In June, I believed that the outlook for The Estée Lauder Companies Inc. (NYSE:EL) was still not pretty as the company continued to cut its guidance, with operational weakness being prolonged and severe, making me cautious. This was certainly the case, as EL shares still looked expensive based on 2022 peak earnings.
Since the summer, shares have fallen another 25%, as the 2024 outlook calls for modest top line sales growth but also just modest earnings per share growth, with margins seen flat. The very tepid pace of earnings recovery provides little fundamental support for the shares and investment case here, making me cautious despite the continued and prolonged share price fall.
A Beauty Conglomerate
Estée Lauder is a beauty product conglomerate which is active in a number of (price) categories, and it has operations across the globe. The company has strong positions in make-up and skincare, being an all-rounded competitor to the likes of L’Oréal (OTCPK:LRLCF) and LVMH (OTCPK:LVMHF) towards the premium end of the market.
These products were sold in old-fashioned department stores, online channels and specialty channels (which includes the like of Ulta Beauty (ULTA), among others).
The company was a star in the 2010s, as a stock in its twenties in 2010 rose to the $200 mark ahead of the pandemic breaking out. After an initial setback following the outbreak of the pandemic, with travel restricted, shares peaked around $375 by the end of 2021. What followed was a significant pullback to levels around $180 in June of this year again.
On the operational front, Estée Lauder reported in August 2022 that sales rose by 9% to $17.7 billion, with most sales being generated from a $10 billion skincare business, a $4.7 billion make-up business, a $2.5 billion fragrance segment and a tiny $600 million hair care business. The vast majority of earnings were generated from the skincare business, with make-up posting very modest margins and the hair activities actually posting losses.
The company posted EBITDA of $4.2 billion, on which adjusted earnings of $7.24 per share were reported, which translated into high valuations as shares traded in the $270s at the time. The company guided for a 3-5% increase in 2023 sales (which included a headwind from a strong dollar and ending of a licensing deal in Russia), so, adjusted for that, the outlook was decent.
After a dismal first quarter earnings report, the company cut the full year sales guidance to just $5 and change, as net debt jumped following a $2.8 billion deal for Tom Ford in November 2022.
In February, second quarter sales fell as much as 17%, with full year earnings seen below a midpoint of $5 per share. In May, third quarter sales were reported down 12% as full year adjusted earnings were now seen at $3 and change, in fact seen at a midpoint of just $3.34 per share.
With 361 million shares trading at $361, the equity valuation of $65 billion was still demanding with sales seen around $15 billion and change, as the enterprise valuation rose to $70 billion if we factor in net debt.
With earnings power reported just over $3 per share the resulting earnings multiple was sky-high at $180, and even if the company could return to earnings power of $7 per share, valuations were not cheap at 25 times earnings.
This came amidst headwinds as Estée Lauder seemed to have self-inflicted (execution) issues and was underperforming many peers, such as a rising stars which included e.l.f. Beauty, Inc. (ELF) towards the lower side of the price spectrum, and losing out to the French giants on the more premium side of the business.
Falling Further
Since June, shares have fallen further, having fallen in a persistent manner to $138 per share, with shares down another quarter since June. By now shares are down two-thirds from the 2021 highs. The news since June has not been all good. In July, Estée Lauder provided information on a cybersecurity incident, with few details reported at the time.
In August, Estée Lauder reported a 1% increase in fourth quarter sales to $3.61 billion which was about the good news as GAAP operating earnings came in at just five million in the seasonally softer quarter. Adjusted earnings fell from $0.42 per share to $0.11 per share.
Full year sales were down 10% to $15.91 billion, as GAAP operating profits fell 52% to $1.51 billion with GAAP earnings of $1.00 billion working down to earnings of $2.79 per share. The company posted adjusted earnings of $3.46 per share if we (mostly) adjust for asset impairment charges, and earnings of $3.72 per share if we add back the currency headwinds.
Somewhat positive news is that net debt of $4.1 billion came down a bit as net interest expenses are thereby rapidly coming down as leverage comes down further. Moreover, the company has a large gross cash position, allowing for some early repayment options.
The outlook for 2024 included an estimated seven cent headwind to earnings as a result of the cybersecurity incident, which is comforting as it tells me that the incident was somewhat manageable, although after-tax costs were still seen around $25 million. For the year, sales are seen up 5-7% which implies that sales are seen close to $17 billion.
While this modest sales growth is comforting, no margin improvement is seen here, as adjusted earnings are seen between $3.50 and $3.75 per share, suggesting that margins are flat. Based on the outlook, shares are seen at 37-40 times forward earnings, steep multiples, but based on paltry margins and thus earnings.
Later that month, Chairman Leonard A. Lauder indicated that he would not stand for the re-election of the board, perhaps opening the door for other and wider strategic options.
What Now?
I understand why shares of Estée Lauder have fallen so much, as the company is not seeing any margin recovery this year. This is based on margins around 10% of sales, while Estée Lauder used to report operating margins between 15-20% of sales over the past decade.
A 5-point improvement in margins could add some $800 million in operating earnings and about $2 per share on the bottom line, opening up the route for earnings of $6 per share. The problem is that this still requires a lot of heavy lifting and even in that case, shares trade at about 23 times earnings here, which is more than fair.
Amidst all this, The Estée Lauder Companies Inc. valuations are rapidly becoming more compelling here, but while the modest growth for the fiscal year 2024 looks comforting, I still cannot find myself to commit here, even as shares are down two-thirds from their highs.
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