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Investment Overview for Estee Lauder (NYSE:EL)
WHAT HAS CHANGED
Estée Lauder reported an 8% jump in sales in fiscal year 2014 (ended June 2014), supported by strong performances from its skin care and make-up product lines. For the first two quarters of fiscal 2015, the company's revenue stood at $5.68 billion, reflecting a 0.3% year-on-year decline. The company experienced a setback in its first quarter due to weak economic conditions in regions such as China and Latin America, underperformance of its travel retail division, and internal issues such as the Strategic Modernization Initiative (SMI) implementation, that led to sellers and distributors pre-ordering products in Q4 FY14 and resulting in a slowdown of orders in Q1 FY15. The company recovered in the Q2 of FY15 due to success in the U.K. and emerging markets, the strong performance of the makeup and luxury segments, and sales growth in the online and freestanding store channels.
- Acquisitions will help fuel growth:
- Estee Lauder announced a string of acquisitions in the span of two months between October and December, 2014. The company’s last acquisition prior to these was in May 2010, when it acquired Smashbox Beauty Cosmetics. The acquisitions are: GLAMGLOW, a prestige skincare brand specializing in facial mask treatments, Le Labo, the high-end fragrance and sensory lifestyle brand, Editions de Parfums Frédéric Malle, the storied fragrance brand established by the iconic perfumer Frédéric Malle, and RODIN olio lusso, a luxury skin care brand, offering a selection of luxury skincare oils.
- Luxury brands are a key growth driver for the company: its luxury brands like La Mer, Jo Malone, and Tom Ford have been delivering double digit growth for several years. Hence, the recent acquisitions, of all premium and luxury brands, are best seen in this light. The company expects global prestige beauty to continue growing at 3% to 4% in fiscal 2015, and 4% to 5% thereafter.
- Skincare is the most important segment in Estee Lauder's portfolio. Consumers are currently demanding products such as masks and oils beyond the traditional skincare formulations like moisturizers and serums. Estee Lauder possesses a strong research and development arm. The recent acquisitions in the beautifying mask and oil-based treatment categories might satisfy the changing demands.
- Focus on digital channels:
- Estee Lauder’s compounded annual growth rate for the last five years was 25%. The global technology platform, combined with the local market’s good performance, and the online distribution channels, helped the company grow. Taking into consideration the increasing consumer preference of shopping via online or mobile channels, the company aims to bring its high-touch services online. Presently, the company has 130 direct-to-consumer e- and m-commerce sites in 30 countries. It observed that shoppers presently are more prone to buying products digitally through the e-commerce sites, or through free standing stores.
- Strategic Modernization Initiative (SMI) might help improve margins :
- During fiscal year 2014, Estée Lauder has eliminated more than $800 million in costs through the implementation of the Strategic Modernization Initiative (SMI). These cost-savings from the SMI initiative helped improve margin performance through higher investments into business-driving activities such as advertising, resulting in operating margins expanding approximately 1.7 percentage points between FY13 and FY14. So far, over 90% of Estée Lauder's sales are SAP-enabled through the SMI initiative, and the company expects to see greater efficiencies in the months and years to come.
Estee Lauder's Skin Care Market Share: Estee Lauder's Skin Care Market Share expanded from 6.6% in 2008 to 7.8% in 2012. However, its share declined to 7.7% in 2013, partly due to cannibalization of its older products, and partly due to a shift in order realizations following its SMI implementation. The company posted a weak top line growth rate of 2.8% in the segment in 2013. Its market share reached 7.8% once more in 2014. We currently forecast Estee Lauder's skin care product market share to decline marginally in the short term before beginning to grow its market share and reach over 8% by the end of our forecast period. There could be a marginal downside of less than 5% to our price estimate, if the market share were to remain flat throughout the forecast horizon.
Estee Lauder's Skin Care EBITDA margin: Estee Lauder's Skin Care EBITDA Margin increased from 20% in 2008 to 26.2% in 2012, before declining to 25.7% in 2013. The EBITDA margin grew to 27% in 2014. We expect margins to remain near 27% by end of our forecast period. There could be almost 15% downside to our price estimate, if margins were to decline to the 2008 levels of 20% over our forecast period.
Estee Lauder's Makeup Market Share: We currently forecast Estee Lauder to gain share in the global makeup market from 12.8% in 2014 to reach almost 14% by the end of our forecast period. There could be a marginal downside if Estee Lauder fails to gain market share over our forecast period.
Estee Lauder's Makeup EBITDA margin: Estee Lauer's Makeup EBITDA Margin increased from 19% in 2008, to 24% in 2014, and we expect it to gradually increase to 25% going forward. There could be close to 10% downside to our price estimate if margins were to decline to the 2008 levels of 19%.
Estee Lauder manufactures and markets premium makeup, skin care, fragrance, and hair care products in the personal and beauty care segment of the market. Estee Lauder's main competitors consist of cosmetics companies such as L’Oreal, Shiseido Company, LVMH Moet Hennessey Louis Vuitton, Revlon, Coty, and Procter & Gamble Company.
Estee Lauder's major brands include Estee Lauder, Aramis, Clinique, M-A-C, Bobbi Brown, La Mer, and Aveda, along with fragrance and cosmetics sold under brands such as Donna Karan, Tommy Hilfiger, Micheal Kors, and Sean John.
Premium priced products that are not branded, yet relatively expensive, are sold through limited distribution channels consisting primarily of upscale department stores, specialty retailers, upscale perfumeries, pharmacies, prestige salons and spas, free standing company owned stores and spas, company websites, authorized retailer websites, stores on cruise ships, direct response television, and in-flight and duty free shops.
Despite a global presence, about 40% of Estee Lauder's net sales come from the Americas, with Europe, Middle East and Africa contributing 38%, and Asia-Pacific constituting the remaining 22%. The company's increased focus on the Asia-Pacific market is expected to further increase in the future.
The Skin Care and Makeup segments have the highest contributions to Estee Lauder's value. Skin Care forms the priority category for the company, contributing more than 50% of Estee Lauder's stock value, and Makeup contributes around 39%. The Skin Care segment is also the most profitable of all its beauty products, generating an EBITDA margin of 27%, compared to the company average of around 24%.
Market sizes and market shares in Skin Care Vs Makeup
The Skin Care market grew by 4.6% in 2011, and 3.2% in 2012, and we expect it to increase by 5% over the next few years. The Skin Care market is currently valued close to $110 billion and could cross $130 billion in the next five years.
In the Makeup category, Estee Lauder had a higher market share of around 13% in 2014 (that increased from 12% in 2010), but the overall market size of the Makeup segment is about half of skin-care. The overall Makeup market is currently valued around $60 billion and could exceed $70 billion by the end of our forecast period.
Higher margins in Skin Care compared to Makeup
We estimate that Estee Lauder's skin care EBITDA margin was around 27% in 2014, compared to 24% for the Makeup business.
Strong prestige beauty sales growth in 2014
The global prestige beauty market grew in 2014 with the United States registering sales growth of 3% to reach $11.2 billion, significantly outpacing the mass segment sales growth. The growth was a favorable mix of more unit sales and pricing growth.
Booming Skin Care due to anti-aging creams
Anti-aging creams and anti-cellulite skin care products are in high demand among aging populations in developed countries notably Japan (oldest demographic), the US, and Western Europe. Half of Estee Lauder's skin-care business comes from anti-aging products. The anti-aging market comprises of those products that can treat multiple signs of skin aging at one time, and is a fast-growing segment under the anti-aging beauty products. Estée Lauder launched its first global anti-aging cream in Europe in February 2012 and a China specific skin care brand Osiao in October 2012.
Growth of natural products categories and "Masstige" segment, as well as male product lines
There is a growing demand for natural / organic products in most countries, a trend led by the developed markets in the US and Western Europe. Additionally, there is an increased preference for less synthetic, eco-friendly, and more natural products and packaging.
There is a growing trend towards the so-called "Masstige," or premium brands sold at lower prices through mass distribution. In addition, beauty care products focused on men is the latest niche being targeted by most players globally. In developed markets, particularly in the US and Western Europe, the introduction and extension of the men’s product lines is a major source of growth.
Focus on travel retail
Estee Lauder has capitalized on the strong growth in its travel retail channel to capture the attention of travelers from emerging markets, who either buy in the channel, in stores at their destination, or when they return to their homes. The channel has performed particularly well for Estee Lauder within Europe, Asia-Pacific, Middle East & Africa, generating double-digit net sales growth in fiscal 2014. The main drivers to the travel retail segment growth were: the launch of new initiatives, an expanded distribution network, an increase in global airline passenger traffic, and accelerated orders.
According to a report from Verdict, the global travel retail has quickly become the fastest-growing retail channel for beauty, fashion, and accessory products. It is likely to grow to $44 billion by 2015, driven by expanding passenger volumes, especially in emerging markets. In particular, beauty sales are likely to grow by more than 80% in the next five years. Global Airport Retailing information for 2012 reveals that the Asia-Pacific airport retail spending stood at $12.2 billion, while spending in Europe was $10.6 billion and for the Americas $7 billion. By 2016, it is expected that the spending will reach $23.2 billion for Asia Pacific, whereas for the Americas and Europe the figures will be $10.1 billion and $12.4 billion, respectively.
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