Estee Lauder: The Road Ahead

Estee Lauder (NYSE:EL) has gained an impressive 60+% last year. After delivering an impressive 2010, Estee Lauder shared its outlook for the future in a recent investor presentation. ^[1] The company’s shares are currently trading at an almost 30% premium to our $71.65 Trefis price estimate of its stock, and so we explore the factors behind the market’s optimism. Estee Lauder competes with other leading beauty and consumer companies such as L’Oreal (PINK:LRLCY), Revlon (NYSE:REV) and Avon (NYSE:AVP) with its portfolio of well known brands like Aramis, Clinique, Aveda, La Mer and its flagship Estee Lauder brand.

Growth in Asia-Pacific

As the global economy recovers from the downturn over 2007-09, the growth in prestige beauty segment is expected to recover to 4%-5% range. Estee Lauder expects to grow by at least 1 percentage point ahead of the global prestige market, which implicitly suggests that it’s gaining market share. ^[1] Growing its presence outside of the U.S., especially in emerging markets, is central to Estee Lauder’s strategy.

Americas currently make up almost 43% of Estee Lauder’s total sales but given the slow pace of economic recovery in the west and the near double-digit growth rates in emerging markets such as China and India validates Estee Lauder’s focus on Asia-Pacific. This region could contribute almost 20% to Estee Lauder’s sales in 2011 from around 15% in 2008. What this means is more product launches, more advertising and more Estee Lauder stores in these markets.

Pamper Women with Skin Care

Women across the world are more financially independent than ever before, which is particularly favorable for prestige cosmetics. The global female income is expected to grow at over 9% from $6 trillions in 2005 to almost $11 trillion by 2013.

Skin Care product segment made up around 37% of Estee Lauder’s total sales in 2005-07, but has been gaining prominence over time. It now makes up over 42% of Estee Lauder’s sales and given the increasing consumer preference for anti-aging skin care, we can reasonably expect more Estee lauder product launches focused on skin care for women.

Improvement in Profit Margins

There is much room for improvement in EBITDA margins at Estee Lauder given that many of its competitors carry margins of over 20%, such as L’Oreal. Estee Lauder’s EBITDA margins have historically been around 14% over 2005-09. While there was much improvement in Estee Lauder’s EBITDA margins in 2010 to 16%, management is targeting further improvements in EBITDA margin by over 1 percentage point, by pursuing restructuring initiatives leading to costs cuts around $625 million to $675 million over 2011-13.

This hints at SKU rationalization i.e. a reduction in the number of variants of a product to control corresponding inventory levels. Estee Lauder also plans on limiting innovation to fewer and bigger product launches, which shall also optimize the corresponding marketing spending. Estee Lauder is also considering global sourcing to reduce expenses associated with transportation and logistics leading to improvements in gross margins as well.

What is the Impact?

We currently estimate EBITDA margins to improve only marginally from 16% in 2010 to almost 16.7% over our forecast horizon, primarily on account of scale benefits. The strategic cost cutting initiatives outlined in the recent investor presentation hint at a focused improvement in margins by over 1% over 2011-13, leading to a potential 8% upside to our current $71.65 Trefis price estimate of Estee Lauder’s stock.

But how does one still explain the remaining 22% price premium?

You can drag the chart below to see the impact of Estee Lauder’s stock price.

See our full analysis for Estee Lauder.

1. Estee Lauder Investor Presentation, February 24′ 2011 [↩] [↩]