Estee Lauder stock (NYSE: EL) is up 35% since the beginning of 2020, and at the current price of $280 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 nearly 2x from its low in March 2020. Further, after posting mixed Q2 ’21 results, it’s evident that Estee Lauder did not benefit from the pandemic, and that makeup and fragrance demand has still not fully recovered to pre-Covid levels. Our dashboard What Factors Drove 115% Change In Estee Lauder Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.
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EL stock’s rise since late 2018 came due to a 4% rise in revenues, which combined with a 2% decrease in the outstanding share count, led to revenue per share (RPS) rising almost 7% from $37.18 in FY 2018 to $39.64 in FY 2020 (Estee Lauder’s fiscal year ends in June). Also, over this period, the rising cost of sales and operating expenses saw EPS drop from $3.01 to $1.90, a decrease of almost 40%.
Estee Lauder’s P/S (price-to-sales) ratio rose from 3.5x in 2018 to around 5x by 2019-end. The P/S multiple has since risen further to 7x, 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 or going to work, makeup and fragrance products especially have seen a drop in demand. However, demand for hair and skin care products is relatively unaffected, 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 in Q2 2020. While gross margins came in roughly at the same level for both periods, operating income rose 4x from $261 million to $1.06 million. However, a closer look reveals that impairment charges came in $700 million higher in Q2 2020 than Q2 2021, playing a major role in the boost for 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 and people stepping out more, 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.
With revenue growth expected to stay low in the near term, if the company is not able to control expenses, we believe the stock will see its P/S multiple decline from the current level of 7x to around 6x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $225, a downside of 20% from the current price of $280.
While Estee Lauder stock doesn’t seem attractive, 2020 has created many pricing discontinuities which can offer further trading opportunities. For example, you’ll be surprised how the stock valuation for Mondelez International vs Tempur Sealy International shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.