Cosmetics giant Estée Lauder reported a glowing set of third quarter results, compared to the same quarter in the previous year, with sales up in every region. The stock did fall though as sales were slightly lower than was expected. For those of you not familiar with the cosmetics counter at your local beauty parlor, or the exotic perfumes at airport duty free, the company specializes in skin care, makeup, fragrance and hair care products. It owns brands such as Tommy Hilfiger, Donna Karan New York (DKNY), MAC, Lab Series, Michael Kors, Clinique, La Mer, Aramis, Editions de Parfums Frédéric Malle and many others (which are equally as difficult to pronounce). But all jokes aside, this is a $100 billion business, with a geographic footprint spanning 150 countries and territories.
Net Sales for the quarter were up 16% year-over-year (13% in constant currency) to $3.86 bn. Gross margins rose 70 basis points to an impressive 75.7%. Operating income jumped 465% to $616 million with margins improving to 15.9% from 3.3% in the year-ago quarter. Net earnings came in $456 million, compared with a net loss of $6 million in the prior-year period. Diluted earnings per share came in at $1.24, compared with a $0.02 loss last year. The company did announce asset, goodwill and intangible asset impairments amounting to $379 million dollars, as well as restructuring costs amounting to $168 million. It ended the period with cash and cash equivalents of $6.4 bn, up 28% year-over-year. In March, the company also resumed share buybacks to the tune of $316 million as of March 31, 2021.
Geographically, sales were led by Asia Pacific which saw double digit growth (35% on a reported basis and 26% on a constant currency basis) to $1.25bn, with luxury brands outperforming in Mainland China. Europe, the Middle East and Africa grew 12% (10% in constant currency) to $1.7bn, and the America’s contributed $916 million, growing 3% (4% in constant currency).
While most brick-and-mortar retail stores that sell the company’s products, were open during the third quarter of fiscal 2021, most notably in China and the United States, there were intermittent closures throughout the rest of the world like Europe, Brazil, Canada and Mexico. In areas where stores were open, consumer traffic was significantly reduced when compared to pre-covid times. And whilst domestic travel in China and some other Asian corridors were open, global international travel was still largely curtailed.
Skincare was the top performing division with sales up 31% (28% in constant currency) to $2.26 bn. Fragrance sales jumped 30% (27% in constant currency) to $454 million. Haircare bounced 8% (6% in constant currency) to $128 million and Makeup sales dropped 11% (13% in constant currency) to $1bn. (Rival L’Oreal posted lackluster makeup sales last quarter)
The impact of lockdowns on consumer habits has been notable. It seems that big nights out (Makeup) were swopped for big nights in (self-care routines). Fresh-faces have replaced seductively caked-ones, and eye serum is the new eye liner. Makeup sales fell across all brands, hitting foundation and lip products hardest. Skincare sales were more than double makeup sales this quarter. In 2018, skincare and makeup were equals (in term of sales). Even with economic re-openings and rebounding travel, Estée is finding that makeup is still lagging because some covid habits are hard to break (eg: eCommerce at Amazon is still growing and people are still buying Crocs for comfort). This explains why Estée Lauder added to their winning investment DECIEM (and will take full ownership in 3 years), as demand for The Ordinary’s skincare range soared.
Consumers generally mix and match products in their beauty routines from a variety of brands, at a range of price points. They buy them because of their utility and are often referred to as “Hero Products”. Hero products like Advanced Night Repair Synchronized Multi-Recovery Complex (say that five times fast) and Créme de la Mer drove the most demand for Estée Lauder in the period. Others like Origins Mega-Mushroom Treatment Lotion and Bumble and Bumble’s Hairdresser’s Invisible Oil, help recruit new customers and have high rates of repeat purchases, up to 50-60% according the company. Hero products have been key to Estée Lauders acquisition strategy. The prestige of Hero products has also expanded to include more accessibly priced brands. The reason for this is competition from lower priced competitors. This is actually a huge advantage. Rather than taking the shine off of Estée’s perceived high quality, it means its products are sold at drug stores (next to mouth wash and loo roll) as well high-end fashion outlets (next to handbags and leftover lattes), giving it a massive consumer reach.
What is most impressive about Estée Lauder is that it generated Free Cash Flows (FCF) of $2.4 bn, and it also has low debt levels. This business has generated returns on invested capital in the 20% range for an extended period and in the process created tremendous shareholder value. The company also has a staff compliment where 84% of staff are female of which 55% are in VP positions and above. The company expects revenues for full year fiscal 2021 to grow between 11% and 12%, and it sees adjusted diluted earnings per share increasing between 45% and 47% on a constant currency basis.
Despite the undoubted quality of the business, the stock is on the pricey side, and we simply cannot justify owning this superb business at these levels. The FCF yield is 2%, and it is on a historic PE multiple of 80x. Estée Lauder’s own earnings forecasts put it on 54x earnings which is still too excessive in our view. However, Lauren Templeton, the great niece of the investing legend Sir John Templeton taught me to make a list of stocks to buy, to leave in my bottom drawer, for when an economic disaster strikes and markets crash. I’m adding Estée Lauder to my list because I think it’s a beauty – and in this case beauty is in the eye of the shareholder.