Prestige beauty products manufacturer Estée Lauder (NYSE:EL) will report its Q1 FY14 earnings on October 31. 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). In the current quarterly results, we expect an efficient business performance from Estée Lauder, with strong single digit sales growth supported by double digit operating and net income margins benefited by the Strategic Modernization Initiative (SMI) program.
Q1 FY13 & Q1 FY12 Recap
The first fiscal quarter marks the start of holiday season sales for Estée Lauder, with sales growing by 20% and 13% sequentially in FY12 and FY13. On a y-o-y basis, sales for the September quarter grew at double digit pace in 2010 and 2011 before dipping to 2.9% in 2012 due to negative currency movements. Although sales grew at double digit pace in previous quarters, both on a y-o-y basis and sequentially, we expect a high single digit growth rate on account of the adverse currency fluctuations seen in the June – September period. Management expects a much lower sales growth estimate between 4% – 6% in the first quarter.
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The last two fiscal quarters saw Estée Lauder post a sequential increase of 565% and 558% in Q1 operating profits over the previous Q4 quarters due to a combination of high growth in sales and a reduction in SG&A expenses. Operating profit margins increased from 3.14% and 3.25% in Q4 FY11 and Q4 FY12 to 17.36% and 18.91% respectively in the next quarter. However, operating margins increased from the 3% range seen in Q4 FY11 and Q4 FY12 to 6.06% in Q4 FY13. A 5% increase in sales from increased demand across all geographies contributed to this margin expansion, offsetting an increase in operational expenses from the roll out of wave 3 of the SMI program.
Net income margins too experienced an expansion in the past quarter over prior fiscals. For Q4 FY13, net income margin stood at 4.8% compared to 2% and 2.2% during the same period in FY11 and FY12. Sequentially, these margins expanded 9.3% and 9.5% into Q1 in FY11 and FY12. We expect a double digit net income margins in the current quarter. However, guidance provided indicates per share earnings to be about $0.67 – $0.71, lower than previous year Q1 earnings.
Rapidly Expanding Skin Care Market To Support Growth
Globally, skin care products have the highest market share in the multi-billion dollar beauty products market, with Euromonitor estimating the market to be worth about $100 billion.  Within the next 4 years, the market is expected to increase by a fifth of its present value, much of this growth resulting from the Asia Pacific region. This growth potential in the skin care market is a reason for heavy investments into producing locally relevant products by players in the industry.
For Estée Lauder, the skin care segment accounts for approximately 44% of overall revenues. According to our estimates, the company’s market share stands at about 7.7% in the skin care market. In order to catch up with its competitors like L’Oréal (PINK:LRLCY) and Procter & Gamble (NYSE:PG), Estée Lauder is pioneering product innovation in the skin care market by launching products specific to the geography. Improved versions of best-selling products such as Advanced Night Repair and Dramatically Different Moisturizing Lotion+ have been scheduled for launch in Q1 FY14. The company has made focused efforts in Q4 FY13 to introduce a new range of fragrances such as Cologne Intense from Jo Malone and Wood Mystique specific to customers in the Middle East. By concentrating 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. We expect an increase in skin care market share for the company going forward, assisted by geographically relevant and technologically advanced product launches.
Future SMI Roll-outs Should Further Reinforce Margins
In 2009, Estée Lauder’s management took up a restructuring program called the Strategic Modernization Initiative (SMI) to streamline business operations and provide SAP based technologies for better inventory and order management practices. Cost savings resulting from this restructuring program are expected to be reinvested into the business to cater to future growth.
So far, three waves of SMI implementation has been provided to the company’s retailers across the world, which 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 advanced technologies as part of SMI, Estée Lauder has witnessed an increase in orders from retailers. Fiscal 2014 would consist of optimizing the three phases of SMI rolled out thus far to ensure maximum savings resulting from the program.
Wave 4 of the SMI program is expected to be implemented in July 2014, which is the first quarter of fiscal 2015. This roll-out would be the last phase of operational restructurings planned by the company and includes the transition of business amounting to approximately 18% of sales. This implies that divisions generating 82% of sales have been implemented with reformed operational platforms from the SMI program, costing about $320 million in restructuring expenses since the start of the program. Savings however stood at $781 million, about 50% more than the original forecast. Reinvestment of these savings into the business along with reduced operational expenses should continue to improve margins.
We will update our price estimate of $71 for Estée Lauder after the company files its financials with the SEC.Notes: