Estée Lauder: “Once Bitten, Twice Shy” as Market Ignores Return to Growth
Company Update (EL US) (Buy): Organic sales growth was 6% in Q3 FY24 and guided to 6-10% next quarter; shares are at 23x FY19 EPS after falling 13.2% in a day.
Highlights
Sales growth has turned positive after Asia Travel Retail inventory normalized.
Gross Margin and EBIT Margin each rose significantly, and EPS doubled.
Restructuring alone would take EBIT to above FY19; shares are at 23x FY19 EPS.
The main negatives seem to be short-term, including a weaker Q4 FY24 margin.
With shares at $127.37, we see an 80% return (32% annualized) by Jun-26. Buy.
Introduction
Estée Lauder (“EL”) reported Q3 FY24 (January-March) results on Wednesday (May 1); shares fell by as much as 15% at one point before finishing the day down 13.2% (and are currently up 2.6% in pre-market trading):
EL Share Price (Last 6 Months)
Source: Google Finance (01-May-24).
We added EL to our “Select 15” model portfolio in September 2023, having originally initiated a Buy rating on the stock when we first published our research on EL in April 2020. We are also long EL in real life (having entered our current position in August 2023) and added significantly to our position during the day.
We believe Q3 FY24 results showed that EL has returned to growth. Organic sales have returned to year-on-year growth, being at +6% in Q3 and guided to be +6-10% for Q4. For the key Chinese market, Mainland China sales grew by low-single-digits and Asia Travel Retail sales grew by single-digits. Channel inventory has normalized as expected, and working capital cashflow is much better year-on-year. Both Gross Margin and EBIT Margin rose significantly, and operational leverage means that EBIT rose 75% year-on-year and EPS more than doubled. (All figures are non-GAAP.) Management is implementing EL’s restructuring plan and expects $1.1-1.4bn of incremental EBIT by FY26, which on its own will take EBIT significantly above pre-COVID FY19 levels, before any underlying business growth.
The main negatives from the results were a small reduction in FY24 organic sales outlook (attributed to weak Chinese macro and Middle East conflicts), a relatively weak implied Q4 FY24 margin, and flat sales in Developed Markets in North America and EMEA. The first two negatives are short-term, while the last one is more concerning, but we believe EL’s premium positioning and historically strong franchises will eventually allow it to grow faster than the Beauty market.
At $127.37, relative to pre-COVID FY19 Non-GAAP earnings, EL shares have a P/E of 23.2x and a Free Cash Flow Yield of 3.3%; the Dividend Yield is 2.1%. Valuation statistics based on more recent financials are less meaningful because of negative operational leverage and elevated Cost of Sales. Our forecasts, which imply a 5.5% FY19-26 Non-GAAP EPS CAGR and assume a 28.0x exit P/E, show a return of 80% (31.8%) by June 2026. Buy.
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