The Estée Lauder Companies Inc.

Moat: 4/5

Understandability: 3/5

Balance Sheet Health: 4/5

The Estée Lauder Companies Inc. is a global manufacturer and marketer of prestige skincare, makeup, fragrance, and hair care products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: The Estée Lauder Companies Inc. (EL) is a prominent player in the prestige beauty sector. Their operations are categorized into skincare, makeup, fragrance, and haircare. The company markets its products through various channels, including department stores, specialty multi-brand retailers, travel retail, and online platforms, reaching consumers across the globe. The company’s brand portfolio is a mix of owned brands such as Estee Lauder, Clinique, MAC, La Mer, Origins, and acquired brands like Too Faced, Bobbi Brown, Aveda, and Jo Malone London.

Revenue Distribution

Skin Care: This segment constitutes the largest revenue share, encompassing a range of products including moisturizers, cleansers, serums, and treatments.
Makeup: This segment includes color cosmetics such as foundations, lipsticks, eyeshadows, and mascaras.
Fragrance: This segment consists of a collection of fragrances for both men and women, often leveraging well-known luxury brands.
Hair Care: This category includes shampoos, conditioners, styling products and treatments.
Other: This category includes sales in other product categories like home fragrance and other items that they sell.

Industry Trends: The beauty industry, particularly the prestige segment where EL operates, is characterized by:

Premiumization: Consumers are increasingly drawn to high-quality, luxury products, driven by a desire for exclusivity, and efficacy.
Digitalization: E-commerce is playing a more significant role, compelling beauty companies to boost their online presence and direct-to-consumer offerings.
Personalization: There’s an increasing demand for personalized products and experiences, leading companies to offer customizable solutions.
Emphasis on Sustainability: Consumers are increasingly conscious of environmental issues, therefore preferring products with sustainable packaging and ingredients.
Brand Authenticity: The authenticity of the brand is increasingly important to consumers, with an emphasis on transparency and ethical manufacturing.

Competitive Landscape: EL operates in a highly competitive market. Its main competitors include:

Other Prestige Beauty Companies: L’Oréal (including Lancôme, Kiehl’s), Shiseido, LVMH (including Dior, Guerlain), and Chanel. These companies have robust brand portfolios and large international presences.
Independent/Niche Brands: A plethora of smaller, independent brands that offer unique and niche products which attract a specific type of consumers.

What Makes EL Different:

Prestige Focus: EL solely focuses on the prestige segment, which allows for premium pricing and higher margins than mass-market competitors.
Strong Brand Portfolio: A diverse portfolio of well-known and reputable brands provides a strong competitive advantage, capturing a wide range of consumers.
International Reach: Its extensive global presence allows it to tap into different markets and reduce reliance on a single region, helping to weather economic fluctuations in different countries.

Moat Assessment (4/5): EL possesses a wide moat, which is primarily based on:

Brand Strength: EL’s portfolio of brands has strong recognition and loyalty, giving them pricing power and the ability to maintain market share.
Intangible Assets The company has developed numerous brands with distinctive identities, allowing it to extract value from consumers, this also includes several patents that protect their innovation in products and processes.
Economies of Scale: Their size enables them to benefit from economies of scale in purchasing and distribution. They are able to have very strong negotiations with manufacturers and retailers, thus maintaining lower costs than smaller competitors.
Product Differentiation: A constant focus on creating innovative products along with a focus on customization to attract diverse consumers builds a level of loyalty which is hard to recreate.

These factors allow EL to maintain premium pricing and retain customers which gives the company an edge over its competition.

Risks That Could Hurt The Moat

There are certain risks that could erode or negatively affect the company’s moat:

Brand Erosion: Changes in consumer preferences, particularly through social media trends and influencers, or a significant event damaging a specific brand’s reputation, can reduce the appeal of existing brands.
Intense Competition: The beauty industry is highly competitive, and new entrants and innovative products can erode market share if not dealt with well. Competition from indie brands might especially threaten existing market leaders.
Economic Downturn: In a recession or times of economic slowdown, consumers may switch to cheaper or more affordable beauty options over their usual luxury options, impacting revenue and brand prestige.
Increased Cost of Raw Materials/Supply Chain Issues: Increases in the cost of raw materials or continued supply chain issues (like the impact of ongoing geopolitical issues) might reduce profit margins.
Failure to Maintain Innovation: The company’s performance relies heavily on constantly innovating. If they fail to innovate and adapt, their product offering will become dated quickly.

Business Resilience: Despite these risks, EL exhibits robust business resilience because:

Diversified Portfolio: The company’s diversified portfolio of brands and product categories helps it withstand fluctuations in a specific market segment or trend and protects from losses in particular segments of the company.
Global Presence: Being present in various economies all over the world reduces its dependency on single regions.
Established Distribution Channels: A strong global network of distribution channels, both physical and online, enhances the company’s stability and market reach.
Proven Track Record They have shown a history of being able to acquire competitors successfully and also maintain their moat and grow over long periods of time with consistency.
Focus on Prestige: The company’s focus on prestige market, which tends to be less price sensitive, offers some degree of protection from economic downturns, and from more value-driven competitors.

Financial Analysis

Revenues: For the three months ended September 30, 2023, net sales were 3.5 billion, a 10% drop from 3.93 billion in the same period in 2022. The overall results were affected by lower volumes and unfavorable foreign exchange rates. Net sales were negatively impacted by a decline in all regions with the Americas seeing the biggest drop at 13.9%.
Gross Margins: Gross profit was $2.43 billion, compared to $2.74 billion in the same time the previous year. There has been a decrease in gross margin over last year, dropping from 70% to 69.2%.
Operating Income: The operating income was $331.8 million in this quarter, compared to $842.7 million in the prior year, reflecting an enormous drop of 60.6%.
Net Earnings: The net earnings attributable to Estee Lauder was 31 million, in comparison to 489 million from the same time last year. There was a huge decrease in earnings from the company with the main driver being the reduction of operating income.
Cash Flows: Cash flow from operations was $1.47 billion in this quarter, up from $611.9 million in the previous period, indicating solid cash flow from operations.
Revenues By Region: Net sales declined in all regions with the Americas suffering the biggest drop at 13.9% (compared to an increase of 1% in the prior year). The revenues in EMEA decreased 9.2% with the main factor being a decline in the travel retail business and a 5.4% decrease in Asia Pacific. There was a 4.4% decrease in net sales in China for the quarter.

Recent Concerns/Controversies/Problems

Declining sales and profitability: Overall results were affected by lower volumes, foreign exchange, and a drop in sales in the travel retail business.
China Rebound: A slowdown in growth in China is also a big concern for the company, as this had been one of the few regions that had been showing positive growth in recent times.
Increased Competitor Activity: In China, domestic beauty brands are beginning to dominate the markets and are offering similar products at a lower price point which has started to impact some of the sales.
Ongoing Restructuring Efforts: In fiscal year 2023, the company introduced a two-year “Profit Recovery Plan” aiming to revive margins and improve cash flow through strategic initiatives. They expect to reduce expenses and improve efficiency in production, operations, and supply chains.

Understandability (3/5): The business of EL is relatively easy to understand in terms of how they make revenues. The complexity arises when trying to understand how their products are differentiated. Also, predicting consumer behavior and preferences in the luxury/beauty space is difficult.

Balance Sheet Health (4/5): EL’s balance sheet is relatively healthy though there are some areas of concern. They have a high amount of debt at almost 10 billion, which is the highest in the past 5-6 years. This amount of debt is significant, but they should have no problem in repaying as they have good liquidity. They are actively pursuing initiatives to restructure the organization and pay down the debt. Although their overall balance sheet is healthy, a sudden dip in revenues could create problems in the coming years.