Operating Profits And Earnings Fall Sharply On SMI Pre-orders For Estée Lauder In Q1FY15

by Trefis Team
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Estée Lauder (NYSE:EL) reported its Q1FY15 earnings on November 04, 2014. (Fiscal years end with June.)  Sales for the prestige cosmetics manufacturer declined nearly 2% to $2,631 billion, impacted by weak economic and geopolitical conditions in certain regions. Additionally, an acceleration of sales orders due to the implementation of the Strategic Modernization Initiative (SMI) in Q4FY14 resulted in weak orders and sales this quarter. The impact of migration of orders into Q4FY14 as part of the SMI rollout was approximately $178 million in sales.

The skin care division, which is the largest segment for Estée Lauder, solely contributed to this decline in sales in Q1FY15. Sales from skin care products decreased about 7% to $1.091 billion, owing to distributors and retailers pre-ordering products in Q4FY14. Make-up products grew the fastest last quarter, driven by strong demand from brands such as M-A-C, Bobby Brown and Smashbox, generating revenues of $1.021 billion. Fragrance sales also grew during the quarter to $377 million, supported by brands such as Jo Malone and Tom Ford.

Despite the modest performance in sales, quarterly operating income and net earnings witnessed a sharp decline during the quarter, partly impacted by the migration of orders into the previous quarter. Q1FY15 operating income declined 23% in Q1FY15 from a prior year period, with the shift in orders in Q4FY14 accounting for a loss of about $127 million in operating income. Similarly, Estée Lauder’s diluted earnings per share declined from $0.76 in Q1FY14 to $0.59 in Q1FY15, driven down by the migration of orders into the previous quarter.

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Americas’ Sales and Margins Impacted By SMI Order Migration

The Americas region, consisting of North America and Latin America, declined the most during the quarter. Sales dropped nearly 7.3% to $1.115 billion. Additionally, operating profit margin witnessed a rapid decline during the quarter, from 13% in Q1FY14 to 5% in Q1FY15. In absolute terms, operating income from the region decreased 63% to $57 million in Q1FY15 from $156 million in Q1FY14. Given that the impact of order migration into Q4FY14 on operating income was $127 million, we believe a majority of the $100 million decline in operating income from the Americas market was due to the pre-ordering completed in Q4FY14.

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 have an impact on Estée Lauder sales. In particular, product segments such as fragrances and make-up products that have high demand in the Latin American market could witness a slowdown in volumes due to the high inflation environment. However, the rapidly strengthening North American market is likely to mask any weaknesses from the Latin American market in the upcoming holiday season, particularly in the prestige and luxury cosmetics segments.

China Slowdown and Unrest in Hong Kong Could Weigh on Q2FY15 Sales

The Asia-Pacific 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. Last quarter, net sales declined marginally in China despite a 5% expansion in retail sales. Sales declined primarily due to a decline in outbound travelers from China to regions such as Hong Kong during the quarter, which 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 masstige and prestige segments lent some pressure to sales from China.

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. On the flipside, other Asia-Pacific markets such as Korea, Japan and Australia reported strong growth in both retail and net sales during Q1FY15. We expect continued support from strong brands in Estée Lauder’s fragrance and make-up portfolio to drive growth. 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.

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