Prestige beauty products manufacturer Estée Lauder (NYSE:EL) will report its fourth quarter and full year fiscal earnings on August 15. The company is a leader in manufacturing high-end cosmetics and skin care products and competes with other beauty and personal care players such as Revlon (NYSE:REV), L’Oréal (PINK:LRLCY), Avon Products (NYSE:AVP) and Procter & Gamble (NYSE:PG).
Estée Lauder saw weak top-line growth (1.9%) in Q3 2013 as weak sales in southern Europe and Korea partially offset the strong performance in Asia Pacific. Net sales in Q3 2013 stood at $2.29 billion compared to $2.25 billion in Q3 2012. Make-up and hair care products showed strong growth of 4.81% and 5.54% over Q3 2012, contributing $919 million and $116 million, respectively, while skin care product sales remained flat at $1 billion. Operating margins and net income margins for Q3 2013 were 10.7% and 7.8%, considerably higher from the year ago period as the firm started realizing the benefits from its Strategic Modernization Initiative (SMI) – a program started a few years ago to create a common framework to standardize business processes across brands, operating units and sales locations to improve performance.
The company is confident of delivering 20% growth in earnings per share (EPS) for the fourth quarter and has raised its EPS guidance for FY2013 between $2.56 – $2.61. However, the company reported a few operational issues such as customer service delays and stock-outs in certain products in the SMI roll-outs completed and has deferred the launch of its latest phase scheduled for January 2014 by six months. We expect this development to have a peripheral impact on margins, resulting from an increase in cost of sales.
New Product Launches and Emerging Market Sales to Drive Top-Line Growth
Estée Lauder is a pioneer in product innovation and has launched products for specific geographies by extensively studying the needs of its customers. Products such as Revitalizing Supreme and Advanced Night Repair have been designed specifically for European women and have gained wide popularity within the region. The company has made focused efforts to introduce a new range of fragrances such as Cologne Intense from Jo Malone and Wood Mystique for customers in the Middle East.
By focusing on key categories and segments such as skin care, make-up and fragrances, Estée Lauder aims to create innovative products that have strong local relevance. Additionally, the company is striving to increase market share across its product portfolio by accelerating the roll-out of brands with low penetration in other geographies. Estée Lauder has planned to increase market share and growth rate in its fragrances segment by expanding advertizing reserves and accelerating roll-out of its ultra-prestige brands such as Jo Malone, Essenza di Zegna and Tom Ford. We expect this effort to expand the company’s existing customer base, thereby increasing market share in the long term.
Although sales from emerging economies contribute to a thin slice of net sales for Estée Lauder, economies such as China, the Middle East and South Africa have shown robust sales growth. Sales from China and Hong Kong grew the fastest at 27% y-o-y in Q3 2013 among Estée Lauder geographic portfolio while South Africa and the Middle East contributed to strong double digit growth The growth potential of these economies has prompted Estée Lauder to invest further in new markets such as Nigeria and Cote d’Ivoire for long-term sustainable growth. However, the lack of retail infrastructure presents multiple challenges for the company.
Strategic Modernization Initiative and Operational Restructurings to Boost Margins
The SMI has helped cut down costs for the company and resulted in an improvement in operating and bottom-line margins. By streamlining its operations and implementing SAP-based technologies as part of SMI, Estée Lauder has witnessed an increase in orders from the retailers.
The cost of sales declined 150 bps as a percentage of revenue over Q3 2012 which boosted margins by 130 bps to 10.7%. The company also improved its bottom-line by 200 bps, from 5.84% in Q3 2012, primarily due to tax benefits which resulted in lower effective tax rates. Although the latest phase of SMI has been deferred by six months due to concerns in meeting demand and delays in customer service, the recent consolidation of Oakland and Melville operations in April should favorably impact margins this quarter.
For fiscal 2013, management guides restructuring charges of $25 million. However, the savings that result from a restructuring in operations and better inventory management practices through SMI are estimated to range between $75 million and $80 million. We expect a gradual improvement in margins with additional streamlining of operations and roll-out of further SMI phases in other geographies.
We will update our price estimate of $66 for Estée Lauder after the company files its financials with the SEC.