No Slowing Down This Cosmetics Retailer

GuruFocus.com
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- By Mark Yu

Estee Lauder (EL), the $38.9 billion New York-based cosmetic manufacturer and marketer, was pitched by Bloomberg to be a qualifiable takeover brought by potential margin improvements that could be achieved if one is to take place.


Meanwhile, Estee Lauder reported a 5% rise to $11.82 billion in revenue in its recent fiscal year that just ended in June. As observed, the 3% increase in total operating expenses did not affect the company's bottom line as it reported a 12% increase in profits to $1.25 billion resulting in a margin of 10.6% compared to 9.9% last fiscal year.


"Throughout the fiscal year, our momentum accelerated, culminating in an outstanding fourth-quarter performance that completed another year of strong net sales and earnings per share growth. These results reflect our success in pivoting our business to the fastest-growing areas of prestige beauty to align with consumers' changing shopping preferences. With our leading brands, quality innovations and the acquisition of two makeup brands, we attracted new consumers globally. Our business accelerated in our online direct-to-consumer and retailer e-commerce sites as well as in the travel retail and specialty multichannels, and we built momentum in key geographies, like China and Italy, aided by enhanced digital and social media communications. Additionally, we began to further improve our organizational efficiency and effectiveness through our Leading Beauty Forward initiative. Importantly, we delivered this performance in the face of external global volatility and one of the biggest moments of change in our industry.

"We expect the great momentum we built throughout the past year to continue in fiscal 2018. We are well positioned to deliver strong profitable growth as we deploy our prestige brand portfolio to new consumers globally through our hero product franchises and robust new product pipeline, new digital-first marketing approach and focused expansion for our smaller to midsized brands

"In our 2018 fiscal year, we expect to see initial net benefits from our Leading Beauty Forward initiative, and we will continue to focus on increasing the efficiency of our operations, eliminating nonvalue-added costs and generating sales leverage while strategically reinvesting to support strong and sustainable growth. Our full-year outlook in constant currency reflects net sales growth of 7% to 8%, including incremental sales from our fiscal 2017 acquisitions and 9% to 11% earnings per share growth. Looking out over the next three years, we continue to target constant currency net sales growth of 6% to 8% and double-digit EPS growth." - Fabrizio Freda, president and CEO



Valuations

Estee Lauder is currently overvalued compared to peers. According to GuruFocus data, the company had a trailing price-earnings (P/E) ratio of 31.55 times vs. the industry median of 20.17 times, a price-book (P/B) ratio of 8.87 times vs. 1.73 times and a price-sales (P/S) ratio of 3.33 times vs. 1.06 times.

The company also had a 1.29% trailing dividend yield with 39% payout ratio.

Average fiscal year 2018 revenue and earnings-per-share estimates indicated forward multiples of 3 times and 26.6 times.

Total returns

Estee Lauder has handsomely returned 39.52% to its shareholders so far this year compared to the Standard & Poor's 500 index's 10.75% total gains.

Estee Lauder

According to filings, the Estee Lauder Companies Inc., founded in 1946 by Estee and Joseph Lauder, is one of the world's leading manufacturers and marketers of quality skin care, makeup, fragrance and hair care products.

The company's products are sold in over 150 countries and territories under a number of well-known brand names including: Estee Lauder, Clinique, Origins, M-A-C, Bobbi Brown, La Mer, Jo Malone London, Aveda and Too Faced.

Estee is also the global licensee for fragrances and/or cosmetics sold under various designer brand names, including Tommy Hilfiger, Donna Karan New York, DKNY, Michael Kors and Tom Ford.

The company sells its prestige products principally through limited distribution channels to complement the images associated with its brands. These channels consist primarily of department stores, specialty multibrand retailers, upscale perfumeries and pharmacies and prestige salons and spas. In addition, Estee 's products are sold in its own and authorized freestanding stores, its own and authorized retailer websites, stores in airports and on cruise ships, in-flight and duty-free shops.

Meanwhile, Estee has been controlled by the Lauder family since its founding. Members of the Lauder family, some of whom are directors, executive officers and/or employees, beneficially own, directly or indirectly, as of Aug. 18, shares of Class A common stock and Class B common stock having approximately 87% of the outstanding voting power of Estee 's common stock.

As of June Estee operated approximately 1,430 freestanding stores and more than 500 freestanding stores are operated around the world by authorized third parties.

Estee currently sells products from most of its brands directly to consumers online through company-owned and operated e-commerce and m-commerce sites in approximately 35 countries.

The company has five segments: skin care, makeup, fragrance, hair care, and other. Estee also provides specific margins it generates per geographic region: Americas (41% of sales), Europe, the Middle East & Africa (39% of sales) and Asia/Pacific.

Skin care

In fiscal year 2017, revenue in Estee 's skin care business increased 1.8% to $4.53 billion (38% of unadjusted sales) and delivered an operating margin of 22.4% (most profitable among all segments) compared to 18.9% in previous year.

Makeup

In fiscal year 2017, makeup revenue rose 7.5% year over year to $5.05 billion (largest revenue generator; 42.7% of unadjusted sales) and had 14% margin compared to 16% a year earlier.

Fragrance

In fiscal year 2017, fragrance revenue increased 10% year over year to $1.64 billion (13.8% of unadjusted sales) and margins of 7% compared to 5.9% in the prior year.

Hair care

Revenue in hair care declined (-)2.7% year over year to $539 million (4.6% of unadjusted sales) and margins of 9.5% compared to 9.4% a year earlier.

Other

Revenue in other business also declined (-)6.8% to $69 million and registered 15.9% margin vs. 6.8% a year earlier.

Sales and profits

In the past three years, Estee Lauder registered revenue growth average of 2.53%, profit growth average 1.23%, and profit margin average of 10.2%.

Cash, debt and book value

As of June, Estee Lauder had $1.14 billion in cash and cash equivalents and $3.57 billion in debt with a debt-equity ratio of 0.81 times compared to 0.63 times a year earlier. Overall shareholder equity increased by $812 million year over year while debt climbed $1.33 billion.

Of Estee 's $11.57 billion assets 28% were identified as goodwill and intangibles while book value increased by 22.7% year over year to $4.4 billion.

Cash flow

In fiscal year 2017, Estee 's cash flow from operations increased by 0.6% year over year to $1.8 billion while capital expenditures were $504 million leaving the company with $1.3 billion in free cash flow compared to $1.26 billion in the prior year.

The company also raised $1.35 billion in debt (net repayments) and provided 69.6% of its free cash flow in dividend payouts to both shareholders and noncontrolling interests including share repurchases.

In the recent three quarters that ended in June, Estee Lauder repurchased 527,594 of its shares at an average price of $94.6 per share.

The cash flow summary

In the past three years, Estee allocated $1.5 billion in capital expenditures, raised $2.25 billion in debt, generated $4.03 billion in free cash flow and provided $3.56 billion in dividends and share repurchases at an average free cash flow payout ratio of 88.3%.

Conclusion

Estee Lauder clearly has had its business continuously growing in recent years including its recent fiscal year as the company recorded even better profitability when compared to its prior yer operations. The company sees no slowdown as it expects the number of freestanding stores (company operated and/or authorized third party) to increase over the next several years.

In addition, the company expects that its online net sales to continually grow strongly on a global basis. Exact growth figures for online sales were not observed in recent company filings.

Meanwhile, Estee has a more leveraged balance sheet this fiscal year accompanied by nearly one-third of its assets in goodwill and intangibles. The company also has rewarded its shareholders with a prudent free cash flow payout ratio in recent years.

Analysts have an average overweight recommendation on Estee 's shares with a target price of $114.52 per share vs. $105.66 at the time of writing. Using average revenue estimates multiplied with a three-year P/S average followed by a 20% margin indicated a figure of $77.23 per share.

Certain takeover approach may be prescient, but Estee should be a hold at the current price.

Disclosure: I do not have shares in any of the companies mentioned.

This article first appeared on GuruFocus.


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