The Estée Lauder Companies Inc. (EL)
February 22, 2013 9:30 am ET
Fabrizio Freda - Chief Executive Officer, President and Director
Carl Haney - Executive Vice President of Global Research & Development, Corporate Product Innovation, Package Development
Tracey Thomas Travis - Chief Financial Officer, Executive Vice President, Member of Corporate Risk Management Committee, Member of Fiduciary Investment Committee and Member of Investment Development Committee
Okay, great, we're ready to get started. I just wanted to point out to you that on your tables and on some tables outside the presentation room, there are some surveys that the CAGNY Board would really appreciate you taking a little extra time to fill out. Be honest in your feedback. We take it seriously, and we want to take into account all your thoughts as we try to make this conference as valuable as possible.
Before I introduce Estée Lauder, please join me in thanking the company for sponsoring this morning's break.
I'm pleased to welcome Estée Lauder to CAGNY once again. Over the past few years, Estée Lauder has sharpened its strategic focus and taken a disciplined approach to investing in its prestige cosmetics and skin care businesses. As a result, its sales and profit growth has been among the best in the group. Here to provide an update on the company's strategy is Fabrizio Freda, President and Chief Executive Officer. This is Fabrizio's third CAGNY conference and we're glad to have him back. I'll turn the podium over to Fabrizio, who will introduce his team. Welcome, everyone.
Thank you. Good morning. So good morning. It's really wonderful to be here again for the third year in a row and update you on some of the exciting opportunities we have in Estée Lauder Companies. I want to remind you that some of our remarks contain forward-looking statements.
Today, we are going to tell the Estée Lauder company story in 3 parts. I will discuss our ongoing commitment to high sales growth, and then, 2 of our newest leaders will take the stage. Carl Haney, our Executive Vice President for Global R&D and Product Innovation will explain our successful innovation process. He will be followed by Tracey Travis, Executive Vice President and Chief Financial Officer, who will discuss our financial results and how we plan to unlock value to support our future growth.
I'm delighted that you will hear from these new members of our executive leadership team. I believe they are among the best in the industry and have added in-depth experience to our team.
Historically, the Estée Lauder Companies has been a high-growth company. This is our strength, and our strategy will continue to leverage this strength going forward. The Estée Lauder Companies is a leader in global prestige beauty, with a share of approximately 16%. The $160 billion industry expanded by 4% in the last decade and is forecasted to rise or, at least then, match over the next 10 years. Our goal is to keep growing at least 1% faster than global prestige beauty and continue to gain share.
In fiscal 2012, our sales climbed 10% equal to twice the rate of prestige beauty growth worldwide. In fiscal '13, we are estimating prestige beauty growth of about 3%, but the industry is expected to accelerate in fiscal '14 and beyond. As we look ahead, we are guided by our 10-year strategic compass, which identifies the biggest and fastest-growing opportunities shaping prestige beauty. We intend to stay ahead of the market by focusing on creativity and our technology on the best opportunities.
Several demographic trends support continued growth. The first comes from emerging markets where more women are entering the middle class and enjoying higher disposable incomes. We have had robust sales gains in many of these markets including China, Brazil and the Middle East. Also as we become more global, we are reaching a larger and more diverse population and generating increased sales by creating products for all ethnicities and women's skin tones. M-A-C, for instance, recently expanded its presence in sub-Sahara Africa by opening stores in Nigeria, Botswana and Zambia. Another factor driving solid growth is the aging of the world population which creates greater demand for many of our products, particularly antiaging skin care foundation.
There is another important way we are sourcing new consumers from mass channel and brands. Thanks in part to our outstanding new products and effective pool of talent, we have attracted consumers to our counters and contributed to global prestige beauty sales, outpacing us in many global markets including the United States, China, the U.K., France, Italy. Prestige beauty accounts for 30% of total beauty globally, so there is enormous opportunity to win over millions of new consumers from us.
We are the largest global beauty company focused solely on prestige which, as we have shown, is a preferred consumer experience in many global markets. Our creativity delivers high-quality breakthrough products, activational brands and High-Touch services in channels which are fully dedicated to "me" time. Our innovation model leverage technology, creativity and services of education and customization to make technology relevant. Our prestige model includes education, customization and personal experience. When you buy products at M-A-C, a make-up artist also teaches you how to apply them to achieve different looks. This is the ultimate one-to-one education model. In customization, a trained Clinique consultant advises the consumer on the right treatment for her skin concerns. And as an example of pleasurable experience, Origins provide Mini Facials in all its stores. Education and customization services are boosting the technology performance of our products.
We are creativity-driven and consumer-inspired and centered solely on prestige, the fastest-growing segment in global beauty.
We have a rich product portfolio of world-class activational brands. Along the prestige spectrum, our brands range from entry-level Clinique and M-A-C up to premium, with La Mer and Tom Ford. They also appeal to different sensibilities. Estée Lauder attracts consumers of varying ages and ethnicities; origins and Aveda emphasize their natural ingredients, and Smashbox and Clinique draw younger consumers. No company has a more comprehensive prestige luxury portfolio.
In the last 3 years, we have been the best-performing company in our industry, having grown twice as fast as global prestige beauty. Driving this performance is an entrepreneurial spirit and a creative mindset to deliver constant innovation across our products and services. We greatly increased our marketing spending to support growth and we also more than doubled our operating margin at the same time, partially by driving out non-added-value (sic) [non-value-added] cost.
Total shareholder return rose 242%. These terrific results prove that our strategy is working. We will continue to leverage our strength and take our strategy now to the next level. We are a $10 billion company with a stellar track record and promising future. We are boosting high-growth channels and markets, focusing on key product categories, leveraging our creativity and innovation to create superb products and High-Touch services. We continue to modernize and sharpen our capabilities and eliminate non-added-value (sic) [non-value-added] cost to reinvest in our growth. Every year, we refine our strategy based on our learnings and to hone in on areas that are the most promising around the world. Our current focus is on emerging market travelers, high-growth distribution channels and creating local relevant products, services and communications. We also are focusing on improving the efficiency and effectiveness of our advertising and promotional spending. And in our strategic modernization initiative, we are transitioning from the rollout phase to leveraging the program in capabilities to unlock new value. Consumers who lead in emerging markets have fueled our growth in recent years. But we have learned that they are also important partners of our product outside of their home countries. So we track their shopping pattern along frequent travel corridors and provide many opportunities and a seamless experience wherever they shop, they choose to shop.
In China, we are the #1 company in our luxury distribution. China is our largest Asian affiliate. It's also our most important emerging market. We continuously expand our presence to capture new consumers by entering new cities. Opening more doors and bringing more brands online through e- and m-commerce. Additionally, with growing incomes, more and more Chinese are traveling. Today, about 42 million Chinese travel internationally, a number that is expected to more than double in a few years.
Likewise, in Brazil, M-A-C Cosmetics stores helped build brand awareness and their influence is felt around the world by listing sales in travel retail locations and in M-A-C stores in destination cities such as Miami or New York. In fact, more than half of M-A-C's top 50 stores worldwide are influenced by Brazilian consumers, but only 3 of them are in Brazil.
Our travel retail business has built and reinforced the equity of all our brands. And this channel holds great potential. This year, worldwide travelers will make over 1 billion international flights and the number keeps climbing. Worldwide passengers traffic growth is estimated nearly 6% this fiscal year. Aside from the higher traffic, there is a terrific opportunity for converting more travelers into shoppers. Currently, less than 15% of them buy beauty products in airport stores. We believe that throughout our marketing and brand assortment, a greater number of travelers will become buyers, leading to incremental sales.
In the past 4 years, our compound annual growth in this high profit channel was 15%, and our travel retail business now represents more than 11% of sales. In fiscal 2012, sales in the channel exceeded $1 billion for the first time, having doubled in 3 years. We are taking our brands into more travel retail stores, aggressively advertising in busy airports and marketing to consumer even before they pack their bags. In travel retail, we are the second biggest company overall, but the first in skin care and makeup, that are the fastest-growing categories.
We have e- and m-commerce sites in 20 countries and are rapidly expanding our brand mobile capabilities, and sales from these devices are rising the fastest. As a leader in online beauty, we are investing to improve our brands' High-Touch experience, marketing tools and technology across various digital platforms. Our e- and m-commerce have more than doubled in the last 4 years, recording a compound annual growth of 24%. We expect growth to continue to be vibrant. In fiscal '13, our e- and m-commerce business is expected to increase to 5% of sales.
Our High-Touch service model is a point of differentiation versus mass in every channel where our products are sold. We tailor our service depending on the channel, and this personal experience generates loyalty and higher sales. As an example, in department stores, our brands continue to evolve their spaces and the personalized experience to stay fresh and appeal to a broad array of consumers. Clinique's unique Experience Bar is part of an open sell environment where consumers can decide how they want to shop.
Another fast-growing channel is specialty-multi, and these retailers are becoming a significant force, particularly among younger consumers. Our brands are expanding in these chains, widening our prestige distribution footprint. Smashbox and Bumble and bumble, for instance, give us a stronger presence in Sephora, and they tailor their product assortment, merchandising and communication to this store format. As Sephora expands in Latin America, for example, and Asia, we will strategically expand in new stores with them.
Our hair care brand partnered with Boots in the U.K. to create a prestige hair care category in selected doors. And many of our brands expanded into Shoppers Drug Mart in Canada, which has created beauty boutiques for prestige brands.
Our freestanding retail stores are an integral part of our long-term strategy and an excellent way to spread brand equity and connect with consumers. M-A-C had recently opened a flagship on 5th Avenue in New York and is scheduled to open soon, another on the Champs-Élysées in Paris in the coming weeks. Freestanding stores also give us an immediate retail entry where there is no existing prestige retail, such as Brazil.
Among our freestanding stores for our brands, M-A-C, Origins, Aveda and Jo Malone have a lion's share. As you can see, our stores showcase the unique personality and positioning of each brand. Of paramount importance is being relevant to all consumers throughout our products and marketing. A consumer in São Paulo may have a very different desire than one in Shanghai. So our brands feature the most appropriate products and adjust their communication and services. At counters, our brands are attuned to local cultures and focus their product assortment, language and expertise to local needs. For example, in Brazil, Clinique emphasizes its makeup collections. While in China, Bobbi Brown known primarily for its makeup, focus much more on skin care. And several of our brands developed wood-based fragrances for Middle East consumers, as shown on this chart. M-A-C recently created a makeup collection for Chinese consumers called Year of the Snake to coincide with the Chinese New Year.
Taking our mission of being locally relevant a step further, last fall, we launched the new skin care brand in Asia called Osiao. It was created in our Shanghai Skin Care Institute specifically for Asian consumers and combines the best of Eastern tradition with Western dermatology. It launched initially in a few stores in Hong Kong and we expect to bring it into China and other Asian markets, showing our deep commitment to the region.
Our local relevance and innovation also extends to our advertising and communication. In Africa, Clinique marketed its wide range of makeup shades by using billboards, buses and in-store merchandising. By eliminating non-added-value (sic) [non-value-added] costs, we have freed up resources that we have invested in greater advertising, merchandising and sampling, particularly on TV commercial and digital edge. We have broadened our media outlets to encompass TV, print, digital in numerous countries which has helped increase traffic to our counters, a source of consumers for us. Our marketing strives to connect with consumer in surprising and creative ways. Bobbi Brown is featuring its first top model, actress Katie Holmes, in its in-store display and promotional material. And Estée Lauder brand has a guest blogger on its website. Several of our brands were backstage at fashion weeks and leveraged the excitement through social media and their websites. Our advertising, promotion and communication are vitally important because they supply the sparks to get our innovation noticed.
Now we are going to show a couple of commercials that highlight some of our products. Then Carl will talk about our dedication to remaining a creative and innovative beauty company and how innovation drives every facet of our business.
Thank you, Fabrizio. I'm honored and excited to be part of this extraordinary company, leadership team and family. And today, I want to outline our strategic vision for R&D and innovation. We are committed to building our strong track record in this field. We want to create a robust portfolio and pipeline of products. We want to fuel growth for short-term, near-term and long-term.
This is our global R&D organization. It's 7 technical centers across 3 continents. Our core is skin care. And we complement this core of skin care with external networks and ecosystems, partners, universities and other sources of technology to complement our strong focus on skin care. We leverage these global capabilities to win, focused on developing locally relevant products. We test with the most demanding consumers in the world, whether it's Shanghai or Paris. And third, we want to develop this for bigger and better launches. We are a creativity-driven company and consumer-inspired. Our global creativity is built on product development teams with each one of our brands that work together with creatives, R&D and technology for a network of creativity and innovation. The best part of my job, frankly, working with one of the best companies in the world -- and I love my job. It's a brand-driven company. This is the chart that you saw earlier from Fabrizio. This is our rich portfolio of brands and we design our innovations to fit with each one of these brands. We've developed a balanced portfolio across these brands and I'm going to talk a little bit more about that. It includes balance across time, region and type of innovation. Specifically, I'll hit on 4 different types of innovation.
One, breakthrough hero product innovation; second, sustaining innovations; third, surprise and new trend; and fourth, launch and leverage. Of course, these innovation streams build up strengths; strengths in creativity innovation, strengths in service innovation and strength in locally relevant innovation.
Here's an example of one of our hero products. It's a transformational product that ensures her loyalty. It identifies what she needs and aspires to, before she even needs it, and we designed it to exceed her expectations. This is built on a track record technology. Advanced Night Repair has 30 years of innovation and technology. And these hero products beget other hero products. Here is the Eye Serum that's inspired by eye serums in Asia that extends our franchises to a whole new generation of consumers.
Clinique, even better, the category where we have led innovation. We are first with proprietary technology to address this unmet need. And we did this with hyperpigmentation technology that created a category, frankly, that others are now following. We then followed it with even better foundation, which also brings the technology in conjunction with the serum for better results on foundation. And we've now just expanded to Even Better Eyes, which converts the benefit to eyes from dark spots to dark circles.
Our hero products are also part of La Mer, where we take our Miracle Broth and improved it with a weightless new texture. And this weightless new texture has helped bring in new consumers. So technology, texture, new consumers. We're incredibly proud of this product, by the way. It's got 12 awards so far, including Marie Claire Prix d'Excellence. And this has resulted in, when you add up our skin care innovations in the United States, 17 of the top 20 SKUs are ours.
Hero products also are being designed for fast-growing segments. The male category is a fast-growing segment. We just announced last week that Lab Series PRO LS will develop a multi-benefit product that delivers 4 benefits in 1: moisture, soothing, repair with a matte finish. Of course, we have the great hero products in makeup and you're all familiar with the BB trend. This is our M-A-C Prep + Prime BB compact. So it's a new form in the BB category. And this is a way you can create new forms, new categories in fast trends.
Clinique is another critical area. But beyond BB creams, we're also creating CC creams. And we're building off a deep expertise that we have in skin tone and skin color technology to bring this benefit. We're leveraging our most popular Moisture Surge hero product and we've created the CC cream to create a new approach to color correction in this category.
Hero products are also important in our fragrance business. As an example, where we developed hero products from entry point Tommy Hilfiger, all the way to Tom Ford -- this is an example of Essenze, which is recently introduced with 5 bespoke fragrances using bergamot oil that comes directly from our own harvest in Colombia.
In hair care, we're addressing the fast-growing trend on oils with insights from our hairdressers to create Bumble's Invisible Hairdresser Oil. So it's codeveloped with hairdressers with R&D and technology to address the benefit. Another example is Ojon, with a rare blend oil. It blends 7 unique oils to provide significant repair to hair.
Second type of innovations are sustaining innovations. And this is where we take upgraded technology, new products and then, improve them. One of the best examples is Advanced Time Zone from Estée Lauder. Likewise, Clinique's Repairwear Laser eye cream are both examples where we've taken an existing property, improved it with technology and upgraded it.
Now beyond these 2 types of innovation, I want to go to a third type which is critical in our company. It's what we call surprise and new trend. What we want to do is charm her with, literally, eye candy. What this does, it leverages our creativity intuition. It builds our strong track record in this field and brings fun and excitement. But what's important about this fun and excitement is not only her to like, but this fun and excitement can be translated to in-store. And when you have eye candy in-store, it drives traffic. The M-A-C collection, Archie's collection, is a great example where we've created news, driven interest and excitement that brings consumers to the store, which then allows a M-A-C artist to then provide service, enhance the product experience, like, once they come in for Archie's Girls, but they will buy other products. We developed 40 of these collections per year and every one is surprising and fun. Another example of surprise and new trend is when we partner with designers. Marni ultra-luxe design is a good example. Artistic and quirky fashion, creatively codeveloped with a designer, bringing the Marni brand to a whole new set of consumers. That way, we partner with lead designers and fragrance houses to attract consumers.
Fourth part of our technology strength is launch and leverage. Fabrizio has talked about this in the past. It's applicable to innovation as well. Advanced Night Repair is 30 years of technology and innovation, and what are we doing? We take new stories, new claims, new regimens to reengage consumers and attract new users. This is an example where we did an unprecedented year-long study with Estée Lauder's Advanced Night Repair to show that the product delivers significant improvements, lines and wrinkles, skin clarity and skin tone.
So those are the 4 types of innovations. Now we're going to talk about some strengths that we leveraged to win. First, creativity and innovation, which builds on our advantage. Our company has extensive internal capabilities and creativity, product development, creatives and brands. But we also leverage extensive networks, makeup artists, hairdressers, salons and beauty advisors. And when you combine this service with this creativity, it enhances the product experience, loyalty and usage. Here's a picture backstage at the fashion show with M-A-C, which happened a couple of weeks ago. Our artist interpret the latest trends into new makeup looks and very quickly, those trends become new products. It helps keep consumers informed and informs the R&D innovation teams to develop better products. And also maintains our continuous collaboration with the fashion industry. That service and creativity helped drive the product experience.
Now we also need to innovate with High-Touch service, because the High-Touch service complement the product innovations. And what we want to do is create what we call "superior me time" and a great example of that "superior me time" is private convenience of Origins and La Mer, where -- when consumers want to have in-depth consultations and special services, it strengthens our relationship with consumers and it develops much deeper loyalty and continually gets them coming back because they've established a relationship with the consultant. So we're constantly searching for new service innovations.
The third area I want to talk is the importance of locally relevant and multi-ethnic design. I want to reemphasize Fabrizio's comments on this area. And our vision is very simple. We want to be a sustainable worldwide beauty powerhouse for multiethnic, multicultural, multi-tiered world. It's that simple. And we want to do that because beauty dreams are unique in preferences, needs and desires and we strive to tailor our offerings, model approaches for local cultures, design for specific populations. A great example of this is our locally relevant and multi-ethnic design on Estée Lauder's Supreme creme. This was designed by, and developed for, Europe to address European needs for multi-benefits in a cream. This allows us to enter new segments and successfully attract new consumers. The result is we're #1 in Italy and France and recognized by the prestigious Marie Claire award. And that gives you an example of how these things come together into products that are recognized as superior and we're being rewarded in the marketplace.
Now I'd like to show you a couple of commercials for some of our more recent innovations. And after which, Tracey Travis, our new CFO, will join and describe how we're working together to unlock for future growth.
Tracey Thomas Travis
Thank you, Carl. It is certainly an exciting time to join the Estée Lauder Companies with so many of our growth opportunities still ahead of us.
Fabrizio and Carl just shared with you our corporate strategy and much of the creativity and innovation that has provided us with additional profit growth opportunities over the past few years. And as we transition from our restructuring and resizing activity, which started in 2009 and which ends this year and has supported the funding of additional capabilities in the organization that will be critical to enable future growth, we have created a company that is also beginning to have greater structural efficiency and flexibility. We will continue to build on, and are beginning to realize value from, the prior efforts to focus resources behind critical growth enablers such as digital marketing, consumer insights, product innovation and talent development. And we are in the final stages of investing behind our Strategic Modernization Initiative or what we call SMI, including the implementation of our enterprise-wide IT system, which should enable us to better leverage the scale of our growing business. We expect this combination of enhanced capabilities and focus resources on our greatest return on investment opportunities, will support a continued increase in shareholder return. And we expect the combination of all of our strategies to continue to deliver strong, mid-single-digit top line growth, which we have targeted ahead of the anticipated global prestige beauty growth. This level of sales growth should give us the flexibility to reinvest appropriately in new opportunities and drive margin expansion through greater productivity and leverage.
Our sales growth will be accomplished from a combination of the innovation we expect to deliver on existing products, the launch of new and exciting products targeted towards our global consumers' desires and aspirations and our ability to leverage the appropriate distribution channels for our portfolio of prestige beauty products.
Over the past 4 years, we have managed to double our operating margins through a combination of both leveraging top line growth and cost savings programs. The restructuring and resizing program, which again began in 2009, is expected to provide savings of approximately $760 million to $785 million through the end of fiscal 2013. Cost of goods and organizational restructuring provided savings at the beginning of the program, while indirect procurement savings are providing an enhanced level of benefits in more recent years. These cumulative savings have allowed us to invest in additional advertising and capability while delivering increasing profitability and free cash flow. In the future, the full implementation of SMI will provide us with the capabilities to generate additional savings and greater operating efficiencies, and combined with our sales growth expectation, should enable additional margin expansion.
Many of you who follow the company are probably aware of our SMI program. For those of you who aren't, and as a reminder to those who are, here's a brief description. We're transitioning to a company that maintains the distinctiveness of our brands while operating and executing in a more consistent manner. The scope of our program covers our entire global footprint and includes our full product delivery system, starting with suppliers to manufacturing to distribution and, ultimately, to our broad base of customers around the world. It will assist us in leveraging our increased skills and in supporting our efforts to drive out non-value-added cost, better manage our increasing product and geographic diversity and help us improve our inventory turnover through providing better information to assist us with decision-making. In short, we're building a highly integrated and more effective company.
We've made tremendous progress so far in implementing SMI. After the January launch of our third phase of this program, we now have over 60 sites deployed, covering approximately 3/4 of our total net sales. The next wave, which is slated to go live in January of 2014, includes markets like Japan, the Middle East and our travel retail channel. By this time next year, following Wave 4, more than 90% of our sales should be SMI-enabled, which should allow us to begin to realize a net benefit from this program for the first time.
The advertising area is another example of where we expect to yield benefits from capability-building and through additional SMI investments. In fiscal 2012, we spent almost $2.5 billion in advertising, merchandising and sampling. It's our largest expense category at approximately 25% of sales. We believe this area represents a meaningful opportunity to improve both efficiency and effectiveness where we expect to generate more return from the spending we do by enhancing our use of additional consumer insights to target our spending more effectively, engaging our consumers more impactfully through enhanced content in our messaging, and utilizing advanced tracking and measuring tools to assess the return on investment from our spending.
We also expect to obtain enhanced returns on the investments we have made in research and development, emerging market expansion, digital capabilities, freestanding stores and as mentioned before, our improved systems capabilities.
As our operating results have steadily improved, we have reinvested our increasing operating cash flow back into the business through capital spending to support counters, new stores and our enhanced IT systems. The remainder of our free cash flow has been primarily returned to shareholders through dividends and share repurchase activity.
In fiscal 2013, our board approved an increase in our authorization to purchase an additional 40 million shares of stock. The board also approved a 37% increase in our dividend to $0.72 per share annually. And we continue to look opportunistically for acquisitions that will further enhance our growth objective. The last major acquisition the company did was Smashbox in fiscal 2011.
All of our recent efforts in enhancing our profitability and investment criteria have resulted in a steady and continuous improvement and return on invested capital over the past few years. Our results are currently best-in-class among our peer group. Earlier this month, we reported our fiscal 2013 first-half results. Sales rose 6% in constant currency, a solid performance given the macro challenges we experienced in both Southern Europe and in Korea. Operating margin reached 20.9% and our earnings per share rose 13%. As mentioned previously, we also distributed more cash back to our shareholders in the form of increased share repurchases and dividend.
For the year, we are forecasting constant currency sales of gains of 6% to 7%, operating margin improvement of 70 to 90 basis points and 11% to 14% earnings per share growth. The combination -- our combination of world-class brands and world-class capabilities allows us to create a best-in-class company for our customers, shareholders and employees. Best-in-class to us means continuing to anticipate our consumers' aspirations globally, reach them where they want to have a premier and inspiring service experience with premium products and continue to exceed their expectations with the incredible advantages we have as a company in terms of creativity, technology and service to our consumers. Delivering important value to our consumers in both the products and services we provide with improved executional efficiency should allow us to continue delivering exceptional value to our shareholders.
Thank you for letting us share our company's strategy with you. And now Fabrizio, Carl and I are happy to take your questions at this time.
Fabrizio, one question with regards to trying to improve the efficiency of the A&P spending. To what extent the flip side of having a fragmented portfolio, having so many brands, inevitably dilute data spending because you just have way too many brands? That's question number 1. And separately, in terms of looking into leveraging and looking into your second or your next leg of savings or margin expansion, I think that by the end of this year, you will be running nearly 900 stores. How does the profitability of these freestanding stores compares to the company level? And to what extent the opening cost is something that needs to be also included into -- as an offset in terms of margin expansion?
Yes. Let me take the one on advertising, then I'll give you a few words on freestanding stores. I'll let, then, Tracey to comment on our future programs, making sure that freestanding stores are profitable. First of all, we have many brands because each brand has a different task and cover a different opportunity. Every brand has a different A&P, advertising and promotion model. So not every brand -- the television, actually, today 3 or 4 of our brands use television, some of our brands do print, most of our brands do digital, some of our brands do only in-store. So the efficiency of A&P in our company is not only about better television advertising. It's really about efficiency, the way we sample, the way we do consulting in stores, the way we manage counter constructions, the way we manage productivity per door from a selling standpoint; and obviously, the way we do digital, the way we do print and advertising. So it's a very complex model that we're working on and will give us competitive advantage in every single one of our brands. Actually, to your question, you say you had too many brands, I think the portfolio brand is a strength but the important thing is to realize that every brand has a different A&P model, and we will make all of them more efficient. In terms of your second question, freestanding stores, yes, we're going to have, soon, 1,000 freestanding stores around the world. It's a huge area of strength. And to be clear, they tend to be more profitable than what the alternative would be, where we use them. Because when we use them -- as an example, M-A-C Brazil, any alternative to that in Brazil will be less profitable. And so they're pretty -- they're profitable. Still, there is work to be done over time to make them more profitable. What is the key word, is high traffic. The better traffic they attract, the more profitable they are. And there is another kind of freestanding stores, which we call flagships. Like, I don't know, the M-A-C in Champs-Élysée that we will open in a few weeks, that they also operate as advertising. In a sense, they create the equity. So some of these stores -- there are a few, there are 5 to 10 in total, but they will also be looked at as advertising investment. And Tracey, do you want to add something?
Tracey Thomas Travis
I think you answered it well. I mean, in terms of store opening costs, obviously, those vary depending on the type of store that we open. But certainly in our financial projections going forward, as we increase our number of stores, the store opening cost expense will be in there. And as Fabrizio mentioned, really, retail is all about high productivity and making sure that you have the capabilities of picking the right locations -- that are in high-traffic locations, that you create the right in-store environment which certainly, I think M-A-C has done a fabulous job of, and our other brands are doing great jobs as well like Jo Malone and Aveda. And we will continue to leverage that and to do that.
My question is about your 2 biggest brands, Clinique and Estée Lauder in the U.S. You sort of led industry growth in skin care with hero products under both brands, and now seem to have moved on a little bit more to flankers and you're being copied. And I know you're doing well, but maybe not as well as you were before in skin care versus the industry. And then, we've got the sonic wave device trend that's going on. So I'm wondering when we're going to get the next hero products out of those 2 brands, are we going to see anything in the next 6 to 12 months? And is there -- and as part of that, do you have any intention to participate in that sonic wave device trend?
I'll just -- to start and I'll let Carl complete the answer. First of all, what category, I think, has demonstrated that we have not totally done what you said, meaning creating some hero products, creating new categories like Dark Spot Correction or Even Skintone. We have created the internal capability to do these repeatedly, sustainably for the next 10, 20 years. So it's not 1 thing. We will do many. I think we have the best-ever pipeline we had in the company so far. And we will continue to surprise and delight the consumer on many aspects. The fact that we are flankering Even Skintone is -- should not be taken as a lateral step. Just because there are so many opportunities to do it. And in fact, the franchise, for example, Even Better, continues to grow outstandingly than the category. Importantly, competition is following and we are flankering ahead of them. They will flanker as well, and we'll go to the next level. To be very clear, we are leading and we'll continue to lead. On your point on devices, yes, devices are in this moment growing for cleaning, cleaning the face with a device. I personally disagree. They are a skin care item amply put in the U.S. It's like putting in the toothpaste market the electrical toothbrushes. It's not the same thing. So devices are growing, but the market of skin care is growing fantastically well and will continue to grow. And in that market, we're winning and continue to build market share at every step. So the question should be, do we have a device strategy for the future? Yes, we have. But that's not the point. The point is that skin care per se will continue to be an attractive category. We will continue to win into skin care per se. Carl?
Sure. And on the -- do we have innovations coming in on our biggest brands? As I said earlier, we have 4 streams of innovations across our brands, and our biggest brands are going to have their tremendous investment across all 4 streams, including hero products and surprise and delight, as well as launch and leverage. So there will be -- and we have a robust portfolio for those brands, and for all our brands.
I just want also to add one thing. You have seen CC cream from Clinique, which is going to be launched in the next weeks in the U.S. You're going to see that. This is a big idea. This is a big, new category. Again, it's the fifth new category we created in only 2 years.
Two questions. I know M-A-C is doing very well in makeup, but if you look at Estée Lauder and Clinique, there've been a lot of growth in color cosmetics that just doesn't seem to have been captured fully by those 2 brands in the U.S. So if you could just talk a little bit about that. And then secondly, I have to ask, out in China, if you could update us, Fabrizio, what you're seeing and how you look at that market, which has been a little soft in same-store sales in the big cities? But how should we think about that?
Yes, let me start. First of all, Clinique is doing very well on makeup globally. Chubby Stick has been the best initiative that's been done in a long time in the entire company. And so I think Clinique is very, very solid. On Lauder, in the U.S., we did have a moment of less strong sales on the color aspect. As you know, the Lauder brand is extremely strong in foundations. And it continues to grow. If you will look by category, it's continuing to do very, very well in foundation. We didn't have the best color collection during a season, and we are going to catch this up in the next year. So don't consider it a trend. Consider it a color collection season that was not the most competitive in the market for a moment. While Clinique, I think, will do very, very well. By the way, yes, the U.S -- the U.S. if you look at the makeup market, brands like Bobbi Brown, M-A-C, Smashbox are doing fantastically well. So it's true that consumers in makeup have been paying a lot of attention to these makeup artist brands. That's why we have a portfolio. And that's why if Clinique wins more in skin care and for 1 year or for 6 months, they win less in makeup, frankly, that's not an issue for the long-term. I just want to say, Clinique will be very successful in makeup. And our total makeup portfolio brands is capturing -- the biggest opportunities. On China, China is doing well. I mean, actually, all the results we have published in December confirm that in China, we are growing. We are the biggest company in China in luxury in our distribution. I don't know how our competitor calculate the numbers, and with China in category, we can put in -- depending which categories you consider. But assuming you consider skin care and makeup and fragrances, we are the biggest company and so the brand is growing the fastest. And it's very, very strong. And as I explained many, many times, in China, I think the issue is not really who grows faster at 1 point or 2. China is big, will be growing big. The first 2, 3, 4 companies that will do a good job will yield enormous rewards from China. So -- and we -- our focus is really to grow strongly also in secondary and tertiary cities because China -- we call it like 1 country, but in reality, China goes to different speeds in different parts of China. The tier 1 cities of China are really very developed. They're already start looking like developed countries which are growing, but they are growing less fast than what's happening in tier 2, tier 3 cities. There are parts of China which is really skyrocketing. Growing very fast is the internal traveling. I mentioned there are 42 million people traveling -- Chinese traveling outside of China. There are 300 million Chinese traveling within China. And so all the internal travel of China is a huge opportunity that we are capturing and trying to address. So China may have some ups and downs in the future, depending on government, changing economy, but the trajectory, frankly, is outstanding, very exciting and we are completely focused on it. Yes?
Fabrizio, if it were up to you, and you didn't have the family involved as it is. What would you do with the capital structure in this business? It just seems to me that you can do a whole lot more with the business, it doesn't seem to need a leveraged structure that you have right now, which is to say, none. So sort of curious if you're going to have to take 1 piece of the puzzle out of it, what would you do? And then secondly, a follow-up question for China. One of the luxury peers out there have commented on cannibalization in these lower-tier cities from the larger cities in terms of new store openings. Maybe, if you could comment a bit on how you see that from your business standpoint? That would be helpful.
Sorry, could you repeat? In China? I didn't understand exactly.
So basically, as you go into Tier 3, 4, 5 cities, how does that affect your sales in Tier 1 and 2 cities, especially as people don't travel as much to those 1 or 2 Tier cities anymore to buy.
Let me take it first, China. I'd like Tracey to think how to answer your capital structure. Because I don't think I want just to clarify, I don't think what we do with the family or without the family. I think the family is one of our most important shareholders. Now what we would do for all the shareholders is the answer. And I'm going to answer this in a second. China is -- I think the development of a Tier 3 or 4 city is high potential but we need to do it well. Meaning, the profitability of our business is depending very much from sales per door. So in these cities, when we arrive and we are first, and we start opening a few doors, these doors are very high traffic. So the good news, the opening a new city for an exciting new door of Estée Lauder creates a lot of traffic. So it's profitable, very fast. The Chinese that are traveling from 4-tier city to Beijing to buy is an important thing. And that's what's making Beijing and Shanghai -- the more we open the cities, the more they will become like developed markets, as I say. So they will stop growing very exponentially. We see a similar trend in e-commerce. Today, we cover with our e-commerce 350 cities. What I think is interesting is that I think it's 70%, 75% of our e-commerce sales comes from cities we do not cover, with brick and mortar. Just showing that our brands' demand is already there, it's just they don't have the possibility to buy. So they buy it when they travel to the capital cities or online. So the point is, the market is growing and the important thing is not if the consumer is buying regimen on a Tier 4 city, it doesn't matter. The total is growing a lot. And as far as we grow with high sales productivity per door, we will grow very profitably and that's the strategy. On the capital structure, I just like Tracey to answer, but I'd like to answer -- the point is really, I don't set a Plan A and Plan B, depending -- if I imagine the family or not the family. We have 1 plan for all our shareholders and that's frankly, the way we look at the company and the business. Now what is our thinking of capital structure in the future? I'd like Tracey to say a few words.
Tracey Thomas Travis
And I'll just reinforce the fact that we are a public company and we actually have a board with independent board members. So this is a conversation, obviously, that we have a quite often with the board as they are interested in our view, given our growth strategies of what the capital structure should look like as well. What I would say in terms of the investment priorities of the company, the first, given the fact that we're a high-growth company, we have lots of growth opportunities, as you heard from Fabrizio and from Carl is to reinvest back in the business. So that's capital -- is to support new counters, capital and expense to support R&D. We also looked for investment in systems and e-commerce. Those are high-growth areas and high return areas for us and I've shared with you our return on invested capital as it relates to that. The second is, is there any acquisitions that are out there that will support our acquisition and our portfolio strategy? We certainly look for that as well. But we, right now have enough operating cash flow globally to support our working capital needs, our capital needs as well as distribute cash back to shareholders via returns -- via dividends and share repurchase activity. Right now we don't need additional debt. And understand that from a return model standpoint, having -- taking out additional debt, really, right now to redistribute back to the shareholders would be the use of debt right now. And it's a great time to take on debt. Debt rates are still low. However, if we saw a real opportunity for a strategic acquisition, I think that's something that the board would consider and ultimately, make a different decision. But right now I think we're managing the balance sheet, albeit, maintained conservatively, but responsibly, given our investment opportunities.
Fabrizio, two questions for you. One is, if you look historically with your local currency growth, can you, just even by gut, disaggregate how much is distribution gain versus how much is kind of comp store? And then, as you look forward your 6% to 8% growth long-term target, what's the composition of that along those 2 dimensions, comp store versus distributions?
Yes, the large majority is comp. We have a relatively small percentage of new doors that we're opening around the globe. The real -- the new doors are concentrated in new countries like China, obviously. And in places like Brazil and in some freestanding stores in Europe. But if you think that the total of our freestanding stores is 10% of our business, and that China is 5%, so you have at least 70% of our business, which is mainly driven by comp and 30% of our business, which is driven by a combination, and this combination, obviously, varies country by country but still, the comp will be at least 60% even in those markets where we are delivering as a growth. The other thing I want to clarify is that I look at comp as an important measure but the new distribution, in most of the cases, means new consumers that were not accessible before don't mean diluting of the existing door. We have a very sophisticated internal model. We never, I say never meaning, even in emerging markets, we never open a new door if this will mainly cannibalize an existing one or take comp, that's actually one of the big subject of debates with many of our retailers. We don't have a concept of full distribution. Simply, it's always done better exactly for that point, to make sure that new distribution is not a different animal from comp, just new consumers.
And then, my other question is around price differentials across CAGR, across geographies. So your prices are different for the like-for-like products across geographies. Is that a net opportunity or is that a net risk as the consumer globalizes more?
I think pricing overall for us is a net opportunity. As I said, historically, we've been growing prices 1% a year. We have learned in the last 2 years, with a lot of work on pricing to go to 2.5%. 2% is what probably we're going to see this year. So we have doubled our ability to using pricing power and to leverage prices versus a few years ago. This is, this 2% is a net of some countries we have the opportunity to increase more. In some countries, we will not increase or even make some decreases to adjust the price. So but the combination of the 2 will to be around 2%, a leverage point for our future. But also the pricing war we have done, which has showed us opportunities in some market -- mainly developed markets, is also our opportunity then to adjust some emerging markets where the price premium, over time, will need to be moderated. And to make sure that the net of the 2 remains a positive for the company overall. There are 3 pricing projects which are existing today. One is the new launches, how we price the new innovation and we know there is a lot of leverage on this 1. The existing business position within every market, where we make adjustments sometimes to make sure that we are competitive within a market. And as you said, the differences between markets which, over time, will need to be adjusted. But adjusted -- exploit in this power -- pricing power in the other 2 elements.
We probably have time for 1 short question.
There was 1 here. Yes?
Excellent, slipped in. Tracey, quick question for you. You mentioned SMI, you expect to become a net benefit for the first around this time next year. Can you give us a sense of how much expense you're absorbing today with that initiative and maybe the timing of how that rolls off?
Tracey Thomas Travis
So I would -- as I mentioned in my remarks, as you referred to. In January of 2014, we're going live with the last wave of SMI. There has been, over the last few years as we've talked about as a company, a fair amount of expense and dedicated people associated with the SMI rolloff or with the SMI implementation. Certainly, those individuals will be absorbed back into the organization into day-to-day business roles. So that startup, if you will, investment that has happened over the last few years will reduce. SAP is certainly a higher cost model than legacy -- we fully depreciated legacy systems, as you're well aware. So it does come with incremental cost. But when I say the net, the net between the cost that we have carried over the last few years, of the project team and the net of the incremental cost that we will have post-SMI, will be a net benefit. And I think we'll be prepared to communicate more when we give guidance over the next few years, what that will mean. We're quite excited about the additional capabilities that SMI will give us to leverage margin expansion as well as top line growth, as I tried to share in my prepared remarks.
Great. Thank you Fabrizio, Tracey and Carl, for an excellent presentation. And thanks, again, for sponsoring the break.
- Investment & Company Information
- Fabrizio Freda
- Estée Lauder