As in most consumer goods categories, the beauty segment finds its growth mainly in emerging markets, where rising incomes and expanding middle classes push the average year-over-year top-line growth of beauty-related companies well above 6%. Here I will take a look at my favorite company, Estee Lauder (EL), which is growing fast and ready to deliver ameliorated margins.
High Growth Potential
As I just mentioned, Estee Lauder, which is held by Mario Gabelli, is my favorite company within its industry. The reason its simple: Estee Lauder has top-line and earnings per share (EPS) growth potential. I believe the company might be able to grow its overall top-line by more than 6% year over year during the next three years while growing its bottom-line at a rate that might go between 11% and 15% year over year thanks to the company's cost cutting initiatives.
Even when Estee Lauder is in its fifth year of the turnaround that managed to increase sales by 40% and double the company's margins, I believe there is still some scope for outperformance going forward. The reason for this is also straightforward: Margins for L'Oreal's (LRLCY) luxury segments are still significantly higher – L'Oreal's luxury operating margins are at about 17.4% versus Estee Lauder's 15.2%.
On the other hand, most of Estee Lauder's brands are extremely well positioned into the luxury categories, which are the ones that are growing faster and carry higher margins. In addition, Estee Lauder's distribution channel base is still in its growth phase through e-commerce, travel retail, and specialized beauty stores with international presence such as Sephora – which is owned by LVMH – and Ulta.
Valuation Looks Steep
Most definitely, Estee Lauder's price looks steep and I would not foresee multiples expanding even further. The company trades at 13.9 times 2014 EV/EBITDA and 25 times earnings. At first sight, this looks expensive even when the company is growing fast and has a net cash position of just over $720 million – or 2.6% of the company's total market capitalization. Other beauty companies such as Coty (COTY), sell for 9.3 times 2014 EV/EBITDA and 19 times earnings.
Of course, Coty is facing troubles where Estee Lauder is finding success since Coty's margins have been diminishing and the company is growing its top-line at a decreasing rate. As a matter of fact, most analysts have decreased their 2014 EPS estimates for Coty by 10% since the IPO six months ago. That said, the current premium looks too high.
I think Estee Lauder is a wonderful company but you should think twice before buying any company – even great ones – at such high prices. Remember, “value is what you get and price is what you pay.” I believe the company is fully valued and, hence, I would wait for a better price in order to go long on the name.