................. 21

3.1.3. Safilo: towards profitable and, more importantly, sustainable growth! .................... 24

3.2. Higher profitability for everyone! ................................................................................................. 25 3.2.1. Essilor still has potential for margin improvement ..................................................... 25

3.2.2. Luxottica: operational leverage is still there! ................................................................. 26

3.2.3. Safilo: towards a gradual recovery of profitability........................................................ 27

3.3. A stimulating positive currency impact! ....................................................................................... 29 3.3.1. Revenues: the sector benefits from USD exposure ..................................................... 29

3.3.2. Profitability: transactional impact is an advantage for Luxottica .............................. 30

4. A combination of positive factors propping up stock prices ............................................ 31

4.1. Positive trend in stock prices in H1 15 ........................................................................................ 31 4.2. Current topics ................................................................................................................................... 32

4.2.1. Concerns over the French optical market? ................................................................... 32 4.2.2. M&A: small deals…? ......................................................................................................... 33 4.2.3. M&A: … or large mergers? .............................................................................................. 34

4.3. Valuation-to-growth profile ........................................................................................................... 38 4.4. DCF valuation .................................................................................................................................. 39

Essilor (BUY, FV EUR124) ......................................................................................................... 43

A wider playing field for new opportunities! .......................................................................................... 43 Luxottica (Buy, FV EUR63) ........................................................................................................ 45

All-Star Game Winner ................................................................................................................................ 45 Safilo (BUY vs. Neutral, FV EUR15) ........................................................................................ 46

Towards a more positive momentum ...................................................................................................... 46 Price Chart and Rating History ................................................................................................... 49

Bryan Garnier stock rating system .............................................................................................. 51


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1. State of the global optical market in 2014

1.1. A market growing at a 4% rate Euromonitor estimates that the global optical market grew by 4.2% in 2014 to EUR29.1bn (wholesale value excluding eye surgery equipment). Although this performance is similar to that of 2013, we observed an acceleration in the growth trend of the sunglasses & frame segment, which more than offset the slowdown of the reading glasses segment:

(i) Corrective lenses: in 2014, this segment was up 3% to EUR11.2bn (+2% in 2013). According to our estimates, Essilor continued to gain market share (~44% in value terms vs. 42% in 2013 and ~39% in volume terms vs. 37% in 2013), whereas its two main rivals Hoya (Japan) and Carl Zeiss (Germany) are lagging noticeably behind, with market shares of 13% and 9%, respectively (BG estimates);

(ii) Sunglasses & frames: with growth near 5% to around EUR11.1bn (+4.4% in 2013), this was the strongest segment. Unsurprisingly, the two industry leaders Luxottica (~29% market share excluding the retail business) and Safilo (~10% market share) are lead the way in the segment, recording organic growth of 8.6% and 5.9%, respectively. As discussed in the next section, the “Made in Italy” label performed quite well last year;

(iii) Contact lenses: this segment grew at a similar pace to 2013 (i.e. +5%), with an estimated market size of EUR5.6bn. In view of the strong competitive pressure, value effect was slightly negative but it was offset by higher volumes in the US (~33% of global market) and in the rest of the world, thanks to emerging countries. Market shares for the four main players were broadly stable: Johnson & Johnson Visioncare (~40%), Alcon (~24%), CooperVision (~19%) and Bausch + Lomb (~10%);

(iv) Non-prescription reading glasses (readers): this segment was almost stable in 2014 (+1%) at around EUR1.2bn, while global leader FGX International (a subsidiary of Essilor) suffered the impact of US distributors’ destocking. Despite that, FGXI is still the market leader, with a value market share of 30%.

Fig. 1: Italian eyewear exports (EURm):

Source: Euromonitor

Corrective lenses39%

Frames & sunglasses

38%

Contact lenses19%

Readers4%


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1.2. The sunglasses market is still enjoying strong momentum!

1.2.1. The “Made in Italy” label is in good shape! The Italian National Optical Product Manufacturers’ Association (ANFAO), which gathers Italian industry leaders, recently reported that Italian sunglasses and frame exports increased by 11.8% to over EUR3.1bn in 2014, that is, the best performance since 2010. Individually, sunglasses and frame exports grew at a similar pace, i.e. +11.7% and +12%, respectively.

The graph on the left shows that Europe is still the main destination for these exports, as it accounts for 50% of total exports. It is noteworthy that they increased by 12.7% in spite of last year’s quite unfavourable environment: challenging economic conditions, slowdown in tourist arrivals (strong euro) and poor weather conditions in H2 in Southern Europe. Exports to the US market (23% of total) also went up by 12.7%.

Exports to Asia-Pacific grew by 15%, driven by China (+178%), South Korea (+20.6%) and Japan (27.6%), which demonstrates yet again that the sunglasses & frame segment was not impacted by the slowdown in this region’s luxury market… quite the contrary! Lastly, shipments to Brazil also expanded by double digits (11.7%) despite heavy customs restrictions (duties, goods blocked, etc.).

Italy holds a global market share of 23%, behind China’s 25% and far ahead of the US, which ranks third with ~8%. In the premium/high-end sunglasses & frames segment, Italy enjoys a market share of 70%!

Fig. 2: Italian exports of sunglasses & frames (EURm):

Source: ANFAO

Manufacturers are ramping up production capacities in Italy…

This global leadership is not surprising as four of the five main global manufacturers of designer frames are Italian: 1/ Luxottica (2014 sales: EUR7.6bn including EUR3.2bn from its wholesale business); 2/ Safilo (EUR1.18bn); 3/ De Rigo (EUR375m including EUR222m from its wholesale business); and 4/ Marcolin (EUR360m). Except for Luxottica, which is gradually globalising its production (see elsewhere), other Italian manufacturers, especially De Rigo or Marcolin, tended to increase their production capacities in Italy.

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8709742 239

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2 2102 459

2 6222 782

3 110

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2008 2009 2010 2011 2012 2013 2014

Sunglasses Frames Lenses & Others % change

Destinations for Italian sunglasses & frame exports (2014, as % of total exports):

Source: ANFAO Bryan, Garnier & Co ests.

Five main destinations for sunglasses exports (2014):

Country Share (%)

1 US 25.2

2 France 11.4

3 Spain 6.3

4 UK 5.6

5 Germany 5.4

Source: ANFAO, Bryan, Garnier & Co ests.

Five main destinations for frame exports (2014):

Country Share (%)

1 US 19.2

2 France 17.8

3 Germany 10.5

4 UK 6.5

5 Spain 5.7

Source: ANFAO, Bryan, Garnier & Co ests.

Europe50%

US23%

Asia18%

Latin America6%

RoW3%


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As shown in the next table, foreign players are following the same trend: manufacturing sites for Louis Vuitton sunglasses are located in France and Italy, while American manufacturer Marchon Eyewear expanded its Italian manufacturing site in 2014 in order for part of the Nike, Lacoste and Calvin Klein glasses to be produced in Italy instead of China where all the production came from previously. Due to the constant increase in production costs in China, heightened by the appreciation of the Chinese yuan against the euro, Italy remains competitive.

It should be highlighted that Cartier is the only luxury brand to produce all its glasses in France, at two manufacturing sites: Sucy-en-Brie (Val-de-Marne) and Besançon (Doubs).

Fig. 3: The “Made in Italy” label is a must-have in the designer eyewear market:

Companies/Brands Comments

Luxottica - Six manufacturing facilities (~43% of the global production output)

- LUX is diversifying its manufacturing locations (China, US, Brazil)

Safilo - Three production facilities in Italy (out of a total of 7 plants)

- Insourcing strategy (70% of total production by 2020 vs. 30% in 2014)

De Rigo - De Rigo has carried out a production internalisation process (2 plants) over the recent

years to reinforce the “Made in Italy” label

Marcolin - 2014: opened a new plant in Italy to double Marcolin’s in-house Made in Italy production

capacity

Marchon Eyewear - One production site (Puos d’Alpago) which was extended in 2014

- Started “Made in Italy” lines for Nike, Lacoste and Calvin Klein

Kering Eyewear - From H2 15: AMQ, Bottega Veneta and Saint Laurent (outsourcing in Italy)

- Gucci: manufacturing agreement with Safilo until 2021

Louis Vuitton - Sunglasses are produced in France and Italy

Allison - Main manufacturing site located in Padua (Italy)

Italia Independent - Premium offering is Made in Italy

- Low cost “Eye Eye” brand is “Designed in Italy, Manufactured in China”

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

… while Luxottica is gradually globalising its production

Compared to most competitors, Luxottica has stronger presence in the international market and outside Europe (20% of sales vs. 41% for Safilo for instance) and is growing fast in emerging markets (27% of wholesale sales in 2014 vs. 22% in 2011). As a result, the Italian group has decided to locate its production sites as close as possible to these new markets, the same way as L’Oréal or Essilor have done. In 2014, Italy only represented 43% of total production vs. 85% in 2006, and 47% of total production now comes from emerging markets.

Fig. 4: Breakdown of Luxottica’s production (as a % of total volumes):

2006 2012 2014

Source: Company Data

85

15

Italy China

50

40

73

Italy China & India US Brazil

43 43

10

4

Italy China & India US Brazil


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1.2.2. Solid medium-/long-term catalysts The sunglasses and prescription lens segments have several structural catalysts in common: (i) favourable demographic trend; (ii) increasing penetration rate (e.g. expansion of the retail segment in emerging countries); (iii) awareness campaigns to educate consumers launched by industry players (e.g.: Think About Your Eyes in the US) or by manufacturers, allowing for a gradual move upmarket, especially in emerging countries.

However, the sunglasses segment also has specific growth opportunities, such as: (i) the diversification strategy pursued by luxury groups in order to intensify their presence in the sunglasses segment; (ii) the emergence of the sunglasses segment in emerging countries; and (iii) more and more selective distribution. In view of these catalysts and of the substantial growth potential:

1/ The sunglasses segment is becoming increasingly strategic for luxury groups

Although Kering will have to solve its distribution network (90% of sales from the Gucci licence are made outside the brand’s DOS) and production issues once the manufacturing agreement with Safilo expires (2021), the integration of eyewear operations by the French group shows its growing importance in the luxury market.

Thanks to its “affordable luxury” positioning, the eyewear segment constitutes a true growth opportunity, not only in mature markets where local customers have been affected by the economic crises, but also in emerging countries where the average price for glasses is more in line with the local middle class’s purchasing power.

As shown in the graph on the left, the sunglasses segment grew by 5% at constant currency (cc) in 2014, that is, twice as fast as the global luxury market (+2% at cc) and better than other categories such as accessories (+4% cc, including +3% for leather goods) or ready-to-wear (+2% cc).

This “accessible luxury” positioning is perfectly illustrated in the table below, even for brands at the top of the price pyramid such as Chanel, which sells its cheapest pair of sunglasses at a price 17x lower than its Classic Flap Bag! This gap has widened further in 2015, as the price of sunglasses has remained broadly stable while that of the 2.55 Classic Flap Bag was increased by 20% last March in order to reduce the price differential between Europe and China.

Fig. 5: The affordable luxury positioning is still predominant in the eyewear segment, even at Chanel (Luxottica licence)…:

Product N°5 Eau de Parfum Eyewear Pumps 2.55 Flap Bag

Selling price (EUR) 90 From 250 580 3,400

Source: Chanel, Bryan, Garnier & Co

The situation is quite similar at Dior (Safilo licence), which sells its sunglasses at price 14x lower than its Diorissimo bag model! Nevertheless, in order to preserve the prestige of their brands, Chanel and Dior are imposing rather strict obligations on Luxottica and Safilo: selective points of sale, whose number is periodically reduced, ban on price promotions, etc.

“Think About Your Eyes” in the US: awareness-raising campaign on UV exposure

Source: Think About Your Eyes

Sunglasses outperformed other luxury segments in 2014 (% chg., on a reported basis):

Source: Bain & Co; Bryan, Garnier & Co ests.

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1

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00

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Fig. 6: … or Dior (Safilo licence):

Product Dior J’Adore (50ml) Eyewear Pumps Diorissimo Handbag

Selling price (EUR) 93 From 230 550 From 3,300

Source: Dior, Bryan, Garnier & Co

2/ Emerging countries: strong growth despite a challenging economic environment

In all major emerging markets, the frame & sunglasses segment is truly taking off, fuelled by three major forces:

(i) Development of modern optical distribution: the emergence of a middle class in these markets has allowed for the expansion of “modern” optical distribution (qualified independent opticians, optical chains, etc.). Sufficient purchasing power and a modern distribution network are part of the indispensable ecosystem that Luxottica and Safilo require to sell their predominantly premium/high-end products. Luxottica is also taking advantage of these trends to expand its own brands (e.g. GMO in Latin America, LensCrafters in China, Sunglass Hut in Mexico, Brazil, China, South East Asia, etc.);

(ii) More effective customer segmentation: thanks to their presence dating back several years, they have gained a better understanding of these markets and they are now able to offer products tailored to local requirements (e.g. exclusive product lines for the Chinese or Indian markets, models adapted to the morphology of Asian customers, etc.) and to each distribution channel (opticians, major chains, malls, etc.). Thanks to this refined segmentation, Luxottica and Safilo are achieving distribution gains every year, perking up organic growth;

(iii) Brand-oriented consumers: consumers in emerging countries have a clear appetite for premium and luxury brands and the development of distribution now gives them access to this segment. This virtuous circle is favourable to premiumisation in these emerging markets and drives growth in the premium/luxury segment.

Given these major catalysts, the Latin American optical market is still relatively spared by the negative economic environment, especially in Brazil which should slip into economic recession in 2015 (-1% forecasted by the IMF). The eyewear market is believed to have grown by 5% in the past three years, but Safilo estimates that designer eyewear has grown at a pace 3x higher than unbranded eyewear in the region and that this outperformance should continue in the MT.

This observation is supported by Luxottica’s (+16.8% at cc) and Safilo’s (+23.4%, see graph on the left) Q1 15 performance. In 2015, Brazil is expected to become Luxottica’s 2nd wholesale market! It should be noted that the demand for ophthalmic lenses also remained high as Essilor posted organic growth of 10%, after double-digit growth in 2014 (+10.8%).

The same is true of the Chinese market, which should grow by an 8-10% CAGR during the period 2014-20, despite a slowdown in the Chinese economy. As shown in the graph below, according to Luxottica, the premium/luxury segment should outperform the global market, with a growth rate in excess of 15%, propelled by the catalysts mentioned above. Furthermore, as Luxottica has announced that its wholesale division is starting to address opticians from Tier 2 and Tier 3 cities, the expansion of its distribution network will be a major catalyst in the coming years.

Organic growth for Luxottica and Safilo in Latin America (Q1/15):


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23

0

5

10

15

20

25

Luxottica Safilo


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In Q1 15, Luxottica’s sales went up by over 30%, despite flat same-store sales growth at LensCrafters, which tends to have more stores in Tier 1 cities. Safilo suffered a sales decline in China due to its stronger exposure to Hong Kong and to the fact that its new sales organisation decided in 2014 still requires time to be fully implemented.

Essilor’s three mid-range brands (Bolon: No.1 in the segment; Prosun: No.3 in the segment and Molsion) were very strong in Q1, especially Bolon, whose sales had already increased by 20% in 2014. Essilor is intensifying brand-building efforts through a marketing campaign featuring its new ambassador (French actress Sophie Marceau, who is very famous in China) and its brands are benefiting from its expertise in terms of supply chain to cover the whole Chinese territory.

Fig. 7: Growth estimates for the Chinese market (by segment):

Source: Luxottica

3/ Increasingly specialised distribution is driving the market in value terms

Even though the market shares reported in the graphs below apply to the US sunglasses market, it should be remembered that this market presents many similarities with emerging markets, especially in terms of average price for a pair of sunglasses (~USD38 in 2014). Therefore, the US has a significant growth potential in value terms compared to Europe (average price: ~EUR100), where the increasing proportion of selective distribution pushes up prices.

While specialty retailers (e.g. Sunglass Hut for Luxottica and Solstice for Safilo) only have a market share of 20% in volume terms (see the left graph below), it stands at 45% in value terms due to an average selling price significantly higher than in mass-market distribution channels (USD16-17) which still represent the majority of units sold (60%). It is noteworthy that, since 2012, the market share of specialised distribution has increased by 5pps in volume terms and by 3pps in value terms. During the same period, the value market share of department stores has also increased by 2pps to 16%, which is an indicator that US consumers are trading up, thanks to a more expert sales force.

Fig. 8: Breakdown of the US sunglasses market by distribution channel:

Units sold (%) Retail value (%)

Source: Vision Council

Drug/Mass60%

Sunglass Specialty

20%

Department stores

7%

Optical chains2%

Sport4%

Optical independent

2%

Other5%

Drug/Mass21%

Sunglass Specialty

45%

Department stores16%

Optical chains7%

Sport5%

Optical independent

5%

Other1%

Marketing campaign featuring Sophie Marceau (Bolon’s new ambassador):


Average retail price for a pair of sunglasses in the US (by distribution channel, in USD): Channel ASP ($)

Optical Chains 172

Sunglass Specialty 124

Dpt Stores 122

Mass Merchants 17

Drug Stores 16

Source: Vision Council


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In order to support and promote the premiumisation of this sunglasses segment, manufacturers are gradually increasing their control over distribution, as shown by the strategy pursued by luxury groups. In this process, Luxottica is clearly ahead of its competitors as it engaged in vertical integration as soon as in the 70s. The group owns global leader in sunglasses distribution Sunglass Hut, while Oakley owns 200 stores worldwide and Ray-Ban is due to open the first flagship store in its history in New York in Q3/15. Safilo has a limited presence in sunglasses distribution, with Solstice, which is only present in North America (~130 DOS).

Fig. 9: Towards greater control over the distribution process:

Distribution channel Comments

Wholesale Distribution

LUX:

=> Mitigation of the risk of destocking and further control on wholesale operations

STARS is an inventory management software platform designed to improve sales performance through continuous product assortment, optimised stock levels and automatic stock replenishments - At end-2014, 4,000 stores were served globally and LUX is on track to open 1,400 more in Q2 (o/w ~300 Michael Kors stores)

SFL:

Operational Excellence (to reduce inventory & obsolescence) is one of the main targets within the 2020 Strategic Plan but no specific software as integrated as STARS

In order to favor a higher customer experience, LUX and SFL have increased their penetration into department store chains which already are a reference for other luxury products. LUX: exclusive agreement with Macy’s (SGH corners in ~670 stores in North America), other partnerships with El Corte Inglés (Spain), Edgars (South Africa), etc. SFL:

SGH Store at Macy’s dedicated sales team in the newly Global Commercial structure,

several sales promotions at Harrods (UK) or GUM (Russia) Corner at Harrods (SFL)

Specialised retailing to step up the market premiumisation: purchase experience is improved by a better-trained sales force, exclusivity in certain ranges and products and these stores are often located within major Luxury shopping areas => These factors prompt consumers to buy upscale sunglasses & frames more easily. LUX: SGH is the global leader in speciality sun retailing with over 3,000 stores worldwide SFL:

Sunglass Hut store (LUX) Solstice has approx. 130 stores only in North America, no plans to

open additional stores in other regions Solstice (SFL)

Like luxury groups, directly-operated stores are the ultimate stage in controlling distribution. Flagship stores and DOS are key for transmitting the image in order to elevate the brand’s added value. This also enables the brand to be in control of the full value chain. LUX:

Ray-Ban is expected to open its first ever flagship store in NYC in Q3 15

Oakley was the first eyewear brand to open DOS to display all Oakley-branded products (eyeglasses, apparel, footwear, accessories, etc.). The brand had 214 stores at end March 2015, mostly in the US

SFL:Oakley “O” store

No own retail for its proprietary brands Ray-Ban Flagship store (Q3 15?)

Source: Company Data, Bryan, Garnier & Co


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1.2.3. Essilor is also contributing to the premiumisation of the sunglasses segment

Essilor has completed the integration of several acquisitions made in 2013 and 2014, which were either sunglasses lens manufacturers (Polycore, Intercast, etc.), or brands such as Costa (US) or Bolon (China). The group is thus able to implement a growth strategy similar to that pursued for prescription lenses: 1/ launching the innovation; 2/ building these consumer brands; and 3/ expanding the distribution of its sunglasses collections.

1/ Innovating to intensify the move upmarket

Essilor’s premiumisation strategy is based on three main pillars:

(i) Sharing expertise within the group: Essilor can already build on its very intense R&D efforts in the field of ophthalmic lenses, in particular multicoated lenses. As shown in the graphs below, the added value generated by Essilor thanks to additional treatments (up to 25 coatings according to the right graph), which could be applied to sunglasses lenses: mirror effect thanks to the “e-mirror UV” technology, “Optifog” anti-fog treatment, anti-UV protection, polarising filters, etc. Few manufacturers have the technology and know-how to apply so many coatings to a single lens;

(ii) Developing prescription sunglasses: since only 10% of glasses-wearers own a pair of prescription sunglasses, this segment shows very little penetration! Essilor can build on its experience and expertise in prescription glasses to develop this segment, especially through its two strong brands of polarised lenses: 1/ Xperio, with a high-end positioning; and 2/ Polaroid (licence from Safilo) within the mid-range;

(iii) Improving manufacturing standards: this shift upmarket of the sunglasses range should naturally imply an improvement in the quality of lenses. To do this, Essilor also has the “Made in Italy” label thanks to the acquisition of Intercast in 2013 and to Polinelli (owned by FGX), as well as its expertise in terms of materials (polycarbonate, Trivex, etc.) and the collaboration of its subsidiary Satisloh for the development of new equipment.

Fig. 10: Essilor: innovation and multicoating in order to grow in value terms:

Basic sunlens (4 layers) Advanced sunlens (6 layers) Ultimate Essilor sunlens (up to 25 layers)


2/ Stepping up efforts to build its consumer brands

Whereas Essilor’s two main sunglasses brands enjoy high consumer awareness in their respective markets (85% for Bolon in China and 60% for Costa within the fishing community in the US), Essilor still intends to increase their respective sales capacities:

(i) In-house production of part of the lenses: Costa has taken in-house the whole coating process and the design of prescription sunglasses and Bolon has also taken direct control of


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the production of its sunglasses lenses, which now falls under the responsibility of Polycore. This decision allowed both brands, among other things, to improve manufacturing standards while reducing lead time. Costa has managed to reduce by half the delivery time of prescription sunglasses by bringing in-house design operations;

(ii) Higher marketing expenses: these efforts can be illustrated by the recruitment of ambassadors for all brands in the portfolio (Costa, Bolon with Sophie Marceau, Molsion, Foster Grant, etc.) and by new advertising campaigns. Of the EUR210m to be invested in direct marketing in 2015 at group level, around EUR26m will be spent in the sunglasses segment in order to raise brand awareness and to better educate consumers and encourage them to trade up.

3/ Global rollout of the sunglasses range

As with all acquisitions made by Essilor, each sunglasses brand will benefit from the group’s expertise in terms of supply chain and its global distribution network, creating a significant potential for synergies. The market shares gained by these brands, almost all of which have a mid-range positioning (except Costa, which is more premium), contribute to the growth of the sunglasses segment in value terms:

(i) Portfolio of Chinese brands (Bolon, Prosun and Molsion): these three brands continue to expand in the Chinese market, either by increasing the number of doors or by targeting new customers (e.g. product range for children offered by Prosun). Bolon has even penetrated two new distribution channels: the online channel, which already accounts for around 20% of sales in the sunglasses segment (~10% of Bolon sales) and the Travel Retail segment outside China (Hong Kong, Singapore, South Korea, etc.);

(ii) Costa: the brand, which is positioned in the Sport/Performance segment (like Oakley), was mostly present in the South East US. Since it was acquired by Essilor, Costa has: widened its coverage to the North East and opened new points of sale (especially through sporting goods distributors). The brand is planning on widening its product range in order to target women, and on developing its prescription category (~5% of sales vs. 25-30% for Oakley);

(iii) Foster Grant Signature: although Foster Grant is one of FGXI’s reading glasses brands, the company created a product range called Foster Grant Signature, with a slightly more upscale positioning (mid-range), which was launched in the Indian market with Bollywood actress Sonakshi Sinha as its ambassador. In the future, this brand might be introduced to other emerging countries.

1.3. Prescription lenses: a slightly more enabling environment

According to Essilor, the global ophthalmic optics market grew by 3% in 2014, which implies a slight acceleration compared to 2013 (+2%). While this positive trend is fuelled by the increasing contribution of emerging countries, the situation in mature countries has slightly recovered, especially in North America.

In our opinion, this early recovery can be explained by: (i) gradual improvement in economic conditions; and (ii) substantial acceleration in Essilor’s marketing expenses, which had a positive impact on high-end sales (Varilux, Crizal, etc.).

Prosun brand:


Costa brand:


Foster Grant Signature: this reading glasses brand is penetrating the mid-range market:



12

1.3.1. Economic conditions are gradually improving The US market illustrates the correlation between the economic situation and the sales trend in the optical retail market, as can be seen in the following graph. In 2014, the US optical market grew by 3.8%, propelled in particular by the prescription lenses segment (+5%) and eye examinations (+4.9%).

Even though this positive performance might be the result of the awareness campaigns launched by industry players and of Essilor’s marketing efforts (see next section), we believe they are due first and foremost to the improved indicators in the US economy (GDP, unemployment rate, consumer confidence) which paved the way for an acceleration in the US ophthalmic market.

Fig. 11: GDP growth and retail statistics (% change):

Source: Datastream, Vision Council

Unsurprisingly, this favourable momentum was associated with better confidence among US independent eye care professionals (optometrists, opticians, etc.): since April 2014, the monthly barometer has stood at higher levels than in the previous three years. As highlighted below, the beginning of the year 2015 shows that these positive trends are still there.

Fig. 12: Barometer of confidence among independent eye care professionals (1 = very negative, 3 = neutral and 5 = very positive):

Source: Jobson Optical Research

-15

-10

-5

0

5

10

15

20

25

US GDP Growth US Total Retail Sales Growth US Retail - Corrective Eyeglasses & Contact Lenses

3,0

3,1

3,2

3,3

3,4

3,5

3,6

3,7

3,8

3,9

4,0

2011

2012

2013

2014

2015


13

1.3.2. Significant increase in marketing expenses to reinvigorate the high-end segment…

This trend is especially evident at Essilor, which is expected to spend near EUR210m in direct marketing in 2015, i.e. twice as much as in 2012! This significant increase in marketing efforts, which is mostly funded by the synergies generated by the integration of Transitions, mainly focuses on Essilor’s four major high-end brands:

Fig. 13: Essilor’s four high-added-value brands:

Brand Varilux Crizal Transitions Xperio

Lenses Progressive Lenses Anti-glare Lenses Photochromic Lenses Polarised Lenses

Source: Company Data, Bryan, Garnier & Co

The other objectives of this strategic decision:

(i) To educate consumers: the marketing campaigns launched on a global scale (US, Europe, Brazil, etc.) are aimed at supporting opticians’ sales arguments in order to make consumers aware of the additional benefits of higher-quality optical products. Without such education and/or awareness-raising, it is hard to persuade consumers to trade up;

(ii) To leave more discretion to the consumer in the buying decision: quite often, uneducated glasses-wearers care more about the design and brand of their frame than about the choice of corrective lenses, which is largely left up to the optician. As happens with other consumer goods, the marketing campaigns are designed to encourage consumers to buy Essilor lenses;

(iii) To expand high potential categories: for instance, the low penetration rate of polarised lenses (<20% of total sunglasses lenses) or photochromic lenses (10% of total corrective lenses) require additional marketing expenses. However, since Essilor owns the leading brands, it is well positioned to take advantage of the expansion of these categories.

In 2014, these marketing expenses revived organic growth (see next section) and increased profitability, as the favourable product mix resulting from the growth of these high-added-value brands more than offset the increase in marketing expenses, which encouraged Essilor to further speed up the process in 2015.

1.3.3. … and the business in mature markets The accelerated growth of high-end brands obviously had a positive influence on the performance of Essilor’s two major markets: North America (41% of lens sales) and Europe (33%). Organic growth reported in 2014 in these two regions exceeded the medium-term objectives set by the management, as shown in the graphs on the next page.

In Europe (+0.1%), we estimate that organic growth would have been around 1.4-1.5% had it not been for the negative impact from the loss of the HAL agreement in H2/13. Apart from the entry into force of a new key agreement with Spanish optical retailer General Optica and the successful partnership with Boots (UK), growth in the area was driven by the high-end segment, especially Varilux S series (France, Spain) and the Crizal Prevencia lenses (France, Southern Europe), which offer protection against harmful blue-violet light.

Breakdown of the direct marketing budget for 2015 (by business area, EURm):


2015 Crizal Campaign (UK):


Transitions XTRActive lenses:



14

In North America, all advertising campaigns for the high-added-value brands Varilux S series, Crizal (Prevencia and UV), Transitions and Xperio had a positive impact on their respective turnover, as US consumers were more inclined to trade up due to a more favourable economic environment. Essilor also benefited from the implementation of its partnership with managed vision care company EyeMed (Luxottica) and from the rollout of online distribution. As a result, North American sales reported their best performance since 2008, with 5% organic growth!

Fig. 14: Essilor’s organic growth between 2012 and 2014 (% change):

Europe (MT growth target: 0-1%) North America (MT growth target: 2-3%)

* Excluding the loss of a contract with HAL Source: Company Data, Bryan, Garnier & Co

With a rather premium/high-end positioning, LensCrafters experienced a sequential improvement in same-store sales growth in 2014, as shown in the table below. Although this recovery can be explained by an internal reorganisation (focus on eye examinations, better customer service and purchasing experience, etc.), the brand’s sales were also positively impacted by an increased conversion rate and a greater average basket size.

While traffic was virtually stable in 2014 (slightly positive in Q4), conversion rate went up by 3.8%. It is worth highlighting that during Q4 alone, average basket size rose by 2.6%, suggesting that the enhanced customer experience had a positive influence on the traffic and on the price mix.

Fig. 15: Same-store sales growth for LensCrafters vs. group:

SSSG (%) 2013 Q1 14 Q2 14 Q3 14 Q4 14 2014

LensCrafters 1.0 -1.8 0.9 2.5 6.3 1.8

Group Retail 3.4 1.9 4.8 4.4 5.0 4.0


The GrandVision group, which is the second optical retailer worldwide and has a strong presence in Europe (90% of sales), showed an acceleration in same-store sales growth, both in Continental Europe (G4 = Benelux, France, Spain, UK & Ireland, Germany and Austria) and in the rest of Europe, with +3.7% and +4.1%, respectively.

Nevertheless, most of the Dutch group’s brands have adopted a mid-range positioning, except for Grand Optical, which is a more premium retailer.

2,6

0,5 0,1

1,4 *

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3

2012 2013 2014

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2012 2013 2014

Same-store sales growth for GrandVision in Europe:


0,9 0,6

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2

3

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5

2012 2013 2014

G4 Other Europe


15

2. Lessons learned in Q1 15 In our sample of optical companies, Luxottica was the only player to post an organic growth slightly above market expectations (+7.2% excluding EyeMed impact vs. +6.5%e) thanks to its favourable exposure to the US market (56%), which drove growth both in the wholesale and retail segments.

On the contrary, Essilor (+4% vs. +4.5%e) and Safilo (+0.8% vs. +1.5%e) were affected by one-off factors in Q1: the former’s organic growth was hindered by weak results in its Equipment (-2.1%) and Readers & Sun (+1.8%) divisions whereas a fall in Asian sales (-22.9% at cc) strongly impacted the latter, largely due to changes in trade practices and in the distribution model in that region.

2.1. US: still the main driver of the sector The excellent momentum described in the previous section continued for the three groups, as indicated in the table below. We should add that Safilo and even more so Luxottica (in its Retail Division) benefited from a more favourable comparison base as their Q1 14 US performance had been affected by bad weather conditions. Luxottica also benefited from the launch of its new Michael Kors licence, whose sales have already reached about EUR20m in Q1 vs. annual target of EUR70m.

Essilor’s growth drivers (in the lens segment) have not changed since 2014: (i) high-end products (double-digit growth for Xperio and Crizal, strong growth for Varilux); (ii) independent opticians and optometrists (favourable to high-end products); and (iii) online sales, with a combined sales growth of over 40% for EyeBuyDirect.com and FramesDirect.com. It should also be emphasised that poor performance in the Readers & Sun division, which is due exclusively to the US readers segment, hides two-digit growth for the Costa brand.

Fig. 16: Performance of optical groups in North America:

FX-neutral growth Q1 14 Q2 14 Q3 14 Q4 14 Q1 15

Essilor (LFL) 2.7 5.6 7.1 4.7 4.5

Luxottica * 1.0 4.0 5.3 12.2 6.7

Safilo 0.3 7.7 14.6 14.8 ** 5.3 **

* Wholesale and Retail combined, Adjusted Growth

** Excluding Latin America which is now reported separately


As indicated in the table below, Luxottica’s retail division posted very strong same-store performance, both in optical and sun. Although there was a favourable base effect due to bad weather conditions in the US in Q1 14, the performance of the Italian group’s brands were mainly attributable to an acceleration in the US market. As in Q4 14, LensCrafters’s growth (+5.9%) was driven by an increase in eye examinations and conversion rates. Mid-range brands (Sears Optical and Target Optical) also showed strong growth rates, thanks in particular to Target Optical.

Finally, SGH maintained strong growth (+7.4%), most likely benefiting from Michael Kors’s take-off.

Essilor’s quarterly organic growth (as a %):


Luxottica’s FX-neutral quarterly growth (adjusted for the impact of EyeMed, as a %):


Safilo’s FX-neutral quarterly growth (as a %):


2,4

3,53,9

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Q1 14 Q2 14 Q3 14 Q4 14 Q1 15

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Q1 14 Q2 14 Q3 14 Q4 14 Q1 15

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Q1 14 Q2 14 Q3 14 Q4 14 Q1 15


16

Fig. 17: Luxottica’s brands performed very well:

SSSG Q1 14 Q2 14 Q3 14 Q4 14 Q1 15

LensCrafters (LUX) -1.8 0.9 2.5 6.3 5.9

Licensed brands (LUX) 2.2 3.8 11.3 8.0 10.7

Sunglass Hut US (LUX) 3.3 8.5 6.7 6.0 7.4

Soltice (SFL) -1.6 3.8 5.6 1.6 -1.5


The outlook for 2015 seems positive for everyone. We expect Essilor’s annual growth to normalise during the financial year (+3.5%e vs. +5% in 2014 and +4.5% in Q1 15) and we remain confident in view of the strong catalysts in place (marketing efforts, key contracts, online sales, etc.). The resilience of the US optical market should keep fuelling Luxottica’s growth in the wholesale (guidance: +9-11%) and the retail (SSSG guidance: +3-5%) divisions. Moreover, we believe Safilo will be able to maintain mid-single-digit organic growth, in line with Q1 results.

2.2. Europe: the improvement that started in 2014 is taking hold

Europe (+2.5%) was the main good surprise for Essilor. The acceleration compared to previous quarters can be explained by: (i) the complete disappearance of the impact from the non-renewal of a contract with HAL (H2/13); (ii) the success of high-added-value products in major markets (UK, Spain, Italy and France) supported by advertising campaigns; (iii) the new business organisation based on “Country Managers” for more efficient market coverage (multi-network strategy) and greater adaptability to each country’s specificities; and (iv) key contracts: strong business flow with Boots (UK) and acceleration with General Optica (Spain).

Following a difficult year-end for Luxottica in the Wholesale Division (-8%) due to the transition of some key accounts to the STARS system, recovery started in Q1 (BG ests: mid-single-digit growth) thanks to the group’s three main markets (Italy, Spain, France) as well as Turkey and the UK. Moreover, SGH grew by double digits in the Old Continent, hence Luxottica’s 6.3% sales growth in Q1.

These same markets from Continental Europe also fuelled Safilo’s sales (+2.8%), thus offsetting the near 30% drop in Russia. These trends bode well since these markets are also the main outlets for the Carrera brand, which was relaunched at the end of March. The area also benefits from Polaroid’s good momentum, the upcoming rollout of Smith Optics, and the licences portfolio.

Fig. 18: Performance of optical groups in Europe:


Essilor (LFL) -1 0 0.3 1.0 2.5

Luxottica * 9 8 0.6 -4 6.3

Safilo 3.1 9.5 1.7 -0.1 2.8

* Wholesale and Retail combined


Outlook for 2015: cautious optimism. The performance of optical groups in Europe (including GrandVision) indicates a recovery of consumption in all major markets. This enabling environment should continue to have a positive effect in the coming quarters but the French market should be kept under scrutiny (see page 32)! The entry into force of new reimbursement terms last April 1 could lead opticians (and consumers) to adopt a wait-and-see attitude when it comes to purchase orders, although no group has forecasted a major impact. According to our forecasts, France represents ~9-10% of Essilor’s sales, ~5-6% of Safilo’s and 3-4% of Luxottica’s.


17

2.3. Emerging countries: surprise in Latin America! As previously mentioned, emerging countries are characterised by an optical market in the midst of a major acceleration phase. This allows the groups in our coverage list to record strong results despite slower economic growth in countries like China and, even more so, in Brazil, which is due to slip into recession in 2015. Despite this, Brazil was one of the best-performing markets in Q1 15 for Essilor, Luxottica and Safilo!

Essilor already has a solid footprint in Brazil (~6% of sales) but the group continued to gain market share in Q1. Growth was driven by high-end products but also by the expansion of the Kodak brand in the group’s mid-range segment, which could be an alternative for consumers affected by challenging economic conditions. Thanks to predominantly local production, Essilor strengthened its competitiveness compared to players whose production is based in Asia and which are suffering from the depreciation of the Brazilian real against the Chinese yuan or the US dollar. Mexico and Colombia were buoyant markets.

The appreciation of these two currencies can explain the weakness of Essilor’s export business to Europe and the US (flat growth), and also Japan (~1.5% of sales) since the country is affected by a very high comparison base (anticipatory purchases). These two factors have thus taken a heavy toll on the performance in Asia-Pacific in Q1 as domestic sales in China, India, Russia or Africa have increased by 12%.

Fig. 19: Essilor’s organic growth in Asia-Pacific and Latin America:


Asia-Pacific 9.1 7.9 8.0 8.0 5.6

Latin America 8.9 7.0 13.3 13.7 10.0

* incl. Japan, South Korea and Australia-NZ


In addition to prescription lenses, the sunglasses segment has also strongly increased in Latin America, as demonstrated by Luxottica’s performance (+16.8% at cc). Whereas Brazil will become Luxottica’s No.2 wholesale market in 2015, the Italian group, similarly to Essilor, takes advantage of its Brazilian factory where it produces the brands Vogue, Ray-Ban, Oakley and Arnette, which represent around 50% of sales in volume terms. Moreover, the group will enter two new markets: Colombia and Chile.

These markets are not completely unknown since its optical chain GMO is already present in Chile (~200 DOS) and Colombia (~70 DOS). GMO, which also operates in Peru and Ecuador, recorded same-store growth above 10% in Q1! And Sunglass Hut is in the same situation, driven by Brazil and Mexico.

Safilo is benefiting from its new organisational and business structure implemented in 2014. The management team (based in Miami) became “self-governing” and strengthened the coverage of this region by: improving the supply chain and customer segmentation and expanding distribution. The group showed 23.4% organic growth in Q1 following an increase of about 30% in 2014.

Luxottica’s and Safilo’s growth in Latin America in Q1 15 (at cc, as a %):


17

23

0

5

10

15

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Luxottica Safilo


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Asia-Pacific was affected by exceptional obstacles

The Asia-Pacific market only grew by 6.4% on an organic basis, although in the case of Luxottica this was only due to Australia (SSSG: +1.4%) where the significant decline in optical was offset by double-digit growth in sun. On the contrary, China, India and South East Asia grew by around 10-15% in organic terms, confirming the huge medium-term potential of these markets. It should be noted that the Italian group is preparing its entry in the large Indonesian market (252m inhabitants).

Safilo’s significant drop in sales in the region (-22.9%) was due to three factors:

(i) New distribution model in South Korea (~7% of sales in the region): until now, Safilo operated in the region through a large department store chain, which acted as its agent: all forecasted volumes for the year were thus shipped in Q1. Since Safilo is taking back direct control of this market, shipments will be more-efficiently spread throughout the whole financial year. Thus, following a Q1 affected by a difficult comparison base, this effect should reverse starting in Q2.

(ii) Implementation of new business methods in South East Asia: the reorganisation of the supply chain and IT system at group level entailed the implementation of a pull strategy (attract customers towards the product) and withdrawal from the push strategy (pushing the product towards the customer), which resulted in gaps between shipments. According to the management, this reorganisation should be completed by Q4 15.

(iii) Weakness in Greater China (~40% of sales in Asia-Pacific region): it seems the world No.2 player was more affected by the challenging economic environment in Hong-Kong and Mainland China than Luxottica, especially since Safilo is about to complete its business reorganisation. We believe there will be a gradual improvement in the coming quarters.

The outlook for 2015 seems promising overall! The emergence of the optical market in those countries should help the groups in our coverage universe avoid a too great impact from the economic downturn, especially in the sunglasses segment. We believe the three groups will continue to enjoy an excellent momentum in Latin America; Essilor has even observed an acceleration in Brazil thanks to the launch of advertising campaigns.

Regarding Asia-Pacific, we forecast a sequential acceleration for Essilor (Japan, easier comparison bases) and Luxottica (OPSM restructuration in Australia, acceleration in China, entry in Indonesia) whereas Safilo’s activity should improve as the quarters go by, although we believe this improvement will be slow.

Luxottica’s and Safilo’s growth in Asia-Pacific in Q1 15 (at cc, as a %):


6

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3. Our estimates for 2015-17 The outlook for the two global leaders (Essilor and Luxottica) is very positive as they are best placed to benefit from the structural catalysts in the global optical market and they will enjoy a very significant currency impact given their high exposure to the US dollar and related currencies (Luxottica: ~68% including 55% in USD; Essilor: ~62% including 47% in USD and ~9% in Chinese yuan).

Safilo’s top-line and margin momentum is expected to accelerate in 2017 but it should be remembered that 2017 will be a pivotal year, as the impact of Gucci will need to be kept under control. However, we believe that this risk is adequately factored into the current stock price, following a convincing presentation during the Investor Day last March. In addition, the world No.2 player will benefit from its currency exposure (~45% including ~37% in USD).

3.1. Towards solid organic growth in 2015-17

3.1.1. Essilor’s strategy is firmly in place! In 2013, Essilor made the strategic decision to broaden the scope of its activities by strengthening its sunglasses and e-commerce activities, while stepping up its expansion in emerging countries. This diversification is in addition to the integration of Transitions and the doubling of marketing expenses in order to boost the prescription lens segment.

Fig. 20: The scope of Essilor’s activities has been expanded since 2013:


These growth drivers have contributed to a first acceleration in organic growth in 2014 and, in our opinion, they will have an increasing impact in the medium term:

(i) Sunglasses: the two main growth drivers will be the rollout of the brand portfolio (Costa, Bolon, etc.) and the premiumisation of the product range, with a higher penetration rate for prescription glasses and polarised lenses. Essilor targets a 12% CAGR during the period 2014-18, including 7% from organic growth and the rest resulting from potential acquisitions which would generate an additional EUR100-150m in sales;

(ii) The online channel: the online offering of FramesDirect (premium/high-end) and EyeBuyDirect (mid-range, unbranded frames) is comprehensive and complementary, hence the strong growth in Q1 15 (40%) and in 2014 (+31%). These product lines were supplemented thanks to the integration of Coastal, which offers a wide selection of eyeglasses, sunglasses and contact lenses. In addition to these BtoC websites, Essilor owns the MyOnlineOptical platform, which offers a turnkey virtual store to optometrists/opticians.


20

The two graphs on the left illustrate the huge potential of this distribution channel: even though EyeBuyDirect offers mid-range products, customers tend to buy more often (user-friendliness, 24-hour availability as opposed to physical stores, multiple pairs) and more expensive items than market average;

(iii) Emerging countries (22% of sales): we expect the strong growth in these markets to continue (+21% at cc in 2014), backed by solid fundamentals and by the acquisitions made by Essilor. Last year, the management set a sales target of EUR2.8bn for 2018, implying a CAGR of 22%, which would result in these fast-growing countries accounting for around 34% of group sales in 2018;

(iv) Increase in marketing expenses: these additional resources are necessary to boost the lens business area (to support new product launches, to educate consumers) and to ensure the emergence of the new drivers discussed above. Last April, Essilor’s management announced an increase in its marketing budget, on account of the first tangible signs of acceleration, especially in the high-end segment (EUR210m vs. EUR200m announced in February).

Some of the activities presented below overlap each other, e.g. the online channel, which is present in the group’s whole range of activities (corrective lenses, sunglasses, readers, etc.).

Fig. 21: 2018 target sales by business area:

EURm 2014 % Sales Mix 2018 % Sales Mix 2014-18

CAGR (%)

Clear Lenses (Rx) ~4,200 74 5,800 71 8

Sun (ANN revenue, incl. sun Rx) 690 12 1,100 13 12

Online ~200 4 500 6 26

Other (Equipment, Readers; etc.) ~580 10 800 10 8

Essilor 5,670 - 8,200 - 10


With the growing contribution of the catalysts discussed below, Essilor intends to reach the 6% organic growth mark by 2018. However, our scenario for 2015-17 is more conservative than the group’s, since we anticipate 4.5% organic growth for 2015 (vs. guidance of “at least 4.5%”) and then +5% for 2016 and 2017.

Fig. 22: Contribution of each growth driver until 2018:

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

Potential in value terms: … and spend 2.75x more than market average


Potential in volume terms: EyeBuyDirect customers buy 4.2x more units than market average



21

3.1.2. Luxottica: the virtues of vertical integration It should be pointed out, once again, that this vertical integration process that started in the 70s has been the key to Luxottica’s success: the fact that the group owns 7,000 stores worldwide helps attract the best eyewear licences (Giorgio Armani in 2013, Michael Kors in 2015) as it grants them access to a well-established distribution network.

Meanwhile, the group’s portfolio of strong brands stimulates the traffic and growth in value terms in the retail division. As an example of these wholesale-retail synergies and of this successful vertical integration, Luxottica’s brand portfolio (licenced and proprietary brands) generated almost 89% of the total turnover of frames by the Retail Division in 2014 vs. 77% in 2009! Luxottica is also an inevitable supplier for optical chains and opticians wishing to provide their customers with the best eyewear brands, which should support growth in the wholesale division.

1/ Wholesale Division: the Ray-Ban and Oakley “crown jewels”…

As shown in the following table, the share of proprietary brands increased by almost 13pps between 2008 and the end of 2014, when it accounted for almost 70% of sales! This performance is undeniably driven by Ray-Ban, which is by far the best-selling eyewear brand in the world, with revenues approaching EUR2bn. Ray-Ban is the group’s flagship brand and it is very often the first one to be launched in emerging countries.

Oakley is the No.1 brand in the Sport/Performance category. Double-digit international growth in 2014 (Europe, emerging markets) helped offset lower performance in the US. Consequently, Luxottica’s management decided to: 1/ integrate the wholesale sales force of the US brand with that of the group for the US and Europe regions, which should generate EUR100m in synergies in the medium term; and 2/ renew the management of the retail and apparel divisions in order to reinvigorate them.

For 2015, the management is anticipating 8-10% organic growth for these two brands. We expect an 11% increase at cc for Ray-Ban but we are more conservative regarding Oakley (+7%e) given the business reorganisation in 2015.

Fig. 23: Ray-Ban and Oakley are still gaining ground:

As a % of total sales 2008 2010 2012 2014

Proprietary brands 57.2 67.6 70.3 69.4 o/w Ray-Ban 15.8 19.9 23.1 27.0

o/w Oakley 10.2 11.9 11.7 11.7

Designer brands 42.8 32.4 29.7 30.6


… Strengthened by an attractive licence portfolio

(i) Michael Kors: in our view, the EUR70m sales target for 2015 should be surpassed (BG est.: EUR75m) given its very good start (Q1: EUR20m) made possible by perfect execution. The implementation of the STARS programme (Superior Turn Automatic Replenishment System) in more than 300 stores should allow for quick expansion in 2015 and 2016 (sales estimate: EUR90m);

(ii) Giorgio Armani: this licence should reach revenues of EUR200m at the end of 2015, an increase of almost 25%. G. Armani would represent over 2% of total sales and would almost become the second biggest licence behind Prada (~4% of sales).

Proportion of licences and proprietary brands in Luxottica’s frame & sunglasses retail revenues (as a %):


77%

87% 88% 89%

2009 2012 2013 2014


22

What about the renewal of the Dolce & Gabbana and Burberry licences due to expire in December 2015?

In May, Luxottica signed an agreement with Prada to extend their partnership by seven years until 2025. The Italian brand is Luxottica’s first licence, with a contribution to total sales of 4% (~EUR305m). This announcement, which comes after the extension of the Chanel licence last July, confirms that the risk a non-renewal is still low at Luxottica, thanks to an execution and a distribution network that remain unrivalled in the sector.

Notwithstanding that the contribution of Dolce & Gabbana has declined in the past few years (~2% of total sales, i.e. ~EUR155m in 2014 vs. ~3.1% of total sales in 2011), it is still among Luxottica’s main licences and eyewear is still a strategic activity for the Italian fashion brand in view of its total sales (EUR1.03bn at the end of March 2015). We believe the licence agreement will be renewed.

In 2012, Burberry terminated its fragrance licence agreement with Interparfums, putting an end to a 20-year partnership, in order to take its fragrance operation in-house. Although this precedent might cast a doubt on the fate that awaits the eyewear licence, we are confident that Burberry will renew its partnership with Luxottica, for three main reasons:

(i) Lack of critical size: the eyewear licence (sales: ~EUR75-80m according to our estimates) is much smaller than the fragrance one (EUR235m in 2012) and it clearly lacks critical size to recover the investments required to bring production in-house (to acquire a plant, to implement a distribution network, to hire a significant sales force in order to cover optical chains, etc.);

(ii) Complex supply chain management: the supply chain is much more complex than for the fragrance business, as it requires a perfect mastery of innovation (e.g. new materials for frames such as wood, aluminium, Liteforce, new designs, etc.), production (small-scale for luxury frames and/or larger-scale) and logistics. Luxottica’s vertical integration is, once again, an irrefutable competitive advantage!

(iii) A distribution network to be built: the example of Gucci (Safilo) is compelling: Gucci stores only account for 10% of sales for the eyewear licence, requiring the company to build a massive sales force in order to cover optical chains and opticians. Nevertheless, with wholesale operations in almost 130 countries and, more importantly, with 7 000 DOS, Luxottica has the largest distribution network worldwide.

However, we do not believe the Stella McCartney licence (Kering) will be renewed. It was due to expire in December 2014 but Luxottica has a “sell-off” clause until December 2015 to dispose of its remaining inventory.

Fig. 24: Licences expiring in 2015:

Date of First Agreement

% Of Total Sales

Comments

Burberry 2006 ~1% - Burberry took its fragrance business in-house in 2013 but: it had a

bigger size (sales of EUR235m) than in eyewear and Burberry was

already in charge of product design, packaging and marketing activities

=> Non-renewal risk is low

Dolce & Gabbana 2006 ~2% - Dolce & Gabbana is committed to the eyewear activity but

internalization is highly unlikely => Non-renewal risk is low

Stella McCartney 2009 NS - JV between Ms. Stella McCartney and Kering, this brand is concerned

by Kering’s decision to take its eyewear business in-house

Source: Bryan, Garnier & Co ests.


23

Taking eyewear operations in-house: Kering is not expected to be emulated in the medium term

Kering’s decision to bring its whole eyewear business in-house (EUR350m in total including ~EUR230m for Gucci) will not be easy to implement and implies a series of medium-term challenges for the P&L (loss of EUR50m-worth annual royalties + opex cost inflation) and working capital (the eyewear business requires rather high stock levels due to the need to offer customers a wide selection of products) in addition to those discussed previously. Moreover, most luxury groups are currently faced with slower organic growth, which is putting pressure on profitability (predominance of fixed costs). Therefore, now is not a good time to implement an internalisation strategy, as it requires additional opex.

As a result, we believe that if some brands intend to bring this activity in-house, they will need to see how Kering handles this process and witness the first signs of success (2017-2018) before they decide whether to pursue the same strategy. We still believe that such a reorganisation is only possible for big licences (sales >EUR150-200m) in view of the high levels of investment required.

2/ Retail Division: strong momentum in all geographic areas except Australia

Q1 15 same-store performance for US brands (LC: 5.9% / SGH: +7.4% / Sears and Target: +10.7%) confirms that the US market will remain the main catalyst of the division, especially since it still represents 77% of sales and 65% of the total number of stores in the retail division. It should be remembered that LensCrafters will be subject to an ambitious modernisation plan consisting in renovating all US stores (935) starting at the end of 2015 in order to improve customer service and increase store traffic.

Sunglass Hut, which is the only brand present in all continents, is planning on opening 280 stores in 2015, in particular in emerging countries (China: 30, Indonesia, Thailand, and Mexico). In 2016, scope effect should remain as high as in 2015 as the management’s objective is to have 4 000 DOS at the end of 2016, vs. 2 880 at the end of 2015, allowing SGH to show high single-digit same-store growth and double-digit growth at cc.

As illustrated in the following graphs, the increasing contribution of emerging markets, with Latin America leading the way (10% of total stores vs. 0 in 2009!) is a significant growth driver, since in 2014 and Q1, GMO (optical) and SGH recorded double-digit same-store sales growth! In Asia-Pacific, there is a dichotomy between Asia, where the market is growing fast (China, South East Asia) and Australia, which is suffering due to the optical segment (OPSM). This brand is now subject to a recovery plan which, in our opinion, should follow the example of that implemented by LensCrafters US. To conclude, growth is mostly expected to accelerate in 2016 in the Pacific region.

Fig. 25: Geographic breakdown of the retail network (as a % of global total):

In 2009: In 2014:


North America76%

Asia-Pacific15%

Europe3%

Greater China4%

Africa/Middle-East2%

Latin America0%

Atelier0%

North America65%

Asia-Pacific12%

Europe6%

Greater China4%

Africa/Middle-East3%

Latin America10%

Atelier<1%


24

In 2015, we forecast an organic growth adjusted for the impact from EyeMed of 7.7%, in line with group guidance (“mid to high-single-digit”). In 2016 and 2017, we expect the Italian group to be able to maintain high-single-digit organic growth, driven by exposure to the North American market and the increasing prominence of fast-growing markets in its portfolio. It should be noted that our assumptions do not include sales from the Intel and Google partnerships for the development of smart eyewear.

Fig. 26: Our FX-neutral growth estimates by division (2015-2017):

FX-n sales growth (%) 2013 2014 2015e 2016e 2017e

Wholesale Division 12.0 8.6 10.0 9.0 9.0

Retail Division – Adjusted * - 5.4 6.0 - - Retail Division – Reported 4.7 4.3 4.2 6.4 5.5

Luxottica – Adjusted * - 6.7 7.7 - - Luxottica – Reported 7.5 6.1 6.6 7.5 7.0

*= Before the change in accounting method at EyeMed

Source: Company Data; Bryan, Garnier & Co ests

3.1.3. Safilo: towards profitable and, more importantly, sustainable growth!

The Investor Day that took place in March showed that the management intends to establish sustainable growth for Safilo and to reduce the group’s risk profile through stronger proprietary brands and a more-balanced licence portfolio:

(i) Stronger proprietary brands (2014-20 CAGR: +15%/ BG est.: +13%): through the relaunch of Carrera (March 2015) and the global rollout of Polaroid and Smith Optics (increasing presence in new sports), as shown in the graphs on the left. The increasing contribution of these proprietary brands mechanically minimises the risk of non-renewal and has a positive impact on margins (no royalties or marketing contribution to be paid);

(ii) Higher diversification within the licence portfolio: Gucci, which is by far Safilo’s largest licence (~20.5% of total sales), demonstrates that Safilo should become less dependent on big licences and should give priority to medium-size licences with a strong potential and which were previously under-developed: brands such as Fendi, Givenchy, Jimmy Choo and Céline have a potential to grow by double digits in the next five years and to diversify the risk of non-renewal;

(iii) Geographic expansion: despite a solid footprint in Europe (41%), sales are mainly derived from three markets (Italy, France, Spain) whereas Northern Europe (Germany, UK) still offers significant growth opportunities. So does the US (~38% of sales), although the potential is highest in emerging countries, especially in Asia-Pacific (~17% of sales) and Latin America (4% of sales). Brands wishing to have access to the largest possible distribution network may be more inclined to stick with Safilo’s instead of trying to build one of their own;

(iv) Ensuring perfect execution: execution used to be a major weakness for Safilo, as it prevented the group from truly benefiting from the potential of these large brands and from market growth. The management has decided to put this issue at the top of its priorities by reorganising production (2020 objectives: produce 70% of volume in-house vs. 30% today), IT/supply chain (stock management, production planning, SAP, etc.) and trade practices (especially in Asia in 2015).

2020 sales target for Polaroid:


… Carrera…:


… and Smith Optics…:



25

As demonstrated in the left graph below, proprietary brands will account for 36% of Safilo’s sales in 2018 and 38% in 2020, to be compared with a guidance of 40%. It should also be noted that our sales assumptions for 2020 are slightly more conservative that the group’s objective (EUR1.57bn vs. EUR1.6-1.7bn).

Fig. 27: Breakdown of sales between licences and proprietary brands: Our sales forecasts by channel Two distinct periods over the 2014-2020 period:

Source: Company Data, Bryan, Garnier & Co ests

Between 2006 and 2014, Safilo’s sales constantly fluctuated within the range of EUR1-1.2bn. The progress made on these four major areas for improvement will help Safilo finally break the mark of EUR1.2bn sales in 2015 (BG est.: EUR1.32bn)!

The non-renewal of Kering’s three licences after H1 15 should only have a minor impact on 2015 and 2016 organic growth rates, as confirmed by our estimates below (BG est.: accumulated sales of EUR16m). 2017 will be the most pivotal year as Safilo will have to handle the transition of Gucci from a conventional licence to a manufacturing agreement, resulting in a revenue shortfall of around EUR160m (-12.5pps for the growth of wholesale sales).

Fig. 28: Sales estimates by distribution channel (% change and at cc):

% change 2014 2015e 2016e 2017e

Adjusted * Reported Adjusted * Reported Adjusted ** Reported

Wholesale channel 6.2 6.4 5.7 7.0 6.3 6.5 -6.0

Retail channel 2.6 3.0 3.0 4.0 4.0 4.0 4.0

Total Safilo 5.9 6.2 5.5 6.8 6.1 6.3 -5.3

* Adjusted = excluding the negative impact related to the non-renewal of AMQ, BV and Saint Laurent (H1 15) ** Adjusted = excluding the negative impact related to the Gucci transition


3.2. Higher profitability for everyone!

3.2.1. Essilor still has potential for margin improvement The last financial year showed that the integration of Transitions had an accretive impact of 170bps on Essilor’s contribution margin, thanks to higher profitability (+100bps) and to the series of synergies generated by the acquisition (sourcing, IT, distribution). This accretion more than offset the dilutive impact of Coastal (-50bps) and of bolt-on acquisitions (-20bps) and, more importantly, the increase in marketing expenses (-60bps), hence a 40bp improvement in contribution margin to 18.6%.

75% 72% 71% 65% 64%

25% 28% 29% 35% 36%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2014 2015e 2016e 2017e 2018e

Licences Proprietary brands


26

For the period 2015-2017, we anticipate the following catalysts:

(i) Accelerated organic growth: this will facilitate leverage and economies of scale, especially if 6% organic growth is reached by 2016-18 thanks to the most profitable segments and markets;

(ii) Favourable product mix: the management reported an acceleration in the growth of high-added-value products during Q1 15, driven by marketing efforts, which will mechanically have a positive impact on H1 15 gross margin. This will come in addition to the integration of Transitions and the continuation of synergies;

(iii) Increase in Coastal’s profitability: Coastal reached operational break-even in 2014 (vs. losses in 2013) and operating margin is expected to gradually rise, underpinned by a new business organisation and a supply chain reorganised by Essilor. It should be borne in mind that Essilor is targeting a profitability of 10-12% for the online business by 2018, thanks to operational leverage driven by volume growth (market share gains, wider product and service ranges) and value growth (upscale positioning, higher average basket size compared to offline retailing, etc.);

(iv) Efficiency programmes: every year, Essilor manages to grow its margin by 10-20bps through productivity gains and optimisation of its whole supply chain.

As for the trend of marketing expenses, we expect them to rise (at cc) slightly faster than sales in 2015, which is in line with a top line increase in 2016. Then, the acceleration in Essilor’s organic growth should allow leveraging these expenses starting in 2017. This would place the group in a good position to achieve its EBITDA objective of EUR2bn in 2018 (i.e. EBITDA margin around 24.4%).

Fig. 29: Our margin estimates for Essilor (2015-17):

As a % of sales 2014 * 2015e 2016e 2017e

Gross Margin (%) 58.7 58.7 58.8 58.9

EBITDA Margin 22.8 23.0 23.5 23.8

Contribution Margin 18.6 18.9 19.4 19.7

* Adjusted results


3.2.2. Luxottica: operational leverage is still there! For the 6th year in a row, Luxottica has reiterated its objective to grow its EBIT twice as fast as its sales (at cc), which presages a further positive leverage effect on the profitability of the Italian group, to be associated with a positive currency impact, which we estimate at 20bps for 2015. The four main catalysts are:

(i) Volume effect: driven by strong growth, especially in the wholesale division. During the telephone conference of Q1 15, the management admitted that the utilisation rate of its Italian plants was nearly 100%, yielding significant economies of scale;

(ii) Slightly positive price/mix effect: although price effect remains historically low at Luxottica, it benefits from a favourable product/mix due to the good performance of the luxury brand portfolio, from the move upmarket of the product range (polarised lenses, new materials for the frames, etc.) and in stores (larger average basket size). Besides, the growing contribution of selective channels such as department stores and the travel retail channel)


27

are having a positive effect on the distribution mix, with a higher average basket size and lower capex intensity (= positive impact on group ROCE).

(iii) Efficiency programmes: these optimisation efforts drove LensCrafters’ profitability in 2013 and 2014, and they should continue since these programmes generate savings of EUR50m/year. All brands have implemented such programmes designed to reduce return rates and time-to-market, to increase productivity in labs, etc. This simplification process will apply to the whole supply chain (design, production, distribution, etc.);

(iv) Increasingly global production: emerging countries currently make up 47% of Luxottica’s total production, vs. 15% in 2008! In 2016, this proportion should reach 50%, allowing the group to move its production facilities closer to markets with strong volume growth, hence a positive impact on profitability thanks to more favourable production costs combined with lower operating expenses (logistics, G&A expenses, etc.);

In this context, we forecast a 60bp increase in operating margin to 15.9% in 2015 (+70bps on a reported basis including the impact from EyeMed), and a similar trend in 2016 (+60bps), then a 50bp improvement for 2017.

Fig. 30: Sales and adjusted operating profit estimates for 2015-2017 by division:

EURm 2013 2014 2015e 2016e 2017e

Wholesale Division Net sales 2,991.3 3,193.8 3,704.8 4,038.2 4,401.6 Lfl change (%) 12.0 8.6 10.0 9.0 9.0

Adjusted Operating Profit 658.1 724.5 855.8 953.0 1,056.4 % of sales 22.0 22.7 23.1 23.6 24.0

Retail Division Net sales 4,321.3 4,505.1 * 5,411.2 * 5,702.2 6,015.8 Lfl change (%) 4.7 5.4 6.0 6.4 5.5

Adjusted Operating Profit 585.5 636.3 787.8 861.0 932.4 % of sales 13.5 14.1 14.6 15.1 15.5

Intra-group EBIT restatements -179 -203 -193 -203 -213 Group Total

Net sales 7,312.6 7,698.9 9,115.9 9,740.4 10,417.4 Lfl change (%) 7.5 6.7 7.7 7.5 7.0

Adjusted Operating Profit 1,064.7 1,177.6 1,450.6 1,611.3 1,776.0 % of sales 14.6 15.3 15.9 16.5 17.0

*= Before the change in accounting method at EyeMed


3.2.3. Safilo: towards a gradual recovery of profitability The trend of margin improvement will be largely dependent on the two top line growth phases anticipated in the strategic plan for 2020, that is: implementation and increasing effects of the drivers until 2017, and acceleration during the period 2017-2020. These similar future trends between margin and top line growth are justified by the high contribution of operational leverage to the profitability increase, which will be new for Safilo as its inability to sustainably grow its revenues previously prevented it from taking advantage of this catalyst.


28

Catalysts for the gross margin rate:

(i) Mix improvement: according to the plan, which is aimed at building profitable growth, the management has established a series of performance indicators in order to boost the value of the products and the price-mix (average selling price, focus on highly profitable brands, etc.). Safilo also has to work on its distribution-mix by achieving a better penetration of independent opticians and of selective distribution channels (department stores, Travel Retail);

(ii) Optimisation of production costs…: the gradual transition to in-house production (2020 objective: 70% of total volumes vs. 30% in 2014) will help shorten manufacturing lead time and delivery lead time, reduce sourcing costs and generate efficiency/productivity gains at all stages of production;

(iii) … and supply chain costs: stock management will be made easier by the move to in-house production and the strengthening of IT systems (synchronisation of production schedules, stock management, etc.). Stocks optimisation will help Safilo reduce provisions for impairment, as shown by the negative impact suffered since Q4 14;

Operational leverage will be key to reaching the 14% EBITDA margin target in 2020. It will be made possible by a sales increase of near EUR400-500m during the period, an unprecedented performance in Safilo’s recent history:

(i) SG&A: the share of these items, excluding marketing expenses, should slowly decline (as a percentage of sales) thanks to productivity gains to be achieved by the G&A and back office functions, including in some recently structured subsidiaries (China, Latin America, Middle East). According to Safilo, staff costs should increase half as fast as the top line. Finally, the expansion of some licences combined with the Gucci transition will have an accretive impact on royalty payments;

(ii) Marketing expenses: the increase will be most significant in 2015-16, to support in particular the relaunch of Carrera and the global expansion of Polaroid and Smith Optics. The group is proposing to spend about EUR1.1bn during the period 2015-2020, including 45% in proprietary brands.

Fig. 31: Factors that will have an impact on EBITDA margin (2014-20):


Implementation of IT systems between 2014-20:



29

The table below shows that 2017 will be a pivotal year, with the entry into force of the Strategic Product Partnership Agreement (SPPA) for Gucci. Safilo will keep development, prototyping and production operations, i.e. 30-40% of the value chain, leading to a dilutive impact on the gross margin rate. This impact will be almost entirely offset by a compensation payment of EUR30m from Kering and by the decrease in royalties as Gucci had among the most favourable royalty terms in the sector.

Fig. 32: Our adjusted EBITDA estimates for Safilo (2015-17, as a % of sales):

% of sales 2013 2014 2015e 2016e 2017e

Net revenues 100 100 100 100 100

COGS -39.0 -39.0 -39.0 -38.3 -41.6

Gross Margin 61.0 61.0 61.0 61.7 58.4

Selling & marketing expenses (excl. A&P) -29.5 -29.7 -29.6 -29.3 -28.3

A&P expenses -10.7 -11.0 -11.4 -11.9 -11.5

G&A & other operating costs -13.2 -13.3 -12.8 -12.6 -7.7

Total Operating costs -53.4 -54.0 -53.8 -53.8 -47.5

Adjusted EBITDA margin 10.9 10.0 10.3 10.9 10.9

o/w D&A -3.3 -3.0 -3.1 -3.0 -3.0

Adjusted EBIT margin 7.6 7.0 7.2 7.9 7.9


3.3. A stimulating positive currency impact!

3.3.1. Revenues: the sector benefits from USD exposure The combination of positive factors is exceptionally favourable to the groups included in our coverage universe, which have quite strong organic growth rates despite a still challenging macroeconomic environment, and which will also benefit from the appreciation of the US dollar due to high exposure to this currency and to related currencies, as illustrated in the graphs below.

Fig. 33: Breakdown of 2014 sales by geographic area:

Essilor Luxottica Safilo


Luxottica benefits mainly from its strong exposure to the North American market (56% of sales), while the Australian dollar (~7% of sales) has been almost stable since the beginning of the year. Lastly, its presence in China is still relatively limited (~2% of sales).

While dollar exposure is slightly lower at Essilor (45% of sales), China is now a major sales contributor for the French group (~8-9% of sales) and the Chinese yuan, which virtually mirrors the US dollar, has gone up by 17% since the beginning of the year.

North America

45%

Europe30%

AMEA18%

Latin America7%

NorthAmerica

56%

Europe20%

Asia-Pacific14%

Latin America6%

RoW4%

North America

38%

Europe41%

AMEA17%

Latin America4%


30

Unsurprisingly, Safilo is the player with the lowest exposure to the US dollar (~38% of sales) due to the share of the European market (41% of sales). However, its presence in the Asia-Pacific region (~17%) is broadly similar to Luxottica’s.

As shown in the graph below, currency impact will literally drive sales growth, especially at Luxottica (~64% of total growth), which is also the player with the smallest presence in the old continent. In the case of Essilor, the contribution of currency impact to sales growth was “only” 53% due to a significant scope effect (+5.3%e), as it is the only group to have made acquisitions so far. The situation is almost the same at Safilo, where currency impact accounts for ~54% of total growth.

Fig. 34: Our detailed sales growth estimates for 2015:


3.3.2. Profitability: transactional impact is an advantage for Luxottica Thanks to a slightly higher level of USD-denominated sales (55%) compared to costs (53%), Luxottica will enjoy a positive transactional impact, which will be slightly affected by the appreciation of the Chinese yuan (2% of sales vs. 6% of costs). On the other hand, its hedging strategy differs from that of luxury groups as the Italian group hardly ever uses hedging, thus allowing it to immediately enjoy a positive impact on profitability, as happened in Q1 15 (+20bps). We anticipate a favourable impact of 20bps in 2015.

Even though Safilo also benefits from a transactional impact, the impact on profitability is relatively minor since a +/- 1% change in sales growth results in a 10bp change in EBITDA margin.

Thanks to its natural hedge, Essilor’s profitability is not affected by exchange rate fluctuations and it was the only group in our coverage universe whose margins were not pressured in 2014 when emerging currencies collapsed and the US dollar weakened.

Fig. 35: FX sensitivity on profitability in the optical universe:

Translation effect? Transaction effect? FX Sensitivity on profitability

Essilor Yes No Natural hedging => Very limited impact

Luxottica Yes Yes +/ 10% top line impact from USD => +/- 8 to 9% EPS impact

Safilo Yes Yes +/-1% top line impact => +/- 10bps EBITDA impact


4,5 6,6 5,5

5,3

10,911,8

6,5

20,6

18,4

12,0

0

5

10

15

20

25

Essilor Luxottica Safilo

Organic Growth Scope effect FX


31

4. A combination of positive factors propping up stock prices

4.1. Positive trend in stock prices in H1 15 Driven by excellent fundamentals in the industry and by a positive currency impact, our optical coverage universe has grown by 22% on average on a year-to-date basis, outperforming the DJ Stoxx 600 index by around 9%.

As discussed in the section “Lessons learned from Q1/15”, Luxottica was the only player in our coverage universe to report better-than-expected organic growth and results in Q1 15. This performance, combined with investors’ preference for its strong USD exposure, has resulted in a 32% surge in stock price since the beginning of the year, that is, the best performance in the optical sector and second best in the consumer goods sector as a whole. This suggests relative market efficiency.

The Safilo stock has risen by 20% since the beginning of the year, driven by investors’ appetite for Italian mid-caps and for players who decided to make announcements during the Investor Day last March. Nevertheless, the stock recently corrected (3M: -7.6%) due to renewed concerns over the Greek situation and to worse-than-expected Q1 15 results.

Lastly, the Essilor stock went up by “only” around 15% (vs. CAC40: +13%), despite solid catalysts and a quite favourable currency exposure. We do not consider the valuation to be an issue, especially in today’s momentum market, and it only reflects a slight disappointment in the organic growth performance (+4% vs. CS: +4.5%) despite a growth rate at cc consistent with consensus (+12.7% vs. +12.6%e). Besides, some investors might adopt a wait-and-see attitude regarding the repercussions of the restrictions in reimbursements of optical expenses in the French market (~9-10% of Essilor’s sales).

We view the current levels of the Safilo stock as attractive entry points, so let us take advantage of that! The sharper-than-expected decline in Q1 15 is mainly attributable to exceptional, temporary factors such as the change in the distribution model in Asia, the impact of provisions for impairment of inventories and the absence of operational leverage due to low organic growth (+0.8%). But in our opinion, the sales and margin momentum will become favourable again starting in Q2 thanks to: 1/ the relaunch of Carrera (~10% of sales) initiated in March (=> no impact on Q1); 2/ gradual improvement in Asia, especially in South Korea; 3/ reduced impact of the inventory obsolescence provision on the gross margin rate; and 4/ more positive operational leverage with the acceleration of organic growth. As a result, we upgrade Safilo to a “buy” rating.

Fig. 36: Stock performance in the consumer sector:

3 months: YTD:


SEBNIKE 'B'BICLUXOTTICAINDITEXESSILOR INTL.ADIDAS (XET)

HENNES & MAURITZ 'B'SAFILO GROUPPUMA (XET)

-20,0 -15,0 -10,0 -5,0 0,0 5,0 10,0 15,0 20,0 25,0

LUXOTTICABICSEBINDITEXSAFILO GROUPADIDAS (XET)ESSILOR INTL.

NIKE 'B'HENNES & MAURITZ 'B'PUMA (XET)

-30,0 -20,0 -10,0 0,0 10,0 20,0 30,0 40,0


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4.2. Current topics

4.2.1. Concerns over the French optical market? A decline in volume terms, not in value terms

Several large French optical retail chains such as Optic 2000 or Krys Group have expressed their concerns over the outlook of the French optical market, after the entry into force of new reimbursement terms last April 1 (cf. table below). According to some of them, this market worth around EUR5.8bn, could decline by 20% in 2015 and result in 10 000 job losses in the retail segment.

Optical professionals are not questioning maximum reimbursement limits, which are relatively in line with French market prices as the average price for unifocal lenses was EUR304 (reimbursement limit = EUR320 for lenses + EUR150 for frames = EUR470) whilst the average price for progressive lenses was EUR589 in 2014 (= EUR600 for lenses + EUR150 for frames = EUR750).

Actually, the restriction to one frame renewal per two-year period (instead of 1 year) would be a much biggest problem for retailers. Some chains estimate that annual renewals accounted for 20% of their sales on average, hence their 20% decline forecast for the French market in 2015.

Fig. 37: New maximum reimbursement limits (in force since April 1, 2015):

As a % of total sales Maximum Reimbursement (EUR)

Standard spectacles (frames + lenses) 470 (o/w EUR150 for frames)

Complex lenses (e.g. Progressive lenses) 750 (o/w EUR150 for frames)

Highly complex lenses 850 (o/w EUR150 for frames)


French retailers will be most affected by this paradigm shift!

Although we consider these forecasts to be deliberately exaggerated in order to alert French authorities, they confirm our impression that retailers will be more severely affected by these new regulations than manufacturers:

(i) One of the strongest optician densities worldwide…: 1 optician for every 5 500 inhabitants, vs. 1/6 800 in Germany, 1/8 500 in the UK and even 1/15 000 in the US;

(ii) … and it is still on the rise! In 2014, whereas the optical market only grew by 0.6%, the number of opticians in France rose by 3%, for a total of over 12 000 points of sale;

(iii) Retailers earn most of the margins: according to several experts, a pair of progressive lenses or designer frames, are sold by opticians at a retail price 3x higher than their purchase price.

The implications for Essilor (France: 9-10% of sales)

During the telephone conference of Q1 15, Essilor indicated a good activity level in the French market at the beginning of the year, especially in the high-end segment. According to the group, this positive momentum was due to a new business organisation (Country Managers) and to the success of the latest innovations promoted through advertising campaigns rather than to anticipatory purchases among French consumers.

Apart from this new business organisation, Essilor can benefit from its excellent coverage of the French market (BG est.: ~60-65% market share) thanks to its multi-network strategy.

Number of inhabitants for every optician:

Source: GfK

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

16 000

France Germany UK US


33

In the ophthalmic lenses category, the group’s flagship brand, Varilux, has a high-end positioning while BBGR and Novacel are mid-range brands, with prices 40-50% lower. Shamir also contributes to this extensive footprint. The group is thus able to quickly offer alternative solutions to opticians wishing to launch new mid-range products minimising the portion of the price to borne by the consumers (EUR50-100).

2004: the German precedent: on January 1, 2004, the German social security system put an end to all vision care reimbursements, causing a 15% drop in Essilor’s German sales in H1 04. However, the graph on the left shows substantial anticipatory purchases in the preceding quarters (Q3: +60% in Germany), followed by two negative quarters (Q4 04 and Q1 05) and then a return to normalcy. Of course, we do not forecast such a dramatic scenario in France, which is why it is impossible to forecast whether they will be an anticipatory effect during Q4 14 and Q1 15, but retailers/consumers might adopt a wait-and-see attitude during one or two quarters this year.

The implications for Luxottica (3-4%) and Safilo (5-6% of sales)

Since the new regulations make a distinction between the price of lenses and that of frames, it will be impossible to be reimbursed more than EUR150 per frame, even if the lens price is lower than the maximum reimbursement limit. This might have a negative impact on designer frames, although neither group observed any inflection in the French market as of the end of May.

Luxottica had already prepared for the impact by intensifying average marketing and PR efforts. The management indicated that 60% of the group’s frames were already below the maximum reimbursement limit of EUR150 thanks to three brands: Ray-Ban, Oakley and Vogue Eyewear, Luxottica’s only mid-range brand. Safilo also has the intention to rely on its wide range of brands positioned in the segment EUR90-150, such as Carrera, Marc by Marc Jacobs, BOSS Orange and Tommy Hilfiger and on an increase in marketing expenses.

Both groups’ marketing campaigns revolve around the optical segment and innovation and are designed to educate consumers, or even to talk them into spending beyond the maximum reimbursement limit by informing them of the contributions of the latest technologies (new materials, UV protection, etc.)

4.2.2. M&A: small deals…?

Luxottica: complementing the Atelier division and strengthening the retail segment in emerging markets

After Olivier Peoples and Alain Mikli, Luxottica might try to add a third brand in order to continue its “luxury without royalty” strategy that is accretive to margins, since the Italian group is the sole owner of the brand. The table on the next page shows that there many independent brands with a strong presence in the frame segment and still controlled by their founders, such as Lindberg (Denmark), Cutler and Gross (UK), Gold & Wood (Luxembourg), Bevel (US), Morgenthal Frederics (US) or Robert Mac (US).

Retail: acquisition targets based in Latin America and South East Asia: Luxottica is targeting both optical retail chains (e.g. Multiopticas bought in 2011) and sunglasses retail chains (Mexico and Israël in 2011). Rather than buying based on size criteria, the Italian group gives priority to chains already positioned in the premium/luxury segment since they target the same customer groups as the brands in Luxottica’s portfolio. In our view, these targets will probably have revenues between EUR20-50m each.

Essilor: organic growth trend in Europe (Q1 03 T3 04):

Source: Bryan, Garnier & Co ests

5,3%4,8%

8,4%

10,6%

5,6%

4,6%

1,8%

0%

2%

4%

6%

8%

10%

12%

Q1 03 Q2 03 Q3 03 Q4 03 Q1 04 Q2 04 Q3 04

Anticipated sales

Jan 1, 2004: new reimbursement conditions


34

Safilo: M&A deals might quickly increase the proportion of proprietary brands

During the Investor Day, CEO Luisa Delgado reconfirmed that external growth was an option to achieve the objective of deriving 40% of group sales from proprietary brands by 2020. In our view, such a scenario would be a very positive catalyst for the Safilo stock:

(i) Growing proportion of proprietary brands: as mentioned above, the proportion of licences (~75% of 2014 sales) is a distinctive feature compared to Luxottica (~31%). In our opinion, the acquisition of a brand with ~EUR50m revenues would increase the contribution of proprietary brands to 32%, vs. 29% expected for 2016;

(ii) Accretive impact on Safilo’s profitability: full ownership of its brands allows Safilo not to pay royalties or marketing contributions (5-10% of sales for Luxottica) which may negatively affect profitability in the event of poor performance. This item accounted 8% of sales in 2014 and it varies depending on licences (between 6-14% of sales for Luxottica).

Who are the target brands?

There are still many independent brands with a strong presence in optical frames, which provides the advantage of being less cyclical than the sunglasses business. As shown in the table on the next page, most brands are relatively small (average sales: ~EUR20m) as they tend to have a high-end positioning, with a rather selective distribution network. In view of the most recent transactions in the sector (Alain Mikli and Polaroid with an EV/sales ratio of 1.4x in 2012), we consider the brands presented above to be affordable targets for Safilo, except if Luxottica decides to make higher bids, of course.

Fig. 38: Some examples of independent glasses brands:

Brand Country Est. Sales (EURm)

Comments

Bevel U.S 10-20 High-end eyewear and sunglasses, hand-made in Japan

Cutler & Gross U.K 30-40 Hand-made in Italy (2 plants), production: ~96k frames per year

Gold & Wood Luxembourg 10-20 Production: ~30k per year, very high-end positioning

Lindberg Denmark 60-70 High end eyewear and sunglasses, known for its titanium frames

Morgenthal Frederics U.S 10-20 11 stores, belongs to Luxury Optical Holdings (optical retailer)


4.2.3. M&A: … or large mergers? Essilor + Luxottica? First failed attempt in 2013

Last September, Luxottica’s management admitted that the merger talks initiated with Essilor in early 2013 actually failed due to the great complexity of the merger, disagreement on operational and financial aspects and, most importantly, on governance issues, in particular at Luxottica.

Of course, this merger scenario recently resurfaced in a context of historically low interest rates and huge cash holdings that is favourable to such M&A deals, as shown by recent transactions in many sectors (LafargeHolcim, Shell-BG Group, merger discussions between retailers Ahold and Delhaize, etc.).

Two groups that know each other very well!

Although each one operates in specific segments of the optical market, the two global leaders have the same objective: to promote access to vision care through innovation and high-quality products in order to shift the optical market to more high-end products. Several partnerships have been entered


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into between Essilor and Luxottica (the main ones are listed below) to actually accomplish this task of improving vision care.

In North America, Essilor is the largest lens supplier for Luxottica’s optical chains (principally LensCrafters), Satisloh has delivered anti-reflective coating machines in over 400 LensCrafters stores, where an exclusive “1-hour anti-reflective coating” service is offered, which contributes to a shift upmarket of corrective lenses.

Fig. 39: The three main partnerships between Essilor and Luxottica:

Retail Optical North America Eyebiz EyeMed

Region/Market U.S Australia-NZ U.S

Implications for Essilor

- Essilor is Luxottica’s largest lens

supplier (~30% of total NA lens

purchases)

- Satisloh (Essilor) provided AR coating

machines in over 400 LensCrafters stores

to offer the “1-hour AR coating” service

- Eyebiz is a JV 70%-owned by Essilor

which provides lens manufacturing,

finished lenses and fitting services for

OPSM, the largest optical retailer in A-NZ

- In 2013 EyeMed decided to open its

network to some independent 3’Os which

chose Essilor as their main supplier (lab

services procurement, supply of products)

Estimated sales (EURm) - ~EUR130m (>2% of sales) - ~EUR40-50m (~0.7-0.8% of sales) - N/A but the ramp up of this partnership

is a significant key growth driver

Source: Company Data, Bryan, Garnier & Co ests

Better to stay friends than enter into a bad marriage …

First of all, a business combination between Essilor and Luxottica would only be possible through a merger by absorption (all-stock deal) given their similar market capitalisations. Even though we often comment on how much these groups have in common, we believe the conditions for a merger are not met, at least in the short term:

(i) There is an actual risk of opposition from competition authorities: although Essilor and Luxottica are global leaders in two separate segments (respectively 44% in corrective lenses and 29% in frames & sunglasses), a merger might raise serious concerns among customers, who have to deal with an all-powerful supplier with no real competitors. Even though Essilor has always applied an open economic model (e.g. Essilors’ US labs are often major clients of Zeiss or Hoya), the group has already been faced with antitrust or price-fixing investigations (France, Germany, China). Therefore, we believe that there is a risk of opposition to a merger both from the European Commission and the FTC, as it would create a player with an excessively dominant position in the optical market;

(ii) Each group has sufficient medium-term growth drivers: “mega-mergers” are generally defensive strategies to either generate cost synergies in highly competitive, slow-growth markets (e.g. telecom sector, pharmaceutical sector in the early 2000s, etc.) or to better withstand the pressure from customers and suppliers (e.g. recent business combinations of several “purchasing hubs” in the retail sector). But Essilor and Luxottica are clearly not operating in such an environment, especially since the optical market has several strong structural catalysts, as confirmed by their ambitious medium-term objectives: Essilor has set a sales target of EUR8.2bn for 2018 (2014-18 CAGR: +10%) and an EBITDA target of


36

EUR2bn (CAGR: +11%) whereas Luxottica is planning on doubling its revenues in the decade to come (2014-24 CAGR: +7%);

(iii) A leadership conflict? In the past few years, the governance of the two groups was strengthened: Essilor now has a 27-member Executive Committee (vs. 18 in 2008) headed by Chairman and CEO Hubert Sagnières and by three COOs (Paul du Saillant, Laurent Vacherot and Jean Carrier since 2014), while in H2 14, Luxottica decided to appoint two co-CEOs (Adil Mehboob-Khan and Massimo Vian). The operational performance of each group shows that they managed to attract the most talented profiles in this industry. However, appointments in newcos are quite complicated, as shown by the failed Publicis-Omnicom merger and by the difficult negotiations between Lafarge and Holcim. The Luxottica-Essilor newco might thus be faced with the same problems and with a risk of talent flight. We even believe this leadership issue might have been one of the reasons why merger discussions failed over two years ago;

(iv) Two difficult-to-combine organisations: the excellent management of the supply chain is one of the keys to Essilor’s and Luxottica’s leadership, as they constantly work on improving it (reduction in lead time, complexity reduction, productivity gains, etc.). Although some synergies are likely in IT systems, we do not believe the two groups’ logistics chains could be combined as different logistics chains are required for corrective and sunglasses lenses. Essilor has even kept its sunglasses business separated from its other activities (3 dedicated plants for sunglasses manufacturing). In our opinion, the same might happen with sales teams as they might remain independent resulting in lower SG&A synergies;

(v) Luxottica’s governance: this was the stumbling block during the 2013 merger talks as we are certain the Chairman and founder of Luxottica (Mr Del Vecchio) was not prepared to relinquish control, especially since the Delfin family holding company, owning a 61.4% stake, was being subject to a capital reorganisation completed at the end of 2014, with Mr Del Vecchio now controlling 25% of Delfin (but having the whole “usufruct”, i.e. 100% of voting rights) and each of his 6 children controlling 12.5% (+ bare-ownership of the shares). Although this new capital structure leaves Mr Del Vecchio with a blocking minority (see elsewhere), we still believe he is determined to retain control, as shown by the failed placement in September 2012 (3.8% vs. initial estimate of 7%) and even by the direct purchase of 813 500 shares from Mr Guerra. Consequently, we do not think that Mr Del Vecchio will want to resume discussions with Essilor in the medium term.

Since governance is a key issue for Luxottica, we attempted to calculate what would be Delfin’s stake in the newco resulting from the merger, based on the following assumptions:

Merger initiated by Luxottica: since Delfin has a majority stake in Luxottica, which has higher EV than Essilor, we believe Luxottica will be the one make a bid to acquire Essilor’s shares;

No merger premium: the calculation of the relative value and exchange ratios was made assuming no premium payment and before potential synergies.

Essilor’s shareholding structure (as of December 31, 2014):


Luxottica shareholding structure (as of April 30, 2015):


Free Float89,8%

Essilor employees

8,4%

Treasury shares1,8%

Delfin61,4%

Mr Giorgio Armani

4,7%Treasury

shares0,7%

Free Float33,3%


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Fig. 40: Calculation of the relative value and exchange ratios (stock price as of 19 June 2015):

Market Cap (EURm) Share Price (EUR) # of shares (m) 2015e P/E

Luxottica 28,827 60 479.2 28.0

Essilor 22,825 106 214.8 32.8

Newco “LUX + EI”

Relative weight (x) 0.8

Economic interest (LUX) 56%

Economic interest (EI) 44%

Merger Parity (x) 1.8

Amount of shares (m) 859 => 379m new shares


As can be seen in table below, the payment of a merger premium to Essilor’s shareholders would mechanically change the relative value ratio of the two ground and, as a consequence, the exchange ratio, resulting in a dilutive impact on Delfin’s stake in the newco.

Fig. 41: It is not in Delfin’s best interest to grant a merger premium:

Premium on Essilor share (%)

Economic interest (LUX/EI)

Merger Parity (x)

“LUX + EI” # of shares (m)

Delfin’s stake in “LUX + EI” (%)

0% 56/44 1.8 859 34.2 5% 55/45 1.9 878 33.5

10% 53/47 1.9 897 32.8

15% 52/48 2.0 916 32.1


Essilor + Safilo? Very unlikely in our opinion

In the sunglasses category, Essilor’s objective is to achieve EUR1.1bn sales by 2018 (2014-18 CAGR: 12%), including 7% organic growth and about EUR100-150m coming from acquisitions. Although acquiring the world No.2 player would help Essilor exceed this objective as soon as in 2015 and gain expertise in the field of frame manufacturing. However, we believe there are four major obstacles to this deal:

(i) The group is focused on its strategic plan for 2018: Essilor is currently deploying considerable financial and human resources to prop up its corrective lens segment, expand the group’s new brands (Transitions, Costa, Bolon, etc.), and develop its online business. We do not believe that Essilor would have the capacity to immediately “digest” Safilo, especially as it operates in a field where Essilor does not: licence management;

(ii) Essilor seems to have no interest in the licencing business: the management has often stated it has no interest in the licencing business. Recent acquisitions (51% stake in Transitions, Costa, Bolon, etc.) confirm that Essilor’s prefers to have complete control of its brands in order to subject them to its growth strategy (brand building, internationalisation, etc.). The licence activity does not give so much latitude as a collaboration with the licensor is required in many aspects (design, positioning, image, scope of distribution) and the risk of non-renewal is a sword of Damocles;

(iii) Direct competition with Luxottica: so far, the two global leaders have carefully avoided direct competition and, as mentioned earlier, they have partnerships in many areas, which would automatically be called into question if Essilor bought Safilo;


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(iv) Net gearing level: according to our estimates, Essilor’s net debt level should stand at ~EUR1.6bn at the end 2015 (net gearing of 28%). We believe the group will refrain from making further large acquisitions so as to keep its debt level under control while continuing its bolt-on acquisition and brand policy to complement its portfolio.

4.3. Valuation-to-growth profile Given stock performance since the beginning of the year, valuations multiples for our coverage universe seem pessimistic at first glance. However, in view of the solid catalysts is the optical market and the growth profile of our sample, it seems more appropriate to monitor the trend in their EV/EBIT to growth ratio.

Yet, as can be seen in the following table, current levels are more attractive than those of June 2014 as we have raised our estimates to reflect better growth prospects, fuelled in particular by a quite favourable foreign exchange environment. It should be stated that most of our forecasts are more conservative than consensus estimates for the three groups.

This is the case, in particular, for Luxottica and Essilor, with EBIT CAGRs of 15.3% and 14.2%, respectively, during the period 2014-17. Regarding Safilo, its valuation to growth ratio is slightly less attractive than last year since the EBIT CAGR includes financial year 2017, which will be characterised by a negative impact from the transition of the Gucci licence. However, the global No.2 still offers the best valuation-to-growth profile, with an EV/EBIT-to-growth ratio of 0.7x for 2016 vs. 1.2x for Essilor and Luxottica.

Fig. 42: Table of EV/EBIT-to-growth ratios for the optical sector:

Companies Market Cap

(EURm) 2015e EV/EBIT

(x) 2016e EV/EBIT

(x) EBIT CAGR EV/EBIT to growth EV/EBIT to growth

2014-2017e (%) 2015e (x) 2016e (x)

Essilor * 22,825 19.8 17.7 14.2 1.4 1.2

Luxottica 28,827 20.6 18.2 15.3 1.3 1.2

Safilo 810 10.1 8.3 11.5 0.9 0.7

* Adjusted EBIT Source: Bryan, Garnier & Co ests

This strong EBIT growth will mechanically drive EPS for the groups in our coverage list during the period 2014-17, as illustrated in the table below. Essilor and Luxottica still have relatively-attractive PEG ratios, and all the more so as execution risk is quite low for these two groups. Even though Safilo’s PEG ratio is higher than last year’s due to the impact of Gucci, it is again the lowest in the sector, with 1.2x (2016) compared to 1.6x for Essilor and 1.7x for Luxottica.

Fig. 43: Table of PEG ratios for the optical sector:

Companies Market Cap

(EURm) 2015e P/E

(x) 2016e P/E

(x) EPS CAGR PEG ratio PEG ratio

2014-2017e (%) 2015e (x) 2016e (x)

Essilor * 22,825 28.0 25.1 15.7 1.8 1.6

Luxottica * 28,827 32.8 28.9 17.1 1.9 1.7

Safilo * 810 17.9 13.2 10.9 1.6 1.2

* Adjusted EPS Source: Bryan, Garnier & Co ests

EV/EBIT-to-growth ratio for the optical sector in June 2014 (2013-16e CAGR):

EV/EBIT

to growth 2014e

EV/EBIT to growth

2015e

Essilor 1.6 1.3

Luxottica 1.7 1.5

Safilo 0.7 0.6


PEG ratios as of June 2014 (2013-16e CAGR):

PEG ratio 2014e

PEG ratio 2015e

Essilor 2.7 2.4

Luxottica 2.2 2.0

Safilo 0.8 0.6



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Why the interest in Safilo now?

Although the implementation of the new strategic plan for 2020 generates some bumps, as shown by the negative impact on Q1 15 sales (Asia-Pacific: -23% cc) caused by the implementation of a new distribution model in Asia, we are confident that the momentum will become more favourable again and will gradually accelerate in the next quarters:

(i) At sales level: the relaunch of Carrera (~10% of sales) that was initiated in March should have a favourable effect starting in Q2. The advertising campaigns for Polaroid and Smith Optics should also generate growth, despite the non-renewal of licences for three Kering brands (sales: ~EUR16m) after H1 15;

(ii) At margin level: stronger organic growth, a gradually smaller impact from the provision for impairment of inventories and a more favourable cost phasing from Q2 will result in a slight increase in EBITDA margin in 2015 (+20bps to 10.2%);

(iii) Current stock prices are good entry points: despite an increase of more than 20% on a year-to-date basis, the stock has dropped 15% from its annual high following Q1 results and concerns over the Greek crisis. Considering Safilo’s favourable valuation-to-growth profile, current stock prices appear attractive.

As a conclusion, Safilo is an interesting alternative for investors finding the Essilor and Luxottica stocks fairly priced. But investing in this stock requires accepting higher volatility due to its market capitalisation (~EUR810m) and to its listing on the Milan stock exchange, which makes it more vulnerable to tensions in peripheral stock markets.

4.4. DCF valuation

Essilor:

For the financial year 2015, we anticipate growth of over 20% on a reported basis, including 4.5% organic growth to be compared with a guidance of “at least 4.5%”. We expect a slightly higher organic growth for 2016 and 2017 (+5%), driven by the increasing influence of new growth drivers and emerging countries. Then, we assume a gradual decline in sales growth, which tends towards a perpetual growth rate of 2.5%.

Theoretical FV of EUR124 is based on a normative operating margin of 18.7% from 2018. Such a level of profitability implies a 130bp increase in operating margin compared with 2014 and is consistent with Essilor’s guidance for 2018 (EBITDA margin of ~24.4%).

We assume a cost of equity of 6.6% (risk-free rate of 2%, risk premium of 6.4% and beta of 0.7) and a cost of debt of 3%, resulting in a WACC of 6.1%.


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Fig. 44: DCF valuation:

EURm 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e 2023e 2024e

Net Sales 6 840 7 323 7 839 8 388 8 891 9 335 9 709 10 000 10 250 10 506 % change 20.6% 7.1% 7.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.5% 2.5%

EBIT 1 231 1 356 1 474 1 568 1 663 1 746 1 811 1 865 1 912 1 959

EBIT margin (%) 18.0% 18.5% 18.5% 18.7% 18.7% 18.7% 18.7% 18.7% 18.7% 18.7%

Income taxes -303 -359 -373 -414 -439 -461 -478 -492 -505 -517

Tax rate (%) 26% 27% 26% 26% 26% 26% 26% 26% 26% 26%

Operating profit after taxes 928 996 1 101 1 154 1 224 1 285 1 333 1 373 1 407 1 442 +Depreciations 342 330 392 377 400 420 437 450 461 473

-Change in WCR 228 51 100 59 62 65 68 70 72 74

-Investments in fixed assets 290 330 286 377 400 420 437 450 461 473

Operating cash flow 752 945 1 107 1 096 1 161 1 220 1 265 1 303 1 335 1 369

PV of terminal value 21,351

+PV of future cash flows (2015-24) 8,289

= Enterprise Value 29,640 Net debt (2015e) -1,595

Other liabilities 814

Minority interest 409

Financial assets 0

Theoretical value of equity 26,822 Number of shares (m) 215

Theoretical FV per share (€) 124


We maintain our ‘buy’ rating and our target price of EUR124, which implies an attractive upside potential of 17%.

Luxottica:

As in the case of Essilor, we anticipate very strong sales growth (+18.4%) in 2015, including a 6.1% increase at cc including the impact from EyeMed. We believe that Luxottica will then be able to maintain high single-digit sales growth between 2016 and 2018 thanks to its unrivalled brand portfolio including proprietary brands (in particular, Ray-Ban and Oakley) complemented by the largest licences in the market (Prada, Dolce & Gabbana, G. Armani, Chanel, Michael Kors…). The increased proportion of emerging countries will stimulate sales growth, both in the Wholesale and Retail Divisions. For 2019 onwards, we assume a gradual decline in sales growth, which tends towards a perpetual growth rate of 2.5%.

We assume the operating margin will increase by 160bps every year between 2015 and 2019 and then stabilise at 17.6% to become our normative level. Profitability should improve in mature countries (productivity gains, optimisation of the retail division, etc.) and to a greater extent in emerging countries where the growth potential is greatest, especially in the retail division.

Based on a cost of equity of 6.7% (risk-free rate of 2%, risk premium of 6.4% and beta of 0.75) and a cost of debt of 3.5%, the WACC is equal to 6.5%.


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EURm 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e 2023e 2024e

Net Sales 9 064 9 740 10 417 11 147 11 871 12 583 13 213 13 741 14 291 14 862 % change 18.4% 7.5% 7.0% 7.0% 6.5% 6.0% 5.0% 4.0% 4.0% 4.0%

EBIT 1 451 1 615 1 776 1 940 2 089 2 215 2 325 2 418 2 515 2 616

EBIT margin (%) 16.0% 16.6% 17.0% 17.4% 17.6% 17.6% 17.6% 17.6% 17.6% 17.6%

Income taxes -482 -547 -610 -650 -700 -742 -779 -810 -843 -876

Tax rate (%) 35.5% 35.5% 35.5% 33.5% 33.5% 33.5% 33.5% 33.5% 33.5% 33.5%

Operating profit after taxes 968 1 069 1 166 1 290 1 389 1 473 1 546 1 608 1 673 1 739 +Depreciations 467 502 536 557 594 629 661 687 715 743

-Change in WCR 136 65 65 78 83 88 92 96 100 104

-Investments in fixed assets 499 487 521 557 588 623 654 680 715 743

Operating cash flow 801 1 018 1 116 1 212 1 312 1 391 1 461 1 519 1 573 1 635

PV of terminal value 22,168

+PV of future cash flows (2015-24) 9,038

= Enterprise Value 31,206 Net debt (2015e) -1,033


Minority interest 7

Financial assets 188

Theoretical value of equity 30,032 Number of shares (m) 479.2



We maintain our target price of EUR63 and our ‘buy’ rating despite a limited upside potential (+4%) and we recommend to take advantage of any price decline to gain exposure to this stock.

Safilo:

In our opinion, the sales of the world’s No.2 player should be up 12% in 2015, the best performance in the last decade! The group is implementing the actions decided in its strategic plan for 2020 in order to be ready to withstand the impact from the transition of the Gucci licence in 2017. Of note, our estimates for 2020 are more conservative than the group’s guidance (EUR1.6-1.7bn).

Our theoretical FV of EUR15 is based on a perpetual EBIT margin of 10.7% from 2021 onwards. We anticipate a 320bp increase (to 10.2%) in operating margin during the period 2014-20, which is, once again, more conservative than the Italian group’s scenario (+400bps in EBITDA margin).

Additionally, Safilo is due to receive compensation payments from Kering (EUR90m) in December 2016 (EUR30m) and September 2018 (EUR30m), while a first EUR30m payment was already received in January 2015.


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EURm 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e 2023e 2024e

Net Sales 1 320.3 1 401.4 1 326.7 1 406.3 1 490.6 1 572.6 1 551.2 1 613.3 1 661.7 1 711.5 % change 12.0% 6.1% -5.3% 6.0% 6.0% 5.5% -1.4% 4.0% 3.0% 3.0%

EBIT 123.7 140.3 104.3 165.5 147.0 161.1 165.2 171.8 177.0 182.3

EBIT margin (%) 9.4% 10.0% 7.9% 11.8% 9.9% 10.2% 10.7% 10.7% 10.7% 10.7%

Income taxes -27.4 -37.1 -36.7 -62.1 -55.1 -60.4 -62.0 -64.4 -67.2 -69.3

Tax rate (%) 38% 38% 38% 38% 38% 38% 38% 38% 38% 38%

Operating profit after taxes 96.3 103.3 67.6 103.4 91.8 100.7 103.3 107.4 109.7 113.0 +Depreciations 40.9 42.0 39.8 42.2 44.7 47.2 46.5 48.4 49.9 51.3

-Change in WCR 36.4 20.9 -19.2 14.1 14.9 15.7 15.5 16.1 16.6 17.1

-Investments in fixed assets 39.6 42.0 39.8 42.2 44.7 47.2 46.5 48.4 49.9 51.3

Operating cash flow 61.2 82.4 86.8 89.4 76.9 85.0 87.7 91.3 93.1 95.9

PV of terminal value 629

+PV of future cash flows (2015-24) 535

= Enterprise Value 1,164 Net debt (2015e) -136


Minority interest 3

Financial assets 8

Theoretical value of equity 971 Number of shares (m) 62.7



Considering the 16% upside to our target price of EUR15, we upgrade the Safilo stock from ‘neutral’ to ‘buy’ in order to potentially take advantage of a gradual return to more positive trends and of the implementation of the strategic plan for 2020.

r r

INDEPENDENT RESEARCH UPDATE Essilor 24nd June 2015 A wider playing field for new opportunities!

Luxury & Consumer Goods Fair Value EUR124 (price EUR106.25) BUY

Bloomberg EF FP Reuters ESSI.PA 12-month High / Low (EUR) 114.9 / 71.5 Market capitalisation (EURm) 22,939 Enterprise Value (BG estimates EURm) 24,533 Avg. 6m daily volume ('000 shares) 545.4 Free Float 89.8% 3y EPS CAGR 15.6% Gearing (12/14) 35% Dividend yield (12/15e) 1.08%

We maintain our ‘buy’ rating and our FV of EUR124. The excellent sales (2014-17 CAGR: +11.4%) and margin (2014-17 EBIT CAGR: +14.2%) momentum, driven by a gradual acceleration in organic growth, recent acquisitions, and a favourable currency impact, justify the stock’s valuation (2016e PEG ratio of 1.6x). Based on current price levels, we believe the stock is a good buy both in bull and bear environments.

The US readers business, which had a negative impact on the group’s organic growth in Q1 (+4% vs. CS: +4.7%e), should bounce back as soon as Q2 15 thanks to the entry into force of a new contract with CVS, the second largest pharmacy chain in the US, with more than 7,800 stores. The lens division (88% of sales) performed well in the US (+4.5%) and Europe (+2.5%), confirming the relevance of the new strategy based on “Country Roadmaps”, and the increase in marketing expenses (2015: ~EUR210m) associated with higher-added-value products such as Varilux S series, Crizal, Xperio and Transitions.

A wider “playing field” = more growth opportunities. Strengthening its positions in the sunglasses and online activities has allowed Essilor to expand its addressable market to EUR27bn (vs. EUR11bn previously), but also to boost sales growth (sunglasses market: +6-7% p.a., online market: +14% p.a. vs. +3-4% p.a. for Rx). Essilor will continue to develop the latter activity in emerging markets (22% of 2014 sales) and further step up its marketing spending to support new product launches and to stimulate demand, especially in mature economies. It should be noted that our LFL growth estimates for 2015 (+4.5% vs. guidance of “at least +4.5%”) and 2016-17 (+5% p.a.) are still rather conservative.

Better-than-expected margins as soon as H1 15? The group has benefited from a clearly positive price/product-mix in Q1 thanks to the strong growth of high value-added brands. Although the management has decided to allocate part of it to marketing efforts, we believe Essilor’s margin will be positively impacted as soon as H1 and in FY 2015 (adj. contribution margin: +30bps to 18.9% in line with guidance). In the medium term, profitability will be driven by volume impact (accelerated LFL growth), the recovery of the online business (especially Coastal), and productivity/efficiency gains.

YE December 12/14 12/15e 12/16e 12/17e Revenue (€m) 5,670 6,840 7,323 7,839 EBIT (€m) 1,222 1,231 1,356 1,474 Basic EPS (€) 4.32 3.72 4.15 4.61 Diluted EPS (€) 3.05 3.79 4.23 4.71 EV/Sales 4.4x 3.6x 3.3x 3.0x EV/EBITDA 23.7x 15.5x 13.9x 12.7x EV/EBIT 20.3x 19.8x 17.7x 16.0x P/E 34.8x 28.0x 25.1x 22.6x ROCE 16.9 21.2 22.1 23.0 Price and data as at close of 19th June

67.5

77.5

87.5

97.5

107.5

117.5

20/12/13 20/03/14 20/06/14 20/09/14 20/12/14 20/03/15 20/06/15

ESSILOR INTL. SXX EUROPE 600 CONSUMER GDS


Virginie Roumage

Essilor

44

Income Statement (EURm) 2012 2013 2014 2015e 2016e 2017e Revenue 4,989 5,065 5,670 6,840 7,323 7,839 Change (%) 19.1% 1.5% 12.0% 20.6% 7.1% 7.0% Gross Profit 2,784 2,838 3,315 4,015 4,306 4,617 Contribution from operations 894 917 1,043 1,296 1,421 1,544 EBIT 832 843 1,222 1,231 1,356 1,474 Change (%) 21.8% 1.4% 45.0% 0.7% 10.1% 8.7% Financial results (18.0) (20.0) (46.0) (65.0) (60.0) (40.0) Profits from associates 23.8 22.0 3.0 0.0 0.0 0.0 Pre-Tax profits 838 845 1,179 1,166 1,296 1,434 Tax (207) (199) (193) (303) (337) (373) Minority interests (46.4) (53.0) (57.0) (64.1) (67.3) (70.7) Net profit 584 593 929 799 891 991 Change (%) 15.5% 1.5% 56.7% -14.1% 11.6% 11.1% Cash Flow Statement (EURm) Operating cash flows 850 912 1,022 1,205 1,325 1,453 Change in working capital 10.1 69.0 10.0 228 93.9 100 Capex, net 230 285 226 290 285 286 Financial investments, net 158 330 1,836 239 256 274 Dividends 201 218 228 221 242 453 Other (5.9) 129 174 0.0 0.0 0.0 Net debt 250 369 1,821 1,595 1,147 807 Free Cash flow 610 558 786 687 946 1,067 Balance sheet (EURm) Cash & liquid assets 667 791 626 852 1,300 1,640 Other current assets 2,732 2,240 2,536 3,021 3,221 3,434 Tangible fixed assets 1,001 998 1,154 1,444 1,729 2,015 Intangible assets 2,087 2,476 4,668 4,668 4,668 4,668 Other assets 421 1,072 1,805 1,805 1,805 1,805 Total assets 6,907 7,577 10,789 11,790 12,723 13,562 LT & ST debt 916 1,174 2,447 2,447 2,447 2,447 Other liabilities 2,070 2,362 3,082 3,639 3,869 4,114 Shareholders' funds 3,921 4,041 5,260 5,704 6,407 7,001 Total liabilities 6,907 7,577 10,789 11,790 12,723 13,562 Capital employed 4,241 4,690 7,195 7,713 8,091 8,478 Financial Ratios Contribution margin (% of sales) 17.92 18.10 18.40 18.94 19.40 19.70 EBIT margin (% of sales) 16.67 16.64 21.56 17.99 18.51 18.81 Tax rate 24.73 23.55 16.37 26.00 26.00 26.00 Net margin 11.71 11.71 16.39 11.67 12.17 12.64 ROE (after tax) 15.94 15.79 18.91 15.08 15.03 15.35 ROCE (after tax) 26.45 24.28 16.88 21.17 22.12 22.95 Gearing 6.36 9.13 34.62 27.95 17.90 11.53 Pay out ratio 31.38 33.67 34.43 30.31 50.77 66.94 Number of shares, diluted 211,015 213,057 214,820 214,820 214,820 214,820 Per share data (EUR) EPS 2.77 2.78 4.32 3.72 4.15 4.61 Restated EPS 2.80 2.87 3.05 3.79 4.23 4.71 % change 14.9% 2.4% 6.2% 24.4% 11.6% 11.1% BVPS 11.21 11.10 11.01 11.01 11.01 11.01 Operating cash flows 4.03 4.28 4.76 5.61 6.17 6.77 FCF 2.89 2.62 3.66 3.20 4.40 4.97 Net dividend 0.88 0.95 1.05 1.15 2.15 3.15


Company description With 2014 sales of EUR5.7bn, Essilor is the global leader in ophthalmic lenses (90% of sales), as well as in reading glasses with FGX. The group still derives 79% of sales from mature countries (o/w 45% in North America). Emerging markets currently account for about 21% of sales. Essilor is listed in Paris and is in the CAC40 index. With free float of c.90%, the group has no key shareholders, although its employees nevertheless own 8.4% of the capital.

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INDEPENDENT RESEARCH UPDATE Luxottica 24th June 2015 All-Star Game Winner

Luxury & Consumer Goods Fair Value EUR63 (price EUR60.15) BUY

Bloomberg LUX IM Reuters LUX.MI 12-month High / Low (EUR) 61.9 / 35.7 Market capitalisation (EURm) 29,025 Enterprise Value (BG estimates EURm) 30,058 Avg. 6m daily volume ('000 shares) 767.0 Free Float 32.9% 3y EPS CAGR 17.1% Gearing (12/14) 21% Dividend yield (12/15e) 1.53%

A peaceful start to the year for Luxottica! It is the only group in our coverage universe to record higher-than-expected Q1 15 results, thanks to its high exposure to the sunglasses segment (~56% of group sales) and to the US dollar and related currencies (~68% of sales including 56% in USD), which provides it with the strongest earnings growth prospects among its peers (2014-17 CAGR: +15.3% for EBIT, +17.1% for EPS). Based on a 2016e PEG ratio of 1.7x, we recommend taking advantage of any price decline to gain exposure to this stock!

Q1 15 results showed that all catalysts are in place! The US was the main driver, both for Wholesale (launch of Michael Kors) and Retail Divisions, with strong performance at LensCrafters (SSSG: +5.9%) and SGH (+7.4%). Emerging markets remained strong, with South America leading the way (+16.8%). Operating margin went up by 120bps to 15.9%, fuelled by volume impact, the price/geographic mix and a favourable currency impact (+40bps).

The highest earnings growth prospects in the sector. In addition to a favourable currency impact in 2015, the margin increase in the medium term is mainly based on company-specific catalysts: (i) volume impact (high-single digit currency-neutral growth seems, in our view, sustainable at least until 2017); (ii) productivity and efficiency gains in Retail; (iii) optimisation of the supply chain; and (iv) the increasing contribution of emerging countries. We believe that our EBIT CAGR estimate of 15.3% for 2014-17 justifies the stock’s current valuation.

Estimates for 2015-17: there is still potential for upward revision. During the AGM last April, co-CEO Massimo Vian confirmed that a new version of Google Glass would be out “soon”, while the partnership with Intel could result in a launch in Q1 16. As of today, neither consensus nor we have made any sales estimate. After two years without acquisitions, M&A could resurface (e.g. chains in emerging markets, acquisition of a high-end brand).

Luxottica is improving shareholder return. With a FcF estimate of near EUR1.1bn in 2017 (vs. EUR800m in 2014), LUX should gradually increase its payout ratio (BG est.: 60-70%e vs. 50% in 2014) and pay a special dividend every other year (2014: 72 cents).

YE December 12/14 12/15e 12/16e 12/17e Revenue (€m) 7,652 9,064 9,740 10,417 EBIT (€m) 1,158 1,451 1,615 1,776 Basic EPS (€) 1.34 1.82 2.06 2.30 Diluted EPS (€) 1.44 1.83 2.08 2.32 EV/Sales 3.9x 3.3x 3.0x 2.8x EV/EBITDA 19.5x 15.7x 14.0x 12.6x EV/EBIT 25.9x 20.6x 18.2x 16.3x P/E 41.6x 32.8x 28.9x 25.9x ROCE 10.4 13.4 14.9 16.2 Price and data as at close of 19th June

33.9

38.9

43.9

48.9

53.9

58.9

63.9

20/12/13 20/03/14 20/06/14 20/09/14 20/12/14 20/03/15 20/06/15

LUXOTTICA SXX EUROPE 600 CONSUMER GDS


Virginie Roumage

Luxottica

46

Income Statement (EURm) 2012 2013 2014 2015e 2016e 2017e Revenue 7,086 7,313 7,652 9,064 9,740 10,417 Change (%) 13.9% 3.2% 4.6% 18.4% 7.5% 7.0% Gross Profit 4,650 4,789 5,078 6,055 6,526 7,001 EBITDA 1,328 1,422 1,542 1,918 2,117 2,312 EBIT 970 1,056 1,158 1,451 1,615 1,776 Change (%) 20.2% 8.8% 9.7% 25.3% 11.4% 9.9% Financial results (126) (99.3) (97.5) (92.5) (75.0) (57.5) Pre-Tax profits 844 956 1,060 1,358 1,540 1,718 Tax (306) (408) (414) (482) (547) (610) Minority interests (4.2) (4.2) (3.4) (4.0) (4.3) (4.7) Net profit 534 545 643 872 989 1,104 Change (%) 18.1% 1.9% 18.0% 35.7% 13.4% 11.6% Cash Flow Statement (EURm) Operating cash flows 1,023 1,015 1,128 1,436 1,570 1,702 Change in working capital 14.2 22.9 (11.8) 136 65.3 65.3 Capex, net 262 375 419 499 487 521 Financial investments, net 217 121 41.1 136 146 156 Dividends 232 277 312 685 438 500 Other (72.0) 18.0 (81.0) 0.0 0.0 0.0 Net debt 1,662 1,461 1,013 1,033 599 139 Free Cash flow 747 617 720 801 1,018 1,116 Balance Sheet (EURm) Cash & liquid assets 790 618 1,454 1,433 1,867 2,327 Other current assets 1,637 1,618 1,714 1,988 2,119 2,250 Tangible fixed assets 1,192 1,183 1,318 1,349 1,334 1,319 Intangible assets 1,346 1,261 1,385 1,385 1,385 1,385 Other assets 3,477 3,403 3,724 3,724 3,724 3,724 Total assets 8,442 8,083 9,594 9,879 10,429 11,005 LT & ST debt 2,452 2,079 2,467 2,467 2,467 2,467 Other liabilities 1,996 1,854 2,199 2,336 2,402 2,468 Shareholders' funds 3,993 4,150 4,929 5,076 5,561 6,070 Total liabilities 8,442 8,083 9,594 9,879 10,429 11,005 Capital employed 6,432 6,188 6,792 6,959 7,010 7,060 Financial Ratios Gross Margin (% of sales) 65.62 65.48 66.35 66.80 67.00 67.20 EBITDA margin (% of sales) 18.75 19.45 20.15 21.16 21.74 22.19 EBIT margin (% of sales) 13.69 14.44 15.13 16.00 16.58 17.05 Tax rate 36.22 42.61 39.06 35.50 35.50 35.50 Net Margin 7.54 7.45 8.40 9.62 10.16 10.60 ROE (after tax) 13.42 13.15 13.06 17.20 17.81 18.20 ROCE (after tax) 9.62 9.79 10.39 13.44 14.86 16.23 Gearing 41.63 35.22 20.55 20.36 10.78 2.30 Pay out ratio 48.16 49.71 49.85 50.22 50.52 51.74 Number of shares, diluted 469,574 476,273 479,247 479,247 479,247 479,247 Per share data (EUR) EPS 1.14 1.14 1.34 1.82 2.06 2.30 Restated EPS 1.19 1.31 1.44 1.83 2.08 2.32 % change 22.1% 9.7% 10.5% 26.8% 13.4% 11.6% BVPS 8.50 8.71 10.28 10.59 11.60 12.67 Operating cash flows 2.18 2.13 2.35 3.00 3.28 3.55 FCF 1.59 1.29 1.50 1.67 2.12 2.33 Net dividend 0.58 0.65 0.72 0.92 1.05 1.20


Company description With 2013 sales of EUR7.65bn, Luxottica is the global leader in luxury eyewear. The Italian group is organised into two businesses: (i) Retail (58% of sales) with the distribution of optical products (LensCrafters, Sunglass Hut…) via more than 7,000 sales points across the globe, and (ii) Wholesale (42% of sales) which concerns the design, production and marketing of prescription glasses and sunglasses thanks to a portfolio of house brands (Ray-Ban, Oakley…) and licences (D&G, Prada, Giorgio Armani, Ralph Lauren…) that is unrivalled in the sector. Mr Leonardo Del Vecchio, the group's founder and current Chairman, remains the majority shareholder with 61.4% of the share capital. Worth noting is that Giorgio Armani holds a 4.7% stake. Free float therefore stands at around 33%.

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INDEPENDENT RESEARCH UPDATE Safilo 24th June 2015 Towards a more positive momentum

Luxury & Consumer Goods Fair Value EUR15 (price EUR12.91) BUY vs. NEUTRAL

Bloomberg SFL IM Reuters SFLG.MI 12-month High / Low (EUR) 16.4 / 9.1 Market capitalisation (EURm) 808 Enterprise Value (BG estimates EURm) 944 Avg. 6m daily volume ('000 shares) 268.4 Free Float 44.9% 3y EPS CAGR 10.9% Gearing (12/14) 17% Dividend yield (12/15e) 1.01%

Despite a rather weak performance in Q1 15 due to one-off factors, we upgrade Safilo from ‘neutral’ to ‘buy’ (FV unchanged at EUR15) as we expect: 1/ a return to a more positive top-line and margin momentum starting in Q2 15 and 2/ in the medium term the successful implementation of the strategic plan for 2020 intended to absorb the negative impacts from the transition of the Gucci licence in 2017, as shown by our EBIT estimates for 2014-17 (CAGR of 11.5%e).

2015: Q1 15 cannot be extrapolated... The change in the distribution model in Asia-Pacific caused a ~23% sales decline in the region and a negative impact from the geographic mix on profitability (adjusted EBITDA margin: -210bps to 10%), which was also affected by an unfavourable cost phasing in Q1.

… And towards a more positive momentum starting in Q2. Contrary to Q1, the relaunch of Carrera (~10% of sales) initiated in March will stimulate growth starting in Q2, and so will the Polaroid and Smith Optics marketing campaigns. This sales growth acceleration will result in a more positive leverage effect which, combined with the gradually decreasing impact from the inventory obsolescence provision and with a more favourable cost phasing, should help achieve the profitability increase target for 2015 (BG est.: adjusted EBITDA margin up 20bps to 10.2%).

Main objective of the strategic plan for 2020: to strengthen and to secure sustainable growth for Safilo. The two major pillars of this plan are: 1/ expansion of proprietary brands (BG est.: 2014-20e CAGR of ~13%), which should account for 37% of 2020 sales (guidance: 40%) vs. 25% in 2014; 2/ diversification within the licence portfolio by growing high-potential brands (Jimmy Choo, Fendi, Givenchy, Céline, etc.). These actions will allow for: 1/ gradual decrease of non-renewal risk; 2/ leverage effect at opex level, especially with the expansion of proprietary brands which do not require royalty payments.

An interesting, though more cyclical growth profile! Despite the transition of Gucci in 2017, Safilo still offers a solid growth profile (2014-17e: +11.5% for EBIT, +10.9% for EPS) and a rather attractive valuation (2016e PEG ratio of 1.2x).

YE December 12/14 12/15e 12/16e 12/17e Revenue (EURm) 1,179 1,320 1,401 1,327 EBIT (EURm) 75.27 93.72 110.31 104.29 Basic EPS (EUR) 0.62 0.71 0.98 0.97 Diluted EPS (EUR) 0.71 0.72 0.98 0.97 EV/Sales 0.8x 0.7x 0.7x 0.6x EV/EBITDA 8.8x 7.0x 6.0x 5.9x EV/EBIT 12.9x 10.1x 8.3x 8.2x P/E 18.1x 17.9x 13.2x 13.3x ROCE 4.0 4.9 5.7 5.5 Price and data as at close of 19th June

8.6

10.6

12.6

14.6

16.6

18.6

20.6

22.6

20/12/13 20/03/14 20/06/14 20/09/14 20/12/14 20/03/15 20/06/15

SAFILO GROUP SXX EUROPE 600 CONSUMER GDS

Analyst: Consumer Analyst Team: Cédric Rossi Nikolaas Faes 33(0) 1 70 36 57 25 Loïc Morvan [email protected] Virginie Roumage

Safilo

48

Income Statement (EURm) 2012 2013 2014 2015e 2016e 2017e Revenue 1,175 1,122 1,179 1,320 1,401 1,327 Change (%) 6.7% -4.6% 5.1% 12.0% 6.1% -5.3% Gross Profit 680 684 719 805 865 775 EBITDA 115 112 111 135 152 144 EBIT 73.9 74.7 75.3 93.7 110 104 Change (%) -14.3% 1.1% 0.7% 24.5% 17.7% -5.5% Financial results (29.3) (22.6) (8.6) (20.0) (10.0) (5.0) Pre-Tax profits 44.0 50.1 64.9 72.2 98.8 97.8 Tax (17.4) (34.1) (25.4) (27.4) (37.1) (36.7) Minority interests (0.74) (0.45) (0.42) (0.47) (0.50) (0.48) Net profit 25.9 15.5 39.0 44.3 61.3 60.6 Change (%) -7.2% -40.0% 151% 13.5% 38.3% -1.0% Cash Flow Statement (EURm) Operating cash flows 67.8 52.9 74.9 85.7 104 101 Change in working capital 3.0 (17.5) 41.3 36.4 20.9 (19.2) Capex, net 28.8 36.7 38.9 39.6 42.0 39.8 Financial investments, net 58.4 0.0 0.0 6.6 7.0 6.6 Dividends 0.0 0.0 0.0 6.2 8.1 10.0 Other (45.3) 0.92 (24.6) (30.0) 0.0 0.0 Net debt 215 182 163 136 111 46.9 Free Cash flow 36.1 33.7 (5.4) 9.7 40.9 80.3 Balance Sheet (EURm) Cash & liquid assets 59.4 82.6 88.6 115 141 205 Other current assets 531 512 565 627 662 630 Tangible fixed assets 205 198 203 202 202 202 Intangible assets 604 585 638 638 638 638 Other assets 93.0 88.5 103 103 103 103 Total assets 1,491 1,466 1,598 1,685 1,746 1,777 LT & ST debt 275 265 252 252 252 252 Other liabilities 354 354 372 397 412 398 Shareholders' funds 863 846 974 1,036 1,083 1,127 Total liabilities 1,491 1,466 1,598 1,685 1,746 1,777 Capital employed 1,086 1,030 1,144 1,179 1,200 1,181 Financial Ratios Gross Margin (% of sales) 57.83 60.96 60.96 61.00 61.70 58.40 EBITDA margin (% of sales) 9.79 9.96 9.39 10.20 10.87 10.86 EBIT margin (% of sales) 6.29 6.66 6.39 7.10 7.87 7.86 Tax rate 39.59 68.09 39.17 38.00 37.50 37.50 Net Margin 2.20 1.38 3.31 3.36 4.37 4.57 ROE (after tax) 3.02 1.84 4.02 4.29 5.67 5.39 ROCE (after tax) 4.11 2.32 4.00 4.93 5.74 5.52 Gearing 24.95 21.57 16.76 13.17 10.22 4.16 Pay out ratio 0.0 0.0 15.99 18.32 16.31 119 Number of shares, diluted 60,477 62,084 62,736 62,736 62,736 62,736 Per share data (EUR) EPS 0.43 0.25 0.62 0.71 0.98 0.97 Restated EPS 0.43 0.63 0.71 0.72 0.98 0.97 % change -12.6% 46.9% 13.5% 1.4% 35.8% -1.0% BVPS 14.27 13.63 15.53 16.52 17.26 17.97 Operating cash flows 1.12 0.85 1.19 1.37 1.65 1.61 FCF 0.60 0.54 (0.09) 0.15 0.65 1.28 Net dividend 0.0 0.0 0.10 0.13 0.16 1.16


Company description With 2014 sales of EUR1.18bn, Safilo is the second-largest player in luxury & premium eyewear. The Italian group has a wholesale-oriented business model (93% of sales) which concerns the design, production and marketing of prescription glasses and sunglasses thanks to a wide portfolio of licences (Dior, Gucci, Bottega Veneta, Hugo Boss...) and three major house brands (Carrera, Polaroid and Safilo). Since April 2012 the main shareholder with a 42% stake is HAL, a holding-company which also owns GrandVision, the 2nd largest optical distribution network. The lion's share is mainly composed of European retail banners (GrandOptical, Pearle Vision Europe, Solaris, etc.) with over 4,800 stores. The Tabacchi family's holding company (Only 3T) now only has a 9% stake. Hence free float amounts approx. 45%


49

Price Chart and Rating History Essilor

Ratings Date Ratings Price 27/10/08 BUY EUR33.545 06/06/08 SELL EUR40.38 30/04/07 BUY EUR44.3

Target Price Date Target price 22/04/15 EUR124 16/04/15 EUR120 20/02/15 EUR110 16/02/15 EUR108 13/01/15 EUR104 18/06/14 EUR96 02/04/14 EUR99 10/01/14 EUR102 10/09/13 EUR98 23/05/13 EUR96 01/03/13 EUR85 16/01/13 EUR80 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

Ratings Date Ratings Price 13/10/11 BUY EUR20.35 29/09/08 SELL EUR16.56 27/06/07 BUY EUR28.58

Target Price Date Target price 05/05/15 EUR63 10/04/15 EUR61 04/03/15 EUR57 03/03/15 Under review 20/01/15 EUR53 09/01/15 EUR50 18/06/14 EUR46 10/01/14 EUR45 23/05/13 EUR44 30/04/13 EUR41 04/03/13 EUR38 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

67.0

77.0

87.0

97.0

107.0

117.0

127.0

20/12/13 20/03/14 20/06/14 20/09/14 20/12/14 20/03/15 20/06/15

ESSILOR INTL. Fair Value Achat Neutre Vente

35.0

40.0

45.0

50.0

55.0

60.0

65.0

20/12/13 20/03/14 20/06/14 20/09/14 20/12/14 20/03/15 20/06/15

LUXOTTICA Fair Value Achat Neutre Vente


50

Safilo

Ratings Date Ratings Price 03/09/14 NEUTRAL EUR16.03 23/05/13 BUY EUR13.89

Target Price Date Target price 10/04/15 EUR15 17/03/15 EUR14.5 07/11/14 EUR13.5 03/09/14 EUR15 26/11/13 EUR19 28/06/13 EUR16.5 23/05/13 EUR15

8.6

10.6

12.6

14.6

16.6

18.6

20.6

22.6

20/12/13 20/03/14 20/06/14 20/09/14 20/12/14 20/03/15 20/06/15

SAFILO GROUP Fair Value Achat Neutre Vente


51

Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating

BUY 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 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.

NEUTRAL 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 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.

SELL 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 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 57,8% NEUTRAL ratings 37,6% SELL ratings 4,6%

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in Issuer Bryan Garnier & Co Limited or another company in its group (together, the “Bryan Garnier Group”) has a 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”).

No

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No

14 Analyst disclosure The analyst hereby certifies that neither the views expressed in the research, nor the timing of the publication of 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.

Yes

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YES

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