Estée Lauder Companies Inc.’s (EL, Financial) stock has witnessed a pullback over the past several weeks on account of macroeconomic headwinds, increasing interest rates and the rising geopolitical tensions affecting broader markets.
The company’s last quarterly results recorded an all-around beat with strong organic sales growth and key brands such as Clinique, Estée Lauder, La Mer and M.A.C. continuing to gain traction. The company also launched a Revitalizing Supreme moisturizer in a recyclable glass jar with new formula and ingredient innovations. Despite posting decent results and seeing an expected recovery in the makeup category that was badly hit by the Covid-19 mask mandate, the company’s stock appears to be beaten down and could become an interesting investment proposition.
Recent financial performance
In February, Estée Lauder reported an all-around beat for the second quarter of fiscal 2022. The company reported revenue of $5.54 billion for the quarter ended Dec. 31, 2021, which implies14.14% growth from $4.85 billion in revenue reported in the prior-year quarter. It also managed to beat the analyst consensus estimate of $5.49 billion.
The revenue translated into a gross margin of 77.90% and an operating margin of 25.89%, which was higher than that in the year-ago quarter. Estée Lauder generated net income of $1.09 billion and adjusted earnings per share of $3.01, well ahead of the average Wall Street consensus of $2.63. In terms of cash flow, the company generated $1.93 billion in the form of operating cash flow and spent $261 million on investing activities, resulting in formidable free cash flow generation.
Strong market position
Estée Lauder's substantial brand equity, long-standing relationships with retail partners and cost advantage are all long-term competitive advantages that give it a wide moat. According to Euromonitor data from 2020, the company is the global leader in prestige beauty with a market share of 14.9%, ahead of L'Oreal SA's (XPAR:OR) 14.3% and LVMH Moet Hennessy Louis Vuitton SE's (MIL:LVMH, Financial) 7.7%. Unlike its beauty peers, which target both prestige and mass beauty markets, the company focuses solely on prestige beauty.
Given its dominant position in this market, Estée Lauder is entitled to scale-based procurement, manufacturing and logistics advantages. Lastly, I believe the company's vast resources enable it to respond more quickly and cost-effectively to changing consumer trends, as well as help it recover more quickly if it misses out on new ideas.
Digital acceleration
Based on Estée Lauder's valuable portfolio of leading global brands, preferred status with channel partners in department stores, specialty beauty outlets and travel retail locations and scale-based cost advantage, I believe it has a strong competitive advantage.
Management has made significant investments in omnichannel, marketing and innovations, which are assisting it in quickly recovering from the pandemic as well as the resulting inflation and supply chain disruptions. The company has worked hard to diversify its distribution channels, establishing strong presence in e-commerce and specialty beauty. These efforts are being directed toward reviving the North American market, where the company’s sales have slowed down, while simultaneously capitalizing on the phenomenal growth in Mainland China. I believe the company's growth prospects will last in the long run, as emerging markets still spend significantly less on prestige beauty than developed markets.
Skincare upside
Skincare remains one of the strongest businesses and growth drivers for Estée Lauder as its brands within this segment have been outperforming in various geographies. The segment has shown double-digit growth over the past year that extended beyond the acquisition of Have & Be Co. Ltd. and Korean skincare brand Dr. Jart+.
Along with hair care, this segment has been one of the key business lines to help the company remain financially stable while the makeup business continued to underperform for many quarters. Besides Estee Lauder's flagship brand, some of the key names in its skincare brand portfolio include Re-Nutriv, Revitalizing Supreme, Perfectionist, Micro Essence. Each of these brands recorded double-digit growth during the quarter. In addition, La Mer, the company’s luxury skincare brand, has picked up momentum in China. Darphin and Clinique continue to be strong performers and have a robust outlook.
Final thoughts
Companies operating in the luxury sector tend to be badly affected by rising interest rates and global economic slowdowns given their direct exposure to higher-priced prestige beauty markets. A potential recovery in the makeup segment could be a silver lining for the company as consumers are gradually giving up masks. The recent crash in the stock price has brought the price-earnings ratio to around 29.82 and, as a result, the stock appears to be far more reasonably valued. Given its current volatility, a cautious approach would be ideal for a company like Estée Lauder.
