Shares of Estee Lauder (NYSE:EL) are up 16% over the last 12 months, outperforming the S&P 500‘s 5% return. But two research firms have downgraded the stock over the past three weeks, citing valuation and risks around the beauty company’s international and travel retail business from the coronavirus, now formally known as COVID-19. Given the run-up in the stock price and the potential macro impact, could it be time to consider buying Estee Lauder?
Skin is in
Estee Lauder has been buffered from the current softness in the cosmetics industry by its growing exposure to skin care. Skin care made up 47% of the company’s total revenue in the quarter ending Dec. 31 (the second quarter of its fiscal 2020), up from 44% in fiscal 2019 and 41% in fiscal 2018. The skin care segment grew sales 28% year over year in constant currency, compared to 7% for makeup and 9% for fragrance. That contributed to 16% sales growth on the same basis, which CEO Fabrizio Freda said was the company’s highest organic growth rate in 20 years in the holiday quarter.
Consumers are still spending on self-care and skin care, even as they spend less on cosmetics. According to market research company NPD Group, sales for the U.S. prestige beauty industry — think higher-end products than you’d find at the drugstore — were flat in 2019 at $18.8 billion, due to a 7% decrease in makeup. However, skin care sales increased 5% and hair care sales increased 16%. Sales of fragrance were up by 2%. NPD’s research also shows that nearly 25% of women in the U.S. are using less makeup now, as a natural look is more popular. “It’s all about wellness and a proactive skincare regimen,” said Jane Hali, chief executive of retail investment researchers Jane Hali & Associates.
Estee Lauder continues to invest in expansion of its skin care business, closing on the acquisition of the Dr. Jart+ brand at the end of the second quarter. Further, the global beauty company’s updates to its flagship products helped drive growth in its fiscal second quarter. Estee Lauder beat expectations for both sales and earnings in its fiscal second quarter, which ended Dec. 31. Adjusted earnings per share were $2.11, above the consensus estimate of $1.91. Sales came in at $4.6 billion, versus the $4.4 billion expected by analysts.
What about China?
The Asia-Pacific region, global online, and retail travel channels also helped boost sales in the quarter. China generated double-digit sales growth, Freda said, and lots of other markets joined in. Estee Lauder continues to see China and other international markets as promising long-term growth drivers.
However, economists are now forecasting the impact from COVID-19 on the Chinese economy to be greater than 2003’s SARS outbreak. Oxford Economics is forecasting 2020 China GDP expansion of 5.4%, down from 6% last year. Three weeks ago on the earnings call, Freda said he expected the next few months to be “very challenging,” but “given what we know now and our experience with past epidemics, we believe our business will gradually recover toward the end of the fiscal year.”
Net sales from China, including travel retail, were about 17% of total sales in fiscal 2019 and 13% in fiscal 2018. Given the double-digit sales growth and the sizable contribution to overall revenue, the impact from COVID-19 could hurt Estee Lauder this year.
The big picture
The stock currently trades at 33 times forward earnings, above the S&P 500’s 19 times and consumer discretionary sector’s 25 times. Even with a premium valuation, Estee Lauder’s marketing and execution continue to make it a leader in the luxury beauty space. While we can’t know what effect COVID-19 will have on the business in the short term, the company is well positioned to increase revenue and take market share in the long term.