CLARIFICATION: Analysis: Oriflame 2026 Notes Fall to Mid-High 60s Amid Ukraine War; Continues to Generate Cash Despite Excluding Impact of Turnover Coming From Affected Geographies; Liquidity Adequate, Lack Triggers With 2026 Maturities; Risks Around EM Currency Exposure, Business Model

Editor's note: The previous version of the analysis excluded leases from cash flow. These have now been included and the article amended accordingly.

Relevant Items:
Financials, Projections
March 7 Update
2026 SSNs OM

Swedish cosmetics group Oriflame's $550 million 5.125% 2026 senior secured notes have fallen more than 20 points in the last weeks and are quoted at 70/75 today with substantial trading in the name as the business suffers the impact of Russia’s invasion of Ukraine. The €250 million E+4.25% notes due 2026 have changed hands in the 67/71 range and are now quoted at 70/75 as well, sources told Reorg.

Russia accounted for 16% of the group’s 2021 turnover while Ukraine and Belarus accounted for 2% each. The group has halted operations in Ukraine but has decided to keep its Russian social selling business open, though it said earlier this week it has been seeing supply chain issues and disruption in trading conditions.

Alongside these factors, the depreciation of the Russian ruble and increase in raw material prices such as palm oil will also impact the group’s topline and margins. However, the business stays cash generative even if all of its Russian, Ukrainian and Belarusian business is excluded from topline and cost of goods sold are stressed to reflect rising raw material prices. The group’s below EBITDA cash costs were only about €100 million - comprising €30 million in taxes, €38 million in cash interest, capex of 1% of sales, about €17 million of leases and assumed neutral working capital, which has resulted in an inflow in each year apart since FY’14 apart from FY’21. This compares with an EBITDA of more than €180 million in each year since FY’17, meaning EBITDA would have to decline to about €100 million for the group to burn cash.

In addition, the group’s liquidity of €218.9 million as of Dec. 31, 2021, remains adequate given the group’s cash generation capacity and minimum capex requirements (about 1% of sales). The group had €118.9 million cash and €100 million super senior undrawn RCF as of Dec. 31. Cash held in Russia was relatively small at 170 million rubles ($1.6 million at the Dec. 31 exchange rate). The group said in its fourth-quarter call it only had over €5 million cash in Russia and Ukraine combined.

There also appears to be a lack of near-term triggers, with bond maturities in 2026 and the springing covenant on the RCF unlikely to become an issue in the near term given adequate cash balance and the absence of drawings under the facility. The RCF has a covenant of 0.8x super senior net leverage ratio, which is tested quarterly if the RCF is more than 35% drawn. A breach results in a drawstop of new RCF utilizations.

That said, the business remains highly exposed to emerging markets. About 90% of the group’s sales were denominated in currencies other than euros. Among the most substantial as of 2020 were:
 

• 16% of sales were denominated in rubles;
• 7% were in Indonesian rupiah;
• 6% were in Indian rupees;
• 11% were in Chinese yuan;
• 7% were in Mexican pesos; and
• 3% were in Turkish lire.

Eighty percent of the group’s COGS were denominated in euros and dollars as per the 2026 notes’ OM. The group’s capital structure is also mostly denominated in euros and dollars. Foreign currency exposure led to an impact of negative 3% on sales in the full-year 2021 with management guiding a negative 4% impact on total sales for full-year 2022. We note that this guidance was given when the ruble was trading at around 92 to the euro, compared with levels of around 144 currently.

Further, the social selling business model poses a risk to topline performance due to its reliance on the group’s ability to grow the number of representatives selling its products.

Sources also said that business is likely viable even if the company loses the Russian business as liquidity is very good. Others said the high exposure to emerging market currencies carries a high risk in the current economic circumstances.

Under our base case, which incorporates potential loss in revenue from Russia and Ukraine and stresses gross margins, Oriflame still generates about €16.6 million of levered free cash flow (compared with an average of about €80 in between FY’15 and FY’20), reflecting around 5% of net debt as of Dec. 31. Our base case assumes partial recovery of revenue to an average of FY’19 and FY’20 (€1.207 billion) after the adverse impact of Covid partially recovers, but we then decline this revenue by 15% to reflect the potential adverse impact on revenue from Russian and Ukrainian markets. Gross margins are forecast to tighten to around 65% compared with historical levels of about 69% to 70%, due to the impact of inflationary pressures on raw material prices for palm oil and paper. Palm oil prices have risen by about 33% since the start of the year and are expected to rise further in the immediate near term, although reports from Reuters suggest a potential decline in the second half of the year.

Oriflame’s asset-lite business model results in low capex levels and we assume capex of 1.3% of sales, which is in line with historical levels, while cash taxes and interest are expected to be at about €30 million and €38.4 million, respectively. We assume neutral working capital to be conservative, though the group has had an inflow from working capital in each year since FY’14 (apart from FY’21). Lease payments were assumed to be in line with historicals at 1.7% of revenue.

Even under our stressed low-case scenario, which assumes a 20% decline in average revenue from FY’19 and FY’20 (reflecting minimal revenue from Russian, Ukraine, and Belarus) Oriflame still generates about €1.9 million of levered free cash. The group’s EBITDA would need to significantly reduce from current levels of more than €180 million to below €100 million for the group to burn cash.
 

Under our base case, the group’s net leverage rises to around 5.4x from 3.5x as of Dec. 31, 2021, which is relatively high for an EM-exposed name but still implies some equity cushion when compared to the 7.3x pro forma EBITDA multiple at which the Jochnick family took over the group in 2019 at an implied post-IFRS 16 EV of €1.393 billion. The family founded Oriflame in 1967 and were the largest shareholders, with about 30% of the shares, at the time of the takeover offer. The transaction was financed through the issuance of the 2026 SSNs.

If leverage stays at elevated levels, refinancing the group’s 2026 bonds could become challenging in 2024 and 2025, though we note that the group has some time until then and could use its adequate liquidity and cash generation to support a partial bond buyback to reduce leverage.

Security under the $550 million 5.125% 2026 SSNs and €250 million E+4.25% 2026 SS FRNs consists of share pledges over the shares of Oriflame Holding AG, Oriflame Swiss Holding AG, Oriflame Cosmetics AG and CETES Cosmetics AG, held by the issuer or the guarantor, as well as a pledge over material bank accounts held by the Swiss guarantor, intercompany receivables and intellectual property held by the Swiss guarantor.

Oriflame’s capital structure and organizational chart is below:
   
Business and Financial Overview

Oriflame is an international beauty company with a presence in more than 60 countries. The CIS region, for which more than half of the revenue comes from Russia, accounted for 28.1% of revenue in 2021. The region also includes some revenue from Ukraine and Belarus which contribute 2% of revenue each.
 
The group also had a manufacturing site in Russia and said it was stopping exports of products from Russia to its global warehouse in Europe. The production from the Russian factory is being redistributed to other manufacturing sites, it added. The group historically manufactured 63% of its products at six facilities in Poland, Russia, China and India, with the rest being supplied from third-party manufacturers. Poland was the largest manufacturing site and Russia’s capacity was greater than India and China.

Oriflame uses a direct-selling model for its products, meaning the business is relatively asset-lite as it does not require a large brick-and-mortar presence or large salaried salesforce. The model works by social selling, whereby products are sold to end customers in a non-retail environment through independent representatives, termed “registered actives”. Registered actives are incentivized to sell Oriflame’s products, which they purchase at a discount, to retail customers as well as building a network of other “down line” registered actives, thereby giving themselves a chance to earn commission on downline sales. During the fourth quarter, 98% of total order volume was placed online.

The number of registered actives has fallen to just below 2.5 million as of December 2021 from about 3 million in FY’19, largely attributable to Covid-19 affecting the level of activity and recruitment of members. The number of registered actives was roughly stable at 3 million between FY’16 to FY’19.

The growth in the number of registered actives is a key avenue for the group to increase revenue. To encourage growth, the company may have to increase the discount offered to new registered actives on the product base or increase commission paid to the more seasoned actives, which can help maintain volumes but would adversely impact EBITDA. In the short term, Oriflame said it aims to regain momentum through stronger recruitment initiatives, renewed focus on social gatherings to boost sales, and a focus on increased usage of digital sales tools - especially the recently launched eCatalogue.

Oriflame’s revenue declined 6.2% year over year from its FY’17 high of about €1.363 billion to €1.279 in FY’18, when the implementation of IFRS 15 (revenue from contracts with customers) negatively impacted sales by around 3%, with the remaining decline mainly being attributed to foreign currency depreciation. Thereafter, Oriflame saw a further 1.6% decline year over year to €1.258 in FY’19. FY’20 and FY’21 saw material year-over-year declines in revenue of 8.1% and 12.1%, respectively, primarily due Covid-19-related restrictions and depreciation in foreign currencies as well as a decline in its registered actives base.
 
The group’s adjusted EBITDA fell by around 16% year over year to €42.6 million in the fourth quarter of 2021, due to the impact of lower sales and gross margins. Cost of sales increased by 14% during the period to €12.2 million, amounting to 36.5% of sales, compared with 28.9% a year earlier. Oriflame said this was a reflection of the increase in product cost as result of the recent cost inflation, alongside lower recoveries in the supply chain and manufacturing and price adjustments made during the quarter. Oriflame is currently looking to adapt its pricing methods as a result of the inflationary environment and aims to track the local inflation in price adjustments, it said during its earnings call.

Palm oil and paper are the main raw materials that Oriflame lists in its OM, both of which saw increases in price over the past few months. Although palm oil prices have risen by about 33% since the start of the year, reports from Reuters suggest that in the second half of the year prices are likely to reverse due to possible stagflation and recession-squeezed demand as discretionary products such as those of Oriflame’s begin to be negatively affected.

At the time of issuance of 2026 SSNs, the group had said that 71% of its cost base was variable with most of the fixed cost relating to employees. Commissions paid to registered actives range between about 25% to 30% of sales on average per year and flow through selling and marketing expenses.

Oriflame has historically been cash generative, producing about €80 million of levered free cash flow on average in each year between FY’15 and FY’20. The group burned €44.3 million of cash in FY’21, largely due to the working capital outflow of €52.9 million (due to build-up in inventory and accelerated payments of payables) and an increase in cash interest to €115 million, which includes one-off charges relating to the issuance of the 2026 notes. We estimate normalized cash interest to be about €38 million.

-- Nikhil Varsani, Noor Sehur