Unveiling Estee Lauder: Performance, Challenges, and Future Prospects
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Please note that this is the final report for 2023 and we're delving into Estée Lauder Companies.
Why Estée Lauder? Estee Lauder caught our attention as it is a leading player within the cosmetics industry, which is forecast to grow at a CAGR of 6% over the next 5 years. It has an impressive brand portfolio in prestige beauty and exhibits a notable level of insider ownership. The recent challenges, including consecutive downward sales revisions due to softening conditions in China, disruptions in Asia's travel retail, and tighter inventory management by U.S. retailers, have led to a significant stock price decline which prompted us to assess if Estee Lauder presents a compelling investment opportunity.
1. Key Facts
Description: The Estée Lauder Companies Inc. (“Estee Lauder”, “ELC”, “Company”), with ticker symbol $EL, stands as a dominant player in the prestige beauty sector, offering a diverse range of Skin Care, Makeup, Fragrance, and Hair Care products.
Key Financials: Over the period FY13 to trailing twelve months (“TTM”) Q1 FY23, the Company depicted a revenue Compound Annual Growth Rate (“CAGR”) of 4.2% and operating income CAGR of -2.5%, reaching a TTM revenue of c. $15.5 billion and operating income of $1.2 billion (margin of 7.7%). ELC has cash and cash equivalents of $3.1 billion compared to total debt and lease liabilities of $9.3 billion.
Price & Market Cap (as of 27th December 2023): Its market cap is $52.2 billion with a 52-week low of $102 and a 52-week high of $284, whereas it currently trades at $146.
Valuation: Estee Lauder trades at a TTM EV/EBITDA of 22.8x (5 Year average of 22.6x) and a TTM EV/Sales of 3.9x (5 Year average of 5.5x).
2. Business Overview
a. History
“I never dreamed about success. I worked for it.” —Estée Lauder
Founding Years: Estee Lauder, was founded by Estee Lauder and her husband Joseph Lauder in 1946. Starting with four skincare products, Estee pioneered the cosmetics industry with innovative marketing, including free demonstrations, makeovers, samples, and word-of-mouth campaigns.
1960s Expansion: In the 1960s, the Company expanded globally, constructing three manufacturing facilities and launching successful brands like Aramis (1964) and Clinique (1968).
Leadership Transition: Leadership transitioned to Estee's son, Leonard Lauder, in 1972, marking a pivotal moment for the Company.
1990s Transformations: The 1990s witnessed significant acquisitions and licensing agreements, notably:
1990: Launch of the skin care brand Origins, led by William Lauder (son of Leonard Lauder).
1993: Licensing agreements for Tommy Hilfiger and DKNY fragrances.
1994: Investment in Mac Cosmetics, leading to its acquisition in 1998.
1995: Acquisitions of luxury skin care brand La Mer and Bobbi Brown Cosmetics.
1999: Acquisition of fragrance house Jo Malone London.
Public Listing: Estée Lauder Companies went public on the New York Stock Exchange on November 17, 1995, at $26.00 a share ($6.50 post-splits).
Leadership Transition (2004): William Lauder became CEO in 2004, and in 2009, Fabrizio Freda, with a background at Procter & Gamble, assumed the role of CEO. William Lauder became Executive Chairman, and both have held their positions since.
Since inception, Estee Lauder Companies has remained a family-run business with the Lauder family, currently owning approximately 38% of the Company, representing about 86% of the voting power. Estee's sons and grandchildren continue to play key roles in the Executive team and on the Board of Directors.
b. Brands and segments
Estee Lauder has a dynamic portfolio comprising of 23 brands spanning to Skin Care, Makeup, Fragrance, and Hair Care.
Source: Proxy 2023
Skin Care accounts for 52% of FY23 revenue, followed by Makeup at 28%, Fragrance at 16% and Hair Care at 4%. Over the last decade, fragrance has been the fastest growing segment achieving 10 year revenue CAGR of 6.7%, followed by Skin Care at CAGR of 6.3%.
Source: Stratosphere.io (use coupon code STOCKOPINE for a 25% discount), StockOpine analysis
In terms of profitability, Skin Care is the highest margin segment with a 10-year average operating margin excluding impairment charges of 24.6% (FY23: 15.9%) followed by fragrance at 10-year average operating margin of 9.2% (FY23: 17.5%).
Large Brands (Above $1 Billion Revenue)
The “Large” stack includes four flagship brands, Estée Lauder, La Mer, MAC and Clinique, with the Company stating in 2019 Investor Day that 3 of the four brands exceed the $2 billion mark in revenue. Estee Lauder, established in 1946, is among the biggest prestige brands globally and the largest revenue contributor. Meanwhile, Clinique secures its position as the #1 prestige skincare brand in the U.S., and MAC stands as the world's largest prestige makeup brand, outperforming the entire portfolio in fiscal year 2023.
Brand value of the leading 10 cosmetic brands worldwide in 2023(in billion U.S. dollars)
Source: Statista
Scaling Brands ($500 Million to $1 Billion Revenue)
This mid-size category of brands includes Jo Malone London, Tom Ford, Aveda, Bobbi Brown Cosmetics, and The Ordinary. Anticipated to surpass the $1 billion sales threshold in fiscal year 2024, Jo Malone London and Tom Ford demonstrate remarkable growth in the lucrative fragrance category. Notably, in 2009 Jo Malone London's net sales were less than $80 million reflecting an impressive CAGR of 18% leading up to FY24. Another testament to the Company's adeptness in scaling brands is The Ordinary, which transitioned to the scale brand category in FY23. Along with Fenty Beauty which is owned by LVMH, The Ordinary is one of the new generation brands (founded after 2005) which exceed the $400 million mark in revenue according to McKinsey.
Developing Brands (Less than $500 Million Revenue):
Encompassing Le Labo, Too Faced, Dr.Jart+, Origins, Kilian Paris, Bumble and bumble, Smashbox, Darphin Paris, Lab Series, Editions de Parfums Frédéric Malle, and GLAMGLOW, this category represents the Company's future scaling brands.
“Looking across our developing brands, in which we strategically invest to realize the scaling brands of the future, Le Labo, Killian Paris and Editions de Parfums Frederic Malle each achieved double-digit organic sales growth in fiscal year 2023 to continue their winning streaks. Impressively, over the last 5 years, these 3 brands have delivered over 30% compound annual growth, demonstrating brand-building acumen.” Fabrizio Freda, CEO
Source: Investor Day 2019
Skin Care
Skin Care products encompass a diverse range addressing various skincare needs, including moisturizers, serums, cleansers, toners, body care, exfoliators, acne and oil correctors, facial masks, and sun care products.
Source: Stratosphere.io (use coupon code STOCKOPINE for a 25% discount), StockOpine analysis
In FY23, the segment generated $8.2 billion in sales with an operating margin of 14.7% and a 10-year revenue CAGR of 6.3%. Despite the strong performance up to FY22, FY23 witnessed a significant 17% decline in revenue and a sharp drop in the operating margin from 27.8% in FY22 to 14.7%. This decline in performance had a substantial impact on the overall profitability of the Company, given the 52% revenue weight of Skin Care business.
The challenges in FY23, were primarily stemming from headwinds in Asia travel retail and inventory destocking by retailers in North America. In Asia travel retail, especially in travel environments like airports, sales were hampered by COVID-19 restrictions and enforcement actions to control Daigou activity (refer to Travel retail for further explanations about Daigou), impacting Hainan and South Korea. The Skin Care segment, being a major contributor to travel retail, bore a disproportionate impact, while brands particularly exposed to travel retail, such as Estée Lauder and La Mer, experienced a decline in sales throughout the year.
We anticipate that the challenges faced in travel retail will be short-term, with a rebound expected as Chinese consumers resume travel and the travel channel undergoes destocking from previous years' Daigou activity.