It’s one of the best known brands in the world but Estee Lauder has been pummeled.
For Northcape Capital’s Fleur Wright this gives a rare opportunity to buy a high quality company at an attractive price.
In her Sohn Hearts & Minds Conference debut, Ms Wright says Estee Lauder is set to regain its premium share market valuation amid emerging “mega-trends” in the cosmetics industry.
Estee Lauder shares rose five fold in the five-years to the start of 2022. Its skin care and travel retail divisions were driving-double digit organic sales growth and strong margin expansion. The company had an enviable track record and brand and still does.
Despite the initial uncertainty of Covid, e-commerce took off and the removal of travel restrictions in the US and Europe had Estee management primed for China’s reopening.
“But then, just like that, the party stopped,” Wright said.
“China didn’t reopen, Asia slowed, and US and European ‘revenge spend’ abated.
“Estee found itself with too much product in the wrong place at the wrong time.”
At that point the company suffered from an excess of inventory built up to meet demand during the pandemic, losing about 80 percent of its value over the next two years.
At current levels around $US64.83 versus a record high of $US374.20 in early 2022, the share price is well below the levels where Northcape began buying in 2019.
“But I’m here to tell you that the worst is over,” Wright said.
The company now has a restructuring plan to boost its profit by $US1.4bn by 2026.
That’s 80 per cent of the profit that the company delivered last year.
“Now we also have a catalyst after their poor performance in recent years,” Wright said.
“We have a whole new senior management team ready to take estate to the next level.
“Put those earnings on Estee’s historic PE multiple, and you get a share price return that is more than double.
“This is one of those rare times to buy a quality company at an attractive price.”
With a $25bn market capitalisation, the US-listed cosmetics company doesn’t just own the Estee Lauder brand. It has over 20 well known global premium beauty brands.
It’s a big part of why its share price has historically commanded a PE premium of 1.7 times, which is what Northcape paid for the shares when it launched its global equity fund in 2019.
“It’s a great example of the type of high quality business I like to invest in,” Wright said.
“It meets all of North Cape’s quality principles, meaning it can sustainably generate returns well above its cost of capital reinvest and grow and hence to live on long term share price out performance.”
Estee is the third biggest cosmetics maker globally, with huge economies of scale in research and development, manufacturing and marketing. It also dominates in “prestige beauty”, where there’s less competition and brand recognition and luxury reputation are “really hard to replicate”.
It’s also in a growth industry, one where Estee has a long track record of outperforming by over 50 per cent, with mid-single plus organic sales growth for over the past 30 years.
Ongoing China stimulus measures could provide a boost, as while cosmetics are thought to be a discretionary spending item, they have actually historically behaved more Like a staple.
Former CEO Leonard Lauder coined it the “lipstick effect”, after observing the purchases of affordable luxuries like lipstick, actually tended to go up as economic growth rates fell.
“So whilst I might be worried about a recession (in China) in coming years, I’m a whole lot less worried about its impact on Estee,” Wright added.
But she also sees “mega trends” driving long-term growth for Estee Lauder.
Firstly, spending per capita has room to grow because consumers in emerging markets countries are spending only a fraction on beauty products compared to the US, Europe and Japan.
Secondly, consumers tend to spend more on beauty products as they age. For countries like China where population growth has stopped, the average age of people is getting older.
Third, additional growth categories are opening up with the help of innovation into areas like home fragrances. Finally, men are increasingly starting to use cosmetics.
“Together, these factors should help return Estee to its mid- to-high single digit organic growth trajectory, and importantly, I think they can do a whole lot better than this,” Wright said.
“After the recent years of declines, Estee can grow again.”
This article was originally posted by The Australian here.
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