Estée Lauder (NYSE:EL) posted a good set of numbers for FY2013 on Thursday with sales growing organically in every product category across all regions. New product launches and aggressive advertising campaigns saw revenues exceed $10 billion for the first time.
Top-line grew 4.28% compared to 10.25% in 2012 and 13% in 2011. Asia Pacific saw the largest decline with the growth rate falling to 5.5% compared to 14.25% last year due to continued weakness in South Korea. Southern European sales were subdued contributing to a deceleration in EMEA sales. Net income also saw the effects of the slowdown growing 19% to over $1 billion compared to 22.25% in 2012 and 46% in 2011.
We believe that the deceleration seen in fiscal 2013 was sharp although consistently maintaining double digit growth rates on sales topping $10 billion is difficult to sustain. Given the weakness in emerging markets, we predict sales growth will remain weak in the short-term in these markets except for Latin America, which we expect to grow at a double digit pace. With a growing focus on these markets, we expect mid-single digit sales growth going forward. Management has guided for sales growth for FY2014 to be 6-8%, double the growth forecast for prestige beauty products.
The business continued to show a strong performance with improving margins despite slowing overall growth. Gross margins crossed 80% in contrast to 79.45% in 2012. Operating margins grew 150 bps and stood at 15% in 2013 while net income margins expanded 120 bps to 10%.
Growing Middle Class in Emerging Markets to Support Growth Rate
Over the last few years, Estée Lauder has focused on increasing penetration of its prestige beauty products into the ‘mass product’ markets of China and Latin America. Latin America for example represents a $24 billion beauty market, 89% of which are mass product sales.  However, the prestige products segment sales have been faster than the mass products’ market fueled by a growing middle class population. The middle class segment has expanded by more than 50% in the last five years, adding 165 million people.  As discretionary income rises for the rising middle class, the demand for aspirational products like beauty products rises.
Sales grew 11% y-o-y in Latin America driven by Brazil and Peru. Skincare and make-up products from Estée Lauder represented 54% of the total sales in Latin America making it the market leader in the segments. Fragrance sales on the other hand are still very weak, and the company is making investments into rolling-out new products. In Mexico, Estée Lauder has become the largest prestige beauty player by leveraging its strength in innovating and developing locally relevant products. The company believes that by staying locally relevant, it can create further in-roads into the Latin American market and is investing into better distribution systems in Latin America to support future growth. With a growing focus on the larger fragrances market, we expect an improvement in market share for Estée Lauder in the Latin American region, contributing to an increase in global market share.
SMI Roll-out Deferral and Higher Investments to Negatively Impact Margins
The decision to defer a further roll-out of the Strategic Modernization Initiative until July 2014 will impact margins in the short-term. Although margins expanded over the past 4 years with the completion of a restructuring program, which resulted in cost savings of $781 million, the deferral in SMI roll-out coupled with decelerating sales numbers could cut down margins going forward. On the flip side, the deferral gives the management an opportunity to optimize the first 3 waves of SMI roll-out completed so far for maximum cost savings on inventory and to reduce obsolescence.
The cost of sales for FY2013 as a percentage of revenues stood at 19.9% compared to 23.47% when the restructuring program was initiated. The latest restructuring involving the shutdown of operations in Oakland and expanding the Melville plant in April has contributed to an expansion in operating margins this fiscal year. However, with the next wave of SMI roll-out scheduled for July 2014, and no restructuring program to reign in costs, we believe margins could come under pressure in the short-term. Additionally, the company is increasing its investment into marketing initiatives and HR systems which will weigh down on margins for FY2014. We are optimistic of an expansion in margins in the long-term with benefits from SMI and all the investments kicking in.
We have updated our price estimate to $72 to reflect the following trends from Estée Lauder’s latest earnings:
- An increase in margins in the long run following complete roll-out of SMI and SAP implementation.
- Accelerating market share gains on all product categories due to locally relevant product launches and intensive advertising.