Prestige beauty product manufacturer, Estée Lauder (NYSE:EL), reported its third quarter fiscal 2014 results on May 2. Quarterly revenues expanded at double-digit pace on a year-on-year basis, reaching approximately $2,550 million. Excluding currency fluctuations, constant currency revenues increased 12%. The company’s largest product segment, skin care products, was a major contributor to Estèe Lauder’s strong Q3’14 performance, generating net sales of $1,132 million which were 12% higher on a year-on-year basis.
Additionally, the company reported an expansion in operating margins for the quarter. Operating profit margin for Q3’14 stood at 13.4%, up from 10.7% during Q3’14. For the nine months into fiscal 2014, operating profit margins for Estèe Lauder were flat at 18% on a year-on-year basis. The quarterly expansion in margins are a sign of a revival in consumer discretionary spending, especially in the domestic U.S. market, resulting in lower promotional and discount related expenses for the company. Sales from the Americas region grew 8.5% year over year this quarter, compared to 1.4% in Q3’13. Similarly, sales in the EMEA and Asia-Pacific regions rebounded strongly this quarter, with growth rates of 13.2% and 13.7% respectively. Comparatively, sales grew 3% and 1.2% for these regions in Q3’13.
In this earnings note, we look at various factors that have contributed to this strong quarterly performance from Estèe Lauder.
New Product Launches In Emerging Markets Drive Sales Higher
Q3’14 sales for Estèe Lauder showed a strong growth pattern this quarter, partly due to an acceleration of orders attributable to the Strategic Modernization Initiative (SMI) last fiscal year. The acceleration of orders into Q2’13 depressed sales for Q3’13 by approximately $94 million, resulting in a strong year-over-year growth rate this quarter. Excluding the impact of order acceleration into Q2’13, revenues this quarter expanded approximately 7% on a year-on-year basis. This top line growth rate is twice the rate registered by competitor L’Oréal (OTC:LRLCY) during the January-March 2014 period. 
What benefited Estèe Lauder this quarter was a revival in consumer discretionary spending in the EMEA and emerging market regions. Cosmetics players have been eying the EM region for many quarters to offset the weakness in developed markets, particularly in the after years of the financial crisis. However, with developed economies beginning to rebound, Esteè Lauder may have taken an earlier lead on its competitors through new product rollouts.
The company launched various new products, particularly in the skin care division, that cater to new demographics. Examples include white-space products that are watery lotions key to Asian skin care regimens. New and innovative products like these introduced in the Asian markets, are key drivers for higher sales from Estèe Lauder. Similarly, new product launches such as Clinique’s Even Better Essense Lotion and Micro Essense Skin Activating Treatment Lotion have performed exceptionally well.  Additionally, venturing into new product categories such as contouring and lift through its reputed brands such as La Mer should provide a broader base for the company.  The company informed that it has new products in its pipeline for launch in other emerging markets for the forthcoming Q4’14, which should also drive sales higher.
SMI Wave 4 Rollout Should Provide Margin Expansion
The fourth and the last major wave of the Strategic Modernization Initiative (SMI) is expected to be completed by July 2014. This rollout would make more than 90% of overall sales SAP-enabled, providing major avenues for further cost reductions for Estèe Lauder.  Q4’14 sales are expected to witness a higher growth rate due to an acceleration in orders from Q1’15 when the rollout occurs. To facilitate this acceleration in orders, Estèe Lauder increased its inventory reserves by approximately 6% to $1,215 million.
Acceleration in shipments relating to the SMI rollout are expected to be between $125-$150 million.  This order acceleration should inflate operating expenses, in addition to one-time SMI related expenses, which should decrease margins in the near term. However, cost benefits resulting from the new IT infrastructure should provide avenues for margin expansion with increased business efficiency and reduced obsolescence expenses for the company in the long term.Notes: