A common misconception is that lower stock prices are akin to cheaper shares. Without much explanation, it is logical that this can only apply when the underlying business has at least been stable. Otherwise it is possible that a stock even becomes more expensive! While this is not the case at Estée Lauder, despite a 75% drop from its all-time high, the stock is still looking ugly valuation-wise. A decent downside risk remains. On top, the likelihood for a dividend cut or even entire suspension is significant.

Summary and key takeaways from today’s Weekly
– Estée Lauder was once a very hyped darling of the masses with its stock trading at lofty valuations.
– The rise was only short-lived and the fall well deserved as the business has been suffering.
– Despite being down by ~75%, I don’t see any reason to rush in. To the contrary, even the dividend is in jeopardy.

Estée Lauder (ISIN: US5184391044, Ticker: EL) was one of the high-flyers until the stock peaked towards the end of 2021 / beginning of 2022 at over 360 USD.

While its business did experience growth and an operating margin expansion, the reality is that the stock price appreciation by far outpaced this development.

Concretely, while temporarily sales grew by 20% and operating earnings by ~30% between 2019–2022, the stock made an incredible double from July 2019 towards its peak. And this starting with a price to earnings multiple of already in the mid-30s – roughly in the ballpark where you would assume Apple (ISIN: US0378331005, Ticker: AAPL) or Microsoft (ISIN: US5949181045, Ticker: MSFT).

I am deliberately saying “incredible”, because Estée Lauder is – with a few exceptions and in a normal environment – just a slow growing company, somewhere in the mid- to high-single digits only with lower margins than its competitors.

At the top, the stock reached an enterprise value of 140 bn. USD, while sales were only 17.7 bn. USD (record number, achieved during FY 2021/2022, until June 2022) and a modest looking free cash flow of just 3.6 bn. USD in summer 2021, respectively 3 bn. USD a year later.

In other words, an EV / FCF in the high-40s for a slow-grower was not to last.

With the beginning of the subsequent fiscal year 2022 / 2023, the business momentum faded dramatically. Until today, sales went down by 15% and operating margins cratered.

The guidance has been adjusted lower many times and the stock has been hammered down in several waves first towards 200 USD, then 100 USD and now even below the triple-digit mark.

All in all, after the stock lost roughly three quarters from the highs, the question arises whether this could be a good opportunity for an entry.

However, I remain pretty cautious and even highly question the sustainability of the dividend. I am expecting that it will be axed over the next few quarters while a downside of another 50% is by no means an over-exaggeration.

Let’s see why lower stock prices do not automatically mean cheap opportunities!

With my risks-first approach (paired with high upside), I am able to find stocks with great returns. The average total return of my best stock ideas is ahead of the S&P500 and the Dow Jones.

Join me and my members on our journey to beat the markets!

^{active Premium PLUS cases as per 07 August 2024 market close, closed Premium cases as per 31 July 2024 – all data since August 2022}

If you struggle to find high-quality stock ideas, let me inspire you. As a Premium or Premium PLUS Member, you receive my exclusive research reports with my best and market-beating stock ideas.

Why this beauty isn’t pretty anymore – prepare for a dividend cut

Estée Lauder was founded in 1946 by Estée and Joseph Lauder. Today, it is one of the world’s leading beauty companies, offering skin care, makeup, fragrance and hair care products over different price ranges.

The snapshot below is from the last annual report, showing how their individual brands are positioned between price points and progressiveness:

Me not being an expert in this field of cosmetics, was a bit surprised, though, that their brand Estée Lauder seems to be only somewhere in the middle of the price range, as I at least have seen it in one or the other stores presented prominently, while I’ve never heard of others, seemingly more expensive ones…

But that’s just as a side note.

It’s positioning and perception, though, is more towards the prestigious luxury market, so it is effectively competing against pure-play names like L’Oréal (ISIN: FR0000120321, Ticker: OR), but also partly against LVMH (ISIN: FR0000121014, Ticker: MC) with brands like Dior.

The founding family still controls the company via a dual-class share structure, comprising an 84% voting majority, while only having a 35% economic interest. Class A has only one vote per stock, while class B has ten.

Before we dive into the numbers, here’s a price chart of Estée Lauder’s stock:

We can see immediately, that there must be a clear issue with the stock, if not the entire company. Stocks don’t shoot up and crater just for fun.

While the strong appreciation after the lockdowns was more in sympathy with the stock market rallies of 2020 and especially 2021, but also of course growing results, the rapid fall from grace happened due to challenges on an individual, i.e. business level.

On the next chart, you can see the development of some business fundamentals which peaked around the high – or the other way around, the stock having peaked around peak business fundamentals (blue = sales, black = operating income, green = free cash flow).

Since fiscal year 2022, the business is trending sharply lower.

Not just a bit, but operating earnings and free cash flow are showing the weakest results over the last ten years!

There were mainly two reasons while Estée Lauder has fallen out of favor:

• one, there were still lockdowns in China during 2022, respectively Asia travel in general was weak
• EL is positioned in a sandwich between the big players L’Oréal and LVMH and others on one side, but also above fast growing cheaper competitors on the other

One such phenomenally fast rising star is e.l.f. beauty (ISIN: US26856L1035, Ticker: elf) – it’s stock tripped in just the last 1.5 years and even 9x-ed over the last five years.

As sales went up by 15x (X, not percent!) over the last five years, it is out of question that this company has grabbed tremendous market share, likely not from L’Oréal, but from such candidates like EL.

EL started restructuring programs, including job cuts and other cost savings initiatives.

It also a few months ago acquired the company DECIEM – a Canadian company with the “The Ordinary” brand. It was from what I could find (never heard of it before) a social media success story, banking on high transparency regarding ingredients.

EL was already the majority owner at the time of the last annual report, hence the brand was already displayed in the brands chart above. However, you’ll have noticed that this brand is positioned on the lower end of the price spectrum – thus likely not generating huge margins and contradictory to wanting to be a premium company.

Now, they bought them out completely for in total 1.7 bn. USD, of which 860 mn. USD were due now in a final tranche for the remaining equity not under control.

DECIEM was a privately-held company and said to have achieved sales of 460 mn. USD in 2021.

This number has likely increased somewhat as EL said that the purchase fits into its set of brands generating all sales between 0.5 bn. USD and a full bn. USD. As EL is generating –15 bn. USD in sales, this is also just a small tuck-on acquisition and certainly not a home run, at least for the time being.

I haven’t found anything regarding profitability, though. But as said, as a lowly-priced brand, it likely won’t contribute too much to the bottom line. All in all, the paid price looks a bit high.

Until the last set of results (the next ones are due later in August), EL was constantly disappointing and lowering their outlook. In May, reporting about their fiscal Q3, they showed some first signs of relief with organic (+6%) and even total sales growth (+5%).

What reads like a first sign of a potentially successful turnaround, should be taken with a grain of salt, though.

First, they still are expecting (this was in May!) a challenging market environment, leading to results for 2024 being lower than 2023. Concretely, despite an assumed acceleration of organic sales growth, reported net sales are expected to be down still by –2% to –3%.

Earnings were expected to be affected negatively due to restructuring charges and higher interest rates on their debt to reach only 1.96–2.09 USD per share. In comparison, last FY saw 2.80 USD and the two years before 6.60 USD and 7.80 USD!

Not only that, the guidance at the beginning of the current fiscal year saw sales to be higher by between 5% and 7% and EPS to arrive in a range between 3.43 USD and 3.70 USD.

That’s a gigantic miss!

And I must admit that I don’t believe they will hit the last, massively lowered guidance either, as the economic development has worsened since their last earnings announcement.

Even if they hit it miraculously, the outlook should be weak.

Now, let’s talk the balance sheet and capital allocation.

Net debt stands at around 5 bn. USD. The chart below shows the numbers until the end of June 2023 (fiscal year 2023), but since then the numbers worsened a bit. In February 2024, they issued a 650 mn. USD bond with a 5% coupon (above their average cost of debt) and also paid 860 mn. USD for the DECIEM acquisition, while paying out a dividend with a yearly run rate of almost a billion USD.

The only good thing here is that they have structured their debt ladder very favorably.

No big near- or even mid-term maturities, only small increments here or there.

Free cash flow was expected to come in around a billion USD for the year. This number is realistic still, however, not due to operational excellence, but rather due to lower inventories – this is a one-time effect.

You can see, FCF should be around a billion USD, however, only this year. The next will likely see a way lower number with weaker consumer sentiment.

And herein lies the danger for the dividend, as the next chart clearly shows.

Above, we can see that the dividend costs them currently ~950 mn. USD p.a.

So, even with the generously positive one-time working capital effect of lower inventories, FCF covers this number only with a small margin.

This is a clear sign for me that the dividend is in danger. The buffer is just too small and there’s a decent chance that the new fiscal year 2025 won’t be strong – to the contrary!

The last chart above also shows when share buybacks have been done aggressively – you likely already guessed it, when the stock was way higher than it is now for in total ~5.5 bn. USD. As a reminder, today their net debt number is higher and at 5x FCF. The end result was a not even 5% lower share count…

With this, let’s have a look at the valuation and let’s be even generous with the assumptions. Think of kind of a base and a bull case scenario.

The base case would be current sales of 15 bn. USD and a FCF of a bn. USD. The market cap is 34 bn. USD, for an enterprise value of 39 bn. USD – still a rich multiple of 39x.

Being a bit more optimistic and assuming that growth reemerges and margins rise again to achieve a FCF of 2 bn. USD. In FY 2021, they had 2.9 bn. USD and in FY 2022 2.0 bn. USD – or at the peak. This translates into an EV / FCF multiple of still ~20x.

In other words, a hefty recovery is still priced in.

That said, the upside for me is basically non-existent.

On top, you also have a realistic risk for a dividend cut, if not entire suspension, depending on how the guidance for the new fiscal year comes in. Should we indeed go into a harsher recession, it’s almost a given that they will completely eliminate the payout, family descendants or not.

That’s why I am looking for ideas that have inherent upside potential and low risk due to low valuations. Case in point, what about a hedge against rising energy (especially gas) prices in Europe? Or a coming break-up of a conglomerate into four pieces with a realistic upside of 50–100%?

Conclusion

Estée Lauder was once a very hyped darling of the masses with its stock trading at lofty valuations.

The rise was only short-lived and the fall well deserved as the business has been suffering.

Despite being down by ~75%, I don’t see any reason to rush in. To the contrary, even the dividend is in jeopardy.

By becoming a Premium or Premium PLUS Member, you get instant access to all my already published research reports as well as several updates.

Likewise, you qualify for eight, respectively three more exclusive reports with my best investment ideas plus updates on the featured businesses over the next twelve months.

Premium PLUS Members also get access to all Premium publications.