Estee Lauder Q2’15 Preview: North America Might Likely Stronger, While Slowdown In China And Latin America Could Have Dampened Sales

Global premium cosmetics giant, Estee Lauder (NYSE:EL) is scheduled to report its second quarter results on February 5th. (Fiscal years end with June.)   Estee Lauder’s sales in fiscal exceeded analyst estimates, reaching $10.97 billion. However, the company experienced a setback in in the first quarter when sales experienced a 2% year-on-year decline and stood at $2.63 billion.

The main factors leading to the Q1FY15 slowdown were:

• Weak economic and geopolitical conditions in regions such as China and Latin America, which led to plummeting sales
• Internal issues such as implementation of the Strategic Modernization Initiative (SMI), which led to sellers and distributors pre-ordering products in Q4FY14, (consequently leading to a slowdown in orders in Q1FY15)
• The under performance of its travel retail division. Travel retail, one of the highest growth channels for Estee Lauder (contributing to 13% of product distribution in FY 2014), was adversely impacted by factors such as the political unrest in certain countries (like Hong Kong), the Ebola scare, and the economic slowdown of the European Region. ^[1]

In this article, we discuss the trends that likely impacted the company’s performance in Q2FY15.

Our price estimate of $85 for Estee Lauder is at a 17% premium to the current market price.

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Americas Sales Expected To Improve

The Americas region, comprising of North America and Latin America, declined the most during Q1FY15. Sales dropped nearly 7.3% to $1.12 billion, primarily due to the SMI migration (which led to decelerating orders) and economic weakness in Latin America. Going forward, sales and margins are likely to recover back to historical levels. In the near term, macroeconomic weaknesses in certain Latin American markets may continue having an adverse impact on Estee Lauder’s sales. However, we expect that the strengthening North American market, and the holiday season masked the weakness from Latin America sales for Q2FY15.  We hope for confirmation of this on the call.

Additionally, new acquisitions catering to North American demands in segments such as skin care, likely boosted the quarter’s sales from this region as well. Their full contribution will be more meaningful going forward.

China Might Still Lag Behind, Though Other APAC Countries Offer Hope

The Asia-Pacific (APAC) market is Estée Lauder’s smallest geography and accounts for about 22% in sales, with China being the region’s largest single market. China alone accounts for as much as the other emerging markets combined in sales for Estée Lauder, indicating its importance.

During Q1FY15, sales in China declined primarily due to a shortfall in outbound travelers from China to regions such as Hong Kong. This in turn impacted the travel retail segment in Asia-Pacific. Estée Lauder has a very high market share in the Hong Kong cosmetics market, and the unrest has had a significant impact on sales. Additionally, increased competition from Korean cosmetics manufacturers in the mass and prestige segments lent some pressure to sales from China. ^[1]

The company expects travel retail and retail sales in Hong Kong to remain subdued due to the geopolitical unrest in the region in Q2FY15. Furthermore, sales from China are expected to slowdown further due to aggressive promotional campaigns from local and regional competitors. ^[1]

During Q1FY15, other  Asia-Pacific markets such as Korea, Japan and Australia reported strong growth in both retail and net sales. We expect continued support from strong brands in Estee Lauder’s fragrance and make-up portfolio to drive further growth in Asia. Also, a recovery in the skin care portfolio following the SMI order acceleration should lend support for sales growth and margin expansion in Q2FY15, particularly in the Asia-Pacific region where demand for skincare products is high.

The Recent String Of Acquisitions Might Help Expand Estee Lauder’s Presence In Some Of Its Crucial Business Segments

Estee Lauder announced a string of acquisitions in the  span of two months between October and December, 2014. The company’s last acquisition prior to these was in May 2010, when it acquired Smashbox Beauty Cosmetics.

The companies Estee Lauder acquired during this period were:

• GLAMGLOW, a prestige skin care brand specializing in facial mask treatments.
• Le Labo, the high end fragrance and sensory lifestyle brand.
• Editions de Parfums Frédéric Malle, the storied fragrance brand established by the iconic perfumer Frédéric Malle.
• RODIN olio lusso, a luxury skin care brand, offering a selection of luxury skincare oils.

Estee Lauder’s management mentioned in its fiscal 2014 year end call, that mergers and acquisitions (M&A) related activities were high on its priority list. Over the next three years, it aims to generate at least 1% of total sales growth through acquisitions ^[2]. Estee Lauder’s M&A strategy has traditionally focused on small brands with global appeal, and brands with the potentials to be developed further into bigger names. Cases in point are its Bobbi Brown, LaMer, and MAC brands. La Mer was a $1 million company when it was acquired by Estee Lauder in 1995. Now, the brand is one of the top five brands in Estee Lauder’s portfolio.

The acquisitions will boost some of the most important sources of its business, such as:

• The U.S. Skincare Market: Skincare is the most important segment in Estee Lauder’s portfolio. In fiscal 2014, Estee Lauder’s net sales were approximately $11 billion out of which 43% was contributed by skincare products. ^[3] In Q1FY15 (ended September 2014), Estee Lauder’s management admitted that the skincare growth was slow in its most important region, the U.S. (U.S. contributed to 42% of Estee Lauder’s net sales in fiscal 2014.)  A major reason for this was that the U.S. consumers expected  innovative products, across newer skincare categories. Innovation needed to be extended beyond the  traditional skincare formulations like moisturizers and serums to newer concoctions such as masks and oils. ^[4] Estee Lauder possesses a strong research and development arm. The recent acquisitions in the beautifying mask (GLAMGLOW) and oil based treatment (RODIN olio lusso) categories will no doubt round out its R&D capability and could well form the basis for the perfect solutions which the U.S. consumers are looking for.

• Luxury Brands’ Portfolio: Luxury brands are a key growth driver for Estee Lauder. Its luxury brands such as La Mer, Jo Malone and Tom Ford have been delivering double digit growth for several years. Hence, the recent acquisitions of all premium and luxury brands are best seen in this light. The company expects global prestige beauty to continue growing at 3% to 4% in fiscal 2015 and 4% to 5% thereafter. Hence, the rationale behind the recent acquisitions seems clear.

• Travel Retail: The new prestige brands are relevant additions for Estee Lauder’s travel retail segment as well. For FY 2014, travel retail was one of the highest growth channels for Estee Lauder, contributing to 13% of product distribution. Luxury cosmetics are one of the highest selling items through the travel retail channel. Hence, the current acquisitions will help Estee Lauder’s growth through this channel too. (See our article on how travel retail boosts cosmetics sales here). On a separate note, travel retail sales for Q2FY15 might be dampened to a certain extent due to the slowdown of international travels. However, we believe that these are short term hurdles, and the acquisitions will boost Estee Lauder’s travel retail sales in the long run.

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More Trefis Research

1. The Estée Lauder Companies’ (EL) CEO Fabrizio Freda on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, November 2014 [↩] [↩] [↩]
2. Estee Lauder Poised To Shop After Deal Drought: Real M&A, Bloomberg, March 2014 [↩]
3. Estee Lauder’s 2014 Annual Report, September 2014 [↩]
4. Estee Lauder’s Q1 2015 Earnings Transcript, Seeking Alpha, November 2014 [↩]