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Estee Lauder BUY

Company Overview
Estee Lauder is one of the best-in-class consumer names with highly defensible competitive moat as a pure-play in high-margin, high-growth prestige beauty space benefiting from the rise of wellness
It has a highly diversified portfolio across skin care (56%), makeup (26%), fragrance (14%), and hair care (4%) with leading brands include Lauder, Clinique, La Mer, The Ordinary, Jo Malone, Tom Ford, and Le Labo...
...with diversified geographic presence:
Geo (FY22): ~30% in APAC, ~25% in Americas, ~45% in EMEA,
Travel Retail mostly in Asia (~27%), included under EMEA
Heavily reliant on Chinese consumers across regions / channels (est. ~60% selling to Chinese consumers)
Recent Performance
EL currently is trading at 3-yr low (4yr low excl. March 2020) due to 3 main issues / concerns:
#1. excess inventory in Asia travel retail (i.e. Hainan + Korea) which one can argue is as a result of bad financial planning and budgeting
#2. slower than expected overall recovery in Asia, particularly in China
#3. concerns about its weakening brand health and share losses in U.S.
Estee Lauder missed earnings and had to cut its FY23 full-year guidance 3 times over the past 3 quarters, significantly damping investor confidence
As a result,
investor sentiments have been very low, causing sharp sell-off of the stock (down -30% YTD)
per Factset, 9 sellside analysts have recently revised down their EPS estimates for the coming quarter, indicating another tough print next month

Investment Thesis:
1. Current valuation is at multi-year low, absolutely and relatively vs. peers, providing an attractive entry point, presenting enough margin of safety with limited downside risk
EL currently trades at (pricing + valuation as of July 25th):
~$177, close to 3yr low, 4yr low if we exclude the COVID crash of March 2020
~63% of 52 wk high: $284.45
It is down ~30% YTD
In terms of multiples: both EV / EBITDA and P/E are at multiple year low
NTM Multiple
Current
3Y Avg
3Y Median
5Y Avg.
5Y Median
1
EV / EBITDA
19.9x
23.3x
23.5x
21.4x
20.8x
2
P / E
34.9x
38.5x
39.0x
35.1x
33.7x
There are no rows in this table
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c. Core peers trading: L’Oreal has largely traded at a discount to EL over the past 5yrs but currently at a premium vs. EL; Shiseido’s delta vs. EL has narrowed by ~1.5x vs. historical, again indicating that current EL valuation is “relatively cheap”
NTM EV/ EBITDA
Current|△ vs.EL
3Y Avg.|△ vs.EL
3Y Median|△ vs.EL
5Y Avg.|△ vs.EL
5Y Median|△ vs.EL
1
L’Oréal
21.5x | +1.6x
22.6x | -0.7x
22.2x | -1.4x
21.2x | -0.2x
20.6x | -0.2x
2
Shiseido
17.6x | -2.3x
19.5x | -3.9x
18.6x | -5.0x
18.1x | -3.3x
17.2x | -3.6x
There are no rows in this table
⁠
d. Future valuation implies ~30 - 70% upside within 12 months
Strong growth per Consensus: CAGR FY24 - FY26 (FY23 is a re-basing year; EPS is going to grow 50% next year)
Revenue CAGR: +11%
EBITDA CAGR: +34%
EPS CAGR: +27%
NTM P/E for June FY24 Price:
3Yr Median 39.0x: @$260, 47% upside
5Yr Average 35.1x: @$234, 32% upside
Current 34.9x: @$232, 31% upside
NTM EV/ EBITDA for June FY24 Price:
3Yr Median 23.5x: @$301, 70% upside
5Yr Average 21.4x: @$274, 55% upside
Current 19.9x: @$254, 44% upside

2. Sign of Asia / China + Travel Retail recovery + strengthening U.S. economy with improving consumer confidence would boost investor confidence and alleviate concerns on EL’s near-term performance
a. Owning EL shares requires confidence in 1) China’s LT potential and Estee’s competitiveness, and 2) the attractiveness of travel retail as a channel/ business model to tap into China, and other emerging markets




3. Despite the scale, there is significant room for growth and EL has been laying the foundation to capture the growth
Category penetration + expansion:
Significant Fragrance (Tom Ford, Jo Malone, Le Labo - just launched in China in June) + Haircare (launched Aveda in China) opportunities in China
currently only 10% of EL’s China business is Fragrance, vs. ~35% in Western Markets
Fragrance drivers incl. self-expression with scent layering/ pairing, increasing distribution
Geo expansion:
China distribution expansion: currently EL’s biggest brand (aka EL) is only in ~145 cities in China, significant room for growth
Huge upside in other emerging markets incl. Africa + India
Consumer development + usage per person


Despite near-term uncertainty around Travel Retail (+Cyberattack) and continued inventory de-stocking headwind possible through next 2 quarters (1H FY24), I believe the recent sell-off is over-reacted, limiting downside risk and providing margin of safety, and EL long-term fundamentals are intact (even strengthened with recent initiatives in Asia - building R&D center in Shanghai, opening 2 new DCs in China, new Factory in Japan + TF acquisition)
To add some CAPEX details/ margin impact associated with those initiatives
Current valuation is at multi-year low (more on this below), with improving broader economy and consumer confidence, which I believe provides an attractive entry point with outsized upside vs. downside

Supporting Ideas - buying good business at a bargain price
Current Valuation is at multi-year low, absolutely and relatively vs. peers, providing an attractive entry point


Key Concerns and Mitigants:
Bet on China / Over-reliance on Chinese consumers (~60% of sales from Asian consumers with majority being Chinese); the reliance on Asia / China from a growth perspective is even more stark: between FY16 and FY22 around 80% of all EL's revenue growth was driven by growth in China and Chinese Travel Retail.
Key mitigants: Owning EL shares requires confidence in 1) China’s LT potential and Estee’s competitiveness, and 2) the attractiveness of travel retail as a channel/ business model to tap into China, and other emerging markets.
China + US + Travel retail are top 3 largest beauty markets (snip below)
Asia travel retail constitutes an undiversifiable growth driver for Estee Lauder: 1) Chinese tourists spend 2-3x more than Europeans when traveling; 2) before the pandemic, Asia duty-frees contributed 95% of all travel retail growth, and 3) taken globally, travel retail was already larger than domestic retail sales of luxury cosmetics in the U.S. and China in 2019. While timing a rebound in Asia TR is tough, see an attractive risk- reward trade-off for EL shares for patient investor
Solid fundamentals with China middle class growth, and opportunities to expand per capita consumption
Brand strength / market share losses
Company stated that its brand heat incl. EL + La Mer is very healthy in China
In the U.S., it is losing market share -
EL is over-indexed in department stores which are being shut-down, causing market share losses
However, it is growing in Ulta, Target and Sephora
Its DTC is growing very strong → to add stats
Near-term Asia / China recovery
Some anecdotes:
Offline is strong per both Shiseido and L’Oreal: Substantial growth in sales value observed in premium shopping malls
Despite macro concerns, the rich Chinese are spending on luxury goods more than before, both in the Mainland and – increasingly – abroad
LVMH announced another robust earnings last week, which confirms the acceleration in Asia post the re-opening of China (offset by a weaker US performance)
Asia ex-Japan sales increased 34% in Q2 (from 14% in Q1), ahead of market forecast
While cosmetics in the travel retail channel remain down YoY (as mgmt. focuses on controlling inventory in the channel to avoid discounting and grey-market activities), all other divisions benefited
​Q4 Earnings - a key catalyst as #1. investors will better understand the inventory issues + China recovery + impact on Margin; any good news there could send the stock soaring, vice versa; #2. company will provide FY24 guidance; #3. company will likely provide update on the latest cyberattack
I believe Q4 will, more likely than not, be another tough quarter despite lowered outlook, putting additional downward pressure on the stock
Offline is promising though Hainan disappointing:
Per Bernstein, China offline has been experiencing a rebound with mall traffic up +30% YoY and sales growing +40% YoY. There has been particular strength in offline premium consumption, with premium brands maintaining momentum while masstige brands have experienced more of a slow down
Per GS research covering China Tourism Group Duty Free, beauty sales in Hainan are falling short of expectations
Hainan’s DFS (DFS is the EL’s largest customer last year) store revenue has dropped 40% QoQ though Hainan tourism has been strong (~113% of pre-COVID level)
Per LVMH, cosmetics in the travel retail channel remain down YoY
Online:
Per Bernstein: for EL, saw a decline of -11% for the month of June. For the first-time in the past few months, the two-year stack of market share performance (our preferred metric of "underlying" company performance today given the volatility in the year-ago period) shows a decline in June-23 vs June-21. The bulk of the weakness appears to be driven by the Estée Lauder brand, which declines -20% for the month, which weighs heavily with the brand representing over 40% of EL's sales in the online data. Bernstein - tentatively - expects that EL brand performance should start to normalise in the second half of the calendar year as we lap the anniversary of ANR reformulation (Summer 2021 launch, with strong growth in Year 1, and weak growth over the past twelve months as trial drops out)

Trading Options:
Buy now - can’t always buy the lowest; the coming quarter could have positive news in Asia (similar to LVMH) - any improvement in Asia / Inventory will drive share price up
Assess after earnings release on Aug 17
[Not Recommend] Buy bear put spread
There could be some derivative strategies: bear put spread
A bear put spread is achieved by purchasing
put options
⁠
while also selling the same number of puts on the same asset with the same
expiration
⁠
date at a lower strike price. The maximum profit using this strategy is equal to the difference between the two strike prices, minus the net cost of the options
better than short since there will be chance for the stock to go up - any good news in China / Travel Retail will send the stock up

+++ Appendix +++
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