Satisfied with the performance of its top two divisions Skincare and Makeup, Estee Lauder (NYSE:EL) is shifting focus to the next biggest division Fragrances. The company tied up with luxury Italian fashion house Ermenegildo Zegna recently to launch a fragrance aimed at the prestige men’s products market. Sales from the fragrances division are still below pre-recession levels and grew at 8% last year. For the quarter ended September 30, fragrances sales were flat year on year and accounted for about 14% of total sales. Given its reputation and reach in the prestige beauty products market, we expect the company’s focus on prestige and high end fragrances to help it gain market share at the expense of competitors L’Oréal (PINK:LRLCY) and Revlon (NYSE:REV). The prestige market fragrances are generally sold at boutique, department and specialty stores instead of discount and drug stores.
Fragrances growth has slowed down
Despite having two of its fragrances (Beautiful and Pleasure) in the top 10 fragrances in the United States, the company lost market share to L’Oréal over the years. According to Euromonitor International, its share of the global prestige fragrance market fell to 8.3 percent in 2011 from 9.8 percent in 2006 in the face of stiff competition.  During the same time period, L’Oréal increased its market share to 14%. With designer/prestige fragrances accounting for about two-thirds of global fragrance sales, the improving economic situation should spur discretionary spending to pre-recession levels and with only a small number of players operating in very high end fragrance market, we now expect the company to grow regain its pre-recession market share by the end of 2014.
Stable high end fragrances is a safer bet
The high end fragrance market with its limited number of players and the company’s image as a prestige products company is a safer bet in our view. Veronique Gabai-Pinksy, global brand president at Estee Lauder who oversees designer fragrances, told Reuters that a strong foothold in the most stable category is essential for the company. Besides “Essenze” a cologne for men in collaboration with Zegna, the company will soon be launching a new women’s fragrance with Italy’s Marni.
We expect these tie-ups will help the company have a wider reach and get vital development inputs. The company is known to produce some of the best selling fragrances and partners include Coach Inc, Michael Kors Holdings Ltd and Tom Ford. Zegna’s popularity in China opens up a huge potential market for the company. It is already making its presence felt there through its skincare products which are widely popular. Its multiple retail channels in China should make the new fragrances quickly available to a wider audience. In the Middle East market the company plans to customize its products with notes and packaging inspired by local culture and history to attract the growing affluent class. 
Sharing development costs to improve profitability
The company has been localizing products across its brand portfolio to promote sales. For example, the Jo Malone brand worked with local teams to create Sakura Cherry Blossom, limited-edition fragrances tailored for Japan. Successful limited launches have been followed up with wider launches paving the way to further success. We believe the process helped the company cut down on costs and improve its margins as focusing on fewer well received products for wider launches frees up resources.
Besides sharing costs through tie ups (for example: Zenga and Marni), the company has been working on reducing the cost of goods and reinvented its product development processes. These efforts were led by Aramis and Designer Fragrances Division which commandeers nine distinctive brands and makes up almost 40% of the fragrance business. The division has focused on prioritizing by region and strategically boosting the support of its classic brands while limiting the number of new product launches.
We have a price estimate of $66 for Estée Lauder which is 15% above the current market price.Notes:
- Estée Lauder sees luxury, men key to re-igniting fragrance sales, Reuters, December 2012 [↩]
- 2012 Annual Report, Estée Lauder, August 2012 [↩]