The Estée Lauder Companies Inc. (EL, Financial) has long enjoyed a reputation as one of the great beauty products companies in the world.
Not only does it sell its namesake products, but through internal development and strategic acquisitions, it has developed a stable of more than two dozen brands that cover both entry-price customers and what it calls Prestige Beauty customers.
Until recently, it had a growing share price that reflected its iconic status. Now it trades well below levels hit in 2016 as shown in this three-year chart:
The company enjoys 5-Star Predictability status at GuruFocus, and Wall Street analysts give it lots of strong buy recommendations. At the same time, though, it has long-term debt, a high price-earnings (P/E) compared with its peers and some overvalued metrics.
What is an investor to make of these mixed messages?
History
1946: Estée Lauder introduces her first four products, selling them in New York beauty salons.
1947: First big department store order from Saks Fifth Avenue.
1960: First international sales to Harrods of London.
1995: The Estée Lauder Companies goes public on the New York Stock Exchange.
1996: The company launches its first e-commerce sites for Clinique and Bobbi Brown.
2000: Buys a majority interest in Bumble & bumble, a hair styling school and hair products.
2010: Acquisition of Smashbox, a line of makeup used by movie studios.
2011: Arranges strategic licensing agreements with high-end luxury brands including Ermenegildo Zegna.
2012: Net sales exceed $10 billion for the first time.
2014: Several acquisitions, including RODIN, Le Labo, GlamGlow, Malle and Kilian.
History based on information at the company’s Web site.
Comments: A now 70-year-old company that went public more than 20 years ago; a good appetite for expansion by acquisitions.
The business
The Estée Lauder Companies is in the fragrance (perfumes), skin care, makeup and hair care products business. It manufactures and/or markets some 25 brands; its own lines include Estée Lauder, Clinique, Origins, M*A*C, Bobbi Brown, La Mer, Jo Malone London and Aveda. It is also the global licensee for several designer brand names including Tommy Hilfiger, Donna Karan New York, DKNY, Michael Kors and Tom Ford (unless otherwise noted, the information here and below comes from the company’s 10-K for 2016).
This image from the company’s presentation to the Barclays Global Consumer Conference on Sept. 8, 2016, shows how it has positioned those brands:
Those brands are segmented into five categories:
- Skin Care: includes moisturizers, serums, cleansers, toners, body care, exfoliators, acne and oil correctors, facial masks, cleansing devices and sun care products.
- Makeup: products for the face, eyes, lips and nails, many in an extensive array of shades and colors, as well as related items such as compacts, brushes and other makeup tools.
- Fragrance: including eau de parfum sprays and colognes as well as lotions, powders, creams, candles and soaps based on particular fragrances.
- Hair Care: shampoos, conditioners, styling products, treatment, finishing sprays and hair color products, sold mainly through prestige salons and other high-end retailers.
- Other: ancillary products and services.
The company refers to itself as being in the Prestige Beauty business; this involves high-end retail channels including upscale department stores, specialty multibrand retailers, upscale perfumeries and pharmacies and prestige salons and spas.
Its biggest customer is Macy’s Inc. (M, Financial), which serves mainly the domestic market and represented 9% of consolidated net sales in fiscal 2016.
Uniquely for a company of this size, the founding family continues to hold the reins: “Members of the Lauder family, some of whom are directors, executive officers and/or employees, beneficially own, directly or indirectly, as of Aug. 18, 2016, shares of Class A common stock and Class B common stock having approximately 87% of the outstanding voting power of the common stock.”
Comments: This family controlled company holds a substantial chunk of the beauty business, through more than 25 brands. Some of those brands are owned in house, and some are based on licenses from leading designers.
Revenues
For fiscal 2016, Estée Lauder generated $11.262 billion of revenue, made up from the following:
As the image shows, makeup is supplanting skin care as the company’s biggest income generator.
This chart shows how revenue has grown over the past 10 fiscal years:
In the First Quarter 2017 Financial Report, management indicated revenue should grow vigorously again this year: “Throughout the remainder of the fiscal year, we expect our sales growth to progressively accelerate based on a steady flow of new products, momentum and increased targeted consumer reach for our small and mid-sized brands and M*A*C, and increased social media initiatives to drive brand engagement.”
Comments: A solid history of revenue growth and more of the same should follow this year. With a broad stable of product lines, the company has multiple opportunities for strategic growth.
Competitors
The company says its important competitors are, like it, big multinational manufacturers and marketers, including L’Oreal S.A.; Shiseido Co. Ltd. (STU:SHD, Financial); Beiersdorf AG (XTER:BEI, Financial); LVMH Moët Hennessey Louis Vuitton (XPAR:MC, Financial); Coty Inc. (COTY, Financial); Proctor & Gamble (PG, Financial); Avon Products Inc. (AVP, Financial); Chanel S.A.; Groupe Clarins; and Amorepacific (AMRPF, Financial).
Hoover’s lists its three main competitors as Proctor & Gamble, L’Oreal and Coty.
In the 10-K, Estée Lauder says factors affecting consumer choice include brand recognition, quality, performance, availability and price. In addition, buying decisions are swayed by advertising, promotion, social media activities, merchandising, the pace and timing of new product introductions, line extensions and the quality of in-store demonstrations.
Comments: Estée Lauder competes in a crowded field with other big, established companies, some specializing in beauty products while others, like Proctor & Gamble, are large, diversified firms.
Moat
Morningstar (MORN) awards the company a narrow moat, saying, “At more than $10 billion in annual sales, Estée Lauder has size, scale and a strong global network spanning more than 150 countries. As a result of its solid brand portfolio, we believe it has earned a narrow moat. The firm has a 25% share in the global prestige makeup market, holding the No. 1 or 2 position in 18 countries.”
The Morningstar analyst also notes the company’s scale should give it more leverage over suppliers, and cash flow to invest in research and development. And the analyst reports consumers are willing to pay up for branded beauty-care products.
In the Barclay’s presentation, the company argues that it has several competitive advantages:
Comments: Given its position of prominence in the beauty-care industry as well as its strong brands, Estée Lauder seems worthy of a solid narrow moat.
Growth
As seen above, revenue has grown over the past 10 years. Looking at specifics, the company has posted ongoing growth metrics on several fronts:
- Revenue (three-year average): 5.1%.
- EBITDA (three-year average): 4.1%.
- EPS (three-year average): 4.7%.
- Operating margin (five-year average): 3.3%.
Regarding the latter, GuruFocus says, “NYSE:EL's Operating Margin is ranked higher than 81% of the 1,565 Companies in the Global Household & Personal Products industry.”
In its Barclay’s presentation, the company provides this snapshot of growth history and prospects:
It also says that it is seeing growth in all regions and all markets. In particular, it calls attention to growth of more than 25% in emerging markets (excluding China) and double-digit growth in the U.K.
Most of its growth emphasis is in brick-and-mortar stores, both its own and those of authorized retailers, but it also sells online through its own Web sites and those of authorized vendors.
In his article, "6 Stocks With Strong and Sustainable Yields," Tiziano Frateschi includes Estée Lauder. His criteria? “Stocks that have a five-year growing dividend yield with strong profitability and a long-term track record of solid returns and growing asset values.”
Comments: While its growth metrics may not match those of other industries, Estée Lauder has a strong record within its industry and good prospects for future growth.
Other
The company is headquartered in New York.
The fiscal year runs from July through June, and fiscal 2016 ended on June 30, 2016.
It employs 46,000 at home and in other countries.
Executive Chairman of the Board: William Lauder, age 55, a member of the family and lifetime employee has held this position since 2009.
CEO and Director: Fabrizio Freda, age 59, has held the post since 2009. Before joining Estée Lauder, he held a number of management positions at Procter & Gamble including a decade in its Health and Beauty Care division.
Chief Financial Officer and Executive Vice President: Tracey Travis, age 54, has held these positions since 2012 (officer information from Reuters.com).
Ownership
Estée Lauder has two classes of shares, A and B, with A being traded publicly. The company says, “The Lauder family owns approximately 40% of the total common stock (through both Class A and Class B shares) and about 87% of the voting power. Class A shares have one vote per share; Class B has 10 votes per share.”
Among the investing gurus followed by GuruFocus, Jim Simons (Trades, Portfolio) holds the largest position, at 1,400,600 Class A shares; that gives him a 0.38% stake in the company. The second- and third-largest holders are RS Investment Management (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio).
Looking at the bigger picture, Estée Lauder’s ownership is dominated by insiders:
As this GuruFocus table shows, the dominant position among insiders is held by Leonard Lauder, a family member, former chairman and CEO and currently chairman emeritus:
Shorts hold a modest position at about 5.3 million shares.
Comments: With the family holding a such a strong position, it has to be assumed that the interests of outside shareholders are well aligned with those of management.
By the numbers
Comments: Current price is near the 52-week low; the P/E is unexpectedly high for a consumer stock; good ROA and excellent ROE; pays a modest dividend; bought back a sizable number of shares in fiscal 2016.
Financial strength
The GuruFocus system gives Estée Lauder Companies a 6 out of 10 for financial strength and 8 out of 10 for profitability and growth:
The red Cash to Debt indicator points to long-term debt and more specifically indicates the ratio has weakened from where it was in previous years.
This 10-year chart shows how long-term debt has grown:
Revenue has grown along with the debt except for, in recent years, a pullback in fiscal 2015:
EBITDA (earnings before interest, taxes, depreciation and amortization) also took a hit in fiscal 2015 but made only a slight recovery in fiscal 2016:
Free cash flow provides yet another profile with no pullbacks until fiscal 2016:
As noted in the Revenue section above, the company said in its first-quarter 2017 financial statement that it expects revenue to progressively accelerate in this fiscal year. Freda went on to say, “Our focus remains on delivering sustainable and profitable annual growth, and the many actions we have planned give us confidence to reaffirm our expectations for constant currency sales growth of 6% to 7% and earnings per share growth of 8% to 10%, before charges, for the 2017 fiscal year.”
He also noted that the disciplined expense management delivered better-than-expected earnings per share.
Comments: The company appears to be reversing the slippage that occurred in fiscal 2015 and 2016, but it continues to carry a significant long-term debt load.
Valuations
According to the All-in-One screener, only 134 of the many thousands of stocks covered by GuruFocus hold a coveted 5-Star Predictability rating. This means Estée Lauder has consistently increased earnings year after year, making it a strong candidate to deliver capital gains if held for the medium or long term.
Right now, though, the DCF Fair Value Calculator has Estée Lauder in the overvalued category:
With a P/E of more than 26, the company appears pricey yet the 10 year chart of its history indicates it’s on the lower side of the range it has established:
GuruFocus also observes, “NYSE:EL's P/E Ratio (ttm) is ranked lower than 65% of the 1,240 Companies in the Global Household & Personal Products industry. (Industry Median: 19.65 vs. NYSE:EL: 26.88).” In other words, Estée Lauder is expensive compared to its peers.
The PEG (P/E divided by the five-year growth rate) also suggests the company is not a value stock. It logs a PEG of 2.8 (a rating of 2.0 or higher is considered overvalued).
Wall Street analysts covered by Nasdaq.com generally like this stock, whether overvalued or not:
The analysts' 12-month price target is $92, which is more than $4 shy of its 52-week high, and a 17% gain over the Jan. 5 closing price of $78.60.
On dividends, Timothy J. McIntosh reports, “The company has paid dividends on a consecutive basis for 20 years. It currently ranks eighth in yield within the large-cap consumer goods-personal products category.” However, he reports, “Its dividend yield is also below that of the market and 20% below its max historical yield of nearly 2%.”
Comments: Mixed messages about the valuation of Estée Lauder: reasonably valued based on its own P/E history and analysts’ expectations; overvalued based on the Fair Value calculator, comparison to its peers and its PEG ratio.
Conclusions
While the messages about its valuation may be mixed, there’s no uncertainty when it comes to Estée Lauder’s earnings power.
A 5-Star Predictability stock should deliver excellent capital gains over the medium and long term, and from what we’ve seen of the company’s history and outlook, investors can be reasonably confident the company will deliver them.
However, prudent investors will shy away because of the ongoing levels of long-term debt, and value investors will take the pessimistic side when considering valuations. Nor will this company suit income investors; there’s not enough yield to compensate for the volatility.
Estée Lauder Companies, though, will suit investors with a long-term outlook and confidence in a suite of well-managed and iconic brands.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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