Estee Lauder stock (NYSE: EL) is up 35% since the beginning of 2020, and at the current price of around $279 per share, we believe that EL stock has around 20% potential downside.
Why is that? Our belief stems from the fact that EL stock is up almost 2x from the low seen in March 2020. Further, after posting mixed Q2 ’21 numbers, it’s clear that EL did not benefit from the pandemic, and that makeup and fragrance demand has still not fully recovered to pre-Covid levels. Our dashboard Buy Or Sell Estee Lauder Stock? provides the key numbers behind our thinking, and we explain more below.
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EL stock’s rise since late 2017 came due to a 4% rise in revenues. However, a rise in cost of sales and operating expenses meant that net margins dropped by 41% between 2018 and 2020 (EL’s fiscal year ends in June). This meant that EPS came in at $1.90 in 2020 vs $3.01 in 2018, a 37% decrease.
Estee Lauder’s P/E (price-to-earnings) ratio rose from 42x in 2017 to 109x in 2019, as a drop in EPS did not lead to an equivalent drop in share price, as expectations of a jump in demand rose. The P/E multiple has since risen to 147x, but given Estee Lauder’s mixed Q2 2021 results, there is possible downside risk for EL’s multiple.
So what’s the likely trigger and timing to this downside?
The global spread of Coronavirus and the resulting lockdowns have hurt demand for beauty products. With people not stepping out, makeup and fragrance products have seen a drop in demand. However, demand for hair and skin care products hasn’t taken as bad a hit, and the combined effect of these two factors is evident from Estee Lauder’s Q2 2021 earnings. Revenue came in at $4.85 billion, up from $4.62 billion for the same period in 2020. However, gross margins came in roughly at the same level for both periods. Operating income rose 4x from $261 million to $1.06 million, but a closer look reveals that impairment charges came in $700 million higher in Q2 2020 than Q2 2021, being the major reason behind Estee Lauder’s low operating income. Further, EPS rose to $2.40 from $1.55, but this was helped by a lower effective tax rate (14.85% in Q2 ’21 vs 30.8% in Q2 ’20).
Despite the economy opening up, it’s likely that work-from-home will become the new norm, and makeup and fragrance demand could struggle to get back to pre-Covid levels, at least in the medium term.
Regardless, if there isn’t evidence of containment of the virus anytime soon, and the company is not able to control expenses, we believe the stock will see its P/E multiple decline from the current level of 147x to around 120x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $225, a downside of almost 20% from the current price of $279.
While Estee Lauder stock may not be attractive, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counterintuitive the stock valuation is for Amazon vs Etsy.