e.l.f. Beauty: Growing on all cylinders

e.l.f. Beauty is growing rapidly, as it is the most popular beauty company among Generation Z. Their business model enables them to sell their products at a lower price compared to their competitors. However, the lower prices don't mean that e.l.f. Beauty delivers lower margins than their competitors, as they have higher margins than Coty, and are getting closer to the high margins of Estee Lauder and L'Oreal. Additionally, they are also gaining market share. Is now the time to be investing in e.l.f. Beauty?

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly describe the company and if it has a moat. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in e.l.f. Beauty. If you would like to copy my portfolio or view the stocks in my portfolio, you can find instructions on how to do so here. I do however own shares in Estee Lauder . As always, I will keep this analysis unbiased. If you want want to purchase shares or fractional shares in e.l.f. Beauty, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.

e.l.f. Beauty is an American cosmetics company that was founded in 2004 and conducted their IPO in September 2016. e.l.f. Beauty sells 100% cruelty-free products, which means that they do not conduct or tolerate any tests on animals. They also do not use any ingredients that have been tested on animals in any of their products. Besides the e.l.f. brands, they also own Well People, Keys Soulcare, and Naturium. e.l.f. E.l.f. distinguishes itself from other beauty companies by its ability to quickly produce new products (on average, within 20 weeks from idea to launch) while also offering them at a lower price point compared to the industry average. The price point is a little over $6 today, compared to over $9 for the legacy mass cosmetics brands and over $20 for prestige brands. I believe that e.l.f. Beauty has established a brand moat as they offer premium quality beauty products at affordable prices. These products have a wide appeal and are also vegan, cruelty-free, and fair trade certified. Furthermore, e.l.f. exemplifies the best combination of cost, quality, and speed in the industry through their supply chain. The income per employee of the company is significantly higher than that of its competitors ($295k per employee compared to $44K that of Coty and $72K for L'Oreal to mention a few).

Their CEO is Tarang Amin. He joined e.l.f. Beauty became the CEO in 2014. Prior to joining e.l.f. Beauty, he held various roles in companies such as Schiff Nutrition, The Clorox Company, and Procter & Gamble. He holds a B.A. in international policy and an M.B.A. from Duke University. He has more than 25 years of experience in the consumer products industry, where he has successfully built brands, led innovation, and assembled high-performance teams. He is widely recognized for his role as CEO at Schiff Nutrition, where he grew the enterprise value from $190 million to $1,5 billion. In an interview with Forbes, he mentioned that he is passionate about brand building, which is something he excels at. Not only has he delivered exceptional growth in e.l.f. Beauty, he was also part of the team at Procter & Gamble that re-launched Pantene in the early 90s, which grew the brand from $50 million to a $2 billion global market leader. He also believes in engaging with customers because it is how e.l.f. Beauty builds relationships and fosters loyalty. e.l.f. Beauty gets better by responding to every single review and take the feedback into account when they develop new products and enhance existing ones. Tarang Amin has done a remarkable job at e.l.f. Beauty, he has the credentials and experience, while I also appreciate the strategy of engaging with customers. Hence, I believe that Tarang Amin is the right person to lead e.l.f. Beauty in the future.

I believe that e.l.f. Beauty has a moat. I really like the management too. Now, let us examine the numbers to determine if Digital Turbine meets our criteria for a strong moat. In case you want an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.

The first number I will investigate is the return on invested capital, also known as ROIC. Ideally, you would like to see a return on invested capital (ROIC) above 10% in all years. e.l.f. Beauty didn't go public (IPO) until September 2016, which falls within their fiscal year 2017. Thus, we don't have any numbers prior to 2017, and the numbers for 2017 only cover 6 months. The ROIC has not been impressive until 2023, but as of now, it has improved significantly. e.l.f. Beauty is a growth company, so it's not something that I'm worried about. It is encouraging to see that e.l.f. Beauty has managed to deliver a return on invested capital (ROIC) above the required 10% in 2023, and hopefully, this is a trend that we will see continuing in the future. Nonetheless, I don't attach too much importance to ROIC at this point.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. It is nice to see that e.l.f. has managed to increase its equity in all years except for fiscal 2019. Growth picked up in 2023, and it will be interesting to see if e.l.f. Beauty can sustain this momentum and propel that growth forward. Overall, I am satisfied to see these numbers.

Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use margins to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. The first thing that springs to mind is that e.l.f. Beauty has been free cash flow positive every year since its IPO, which is quite impressive and very encouraging. Levered free cash flow margin was affected in fiscal 2021 and fiscal 2022, which could be caused by higher transportation costs for e.l.f. Beauty has their products produced in China. It is encouraging to see that the levered free cash flow margin increased significantly in fiscal 2023. The free cash flow yield indicates that the share is trading at a high price. However, we will discuss this further in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine whether a business has a manageable debt that can be repaid within a three-year period. This can be assessed by calculating the ratio of long-term debt to earnings. After performing the calculation on e.l.f. Beauty, it shows that the company has a debt-to-earnings ratio of 0,99 years. It is within the three-year requirement; thus, debt is not an issue when investing in e.l.f. Beauty.

Like every other investment, there are risks associated with investing in e.l.f. Beauty. One risk is competition. The beauty industry is highly competitive, and e.l.f. Beauty is facing competition from companies that have greater financial, technical, or marketing resources, longer operating histories, greater brand recognition, or larger customer bases than e.l.f. Beauty. Additionally, these companies may be more capable of responding effectively to changing business and economic conditions due to their size and resources. Furthermore, e.l.f Beauty has done a tremendously good job at marketing through social media, such as TikTok, where they have had a head start. Competition may catch up as they can follow the blueprint that e.l.f. Beauty has established. Another risk is the China risk. Pretty much all of e.l.f. Beauty's products are manufactured in China. As the relationship between the United States and China continues to deteriorate, any new restrictions or tariffs could potentially impact e.l.f. Beauty's business. Furthermore, with the rapid development of the Chinese economy, the cost of labor has increased and may continue to increase in the future. This could potentially have a negative impact on profit margins. Another risk is customer concentration. Target, Walmart, and Ulta Beauty accounted for 25%, 20%, and 15% of e.l.f. Beauty's net sales in fiscal 2023, and management expects that Target, Walmart, and Ulta Beauty, along with a small number of other customers, will, in aggregate, continue to account for a large portion of our net sales in the future. Thus, if one of their three large customers were to choose not to promote e.l.f. Beauty products can have a significant impact on the business.

There is also a lot of potential for e.l.f. Beauty. e.l.f. Beauty has identified three areas with significant potential for growth. The first one is the color cosmetics segment. e.l.f. continues to expand its color cosmetics segment. So far in fiscal 2023, e.l.f. Beauty has experienced a growth of 48% in tracked channels, surpassing the sector category growth of 6%. It means that they have expanded their market share by 260 basis points. It has resulted in e.l.f. Beauty has been able to gain market share for 18 consecutive quarters. However, despite the impressive results, management will not rest on their laurels as they see an opportunity to double our market share over the next few years. Meaning that their market share will grow from 9,5% today to 19% in a few years. The second one is the skincare segment. e.l.f. Beauty is also rapidly expanding its skin care segment. So far in fiscal 2023, e.l.f. has experienced a 127% growth in their skin care segment, compared to the industry's growth of 10%. e.l.f. Beauty is also gaining market share in the skincare industry, as they have increased their market share by 75 basis points in fiscal 2023. Management believes they have a significant growth opportunity in the skincare industry. They have a strong pipeline of skincare products and have recently acquired Naturium, a company that has achieved an impressive compound annual growth rate of 80% over the past two years. The third is growing internationally. Currently, e.l.f. Beauty is selling its products in Canada and the United Kingdom. And international sales are growing, with a 79% increase so far in fiscal year 2023. Additionally, the company has been gaining market share in both countries. e.l.f. Beauty wants to expand its brands internationally, and although they haven't specified any particular countries, management has expressed their desire to expand into Western Europe. Thus, if e.l.f. continues to gain market share in Canada and the United Kingdom, while successfully expanding into Western Europe it could lead to significant growth for e.l.f. Beauty.

Now it is time to calculate the price of shares in e.l.f. Beauty. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 1,11, which is from fiscal year 2023. I have selected a projected future EPS growth rate of 15%. (Finbox expects 34% growth, but I am using 15% as the highest rate.) Additionally, I have chosen a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on the fact that e.l.f. Beauty has historically had a higher price-to-earnings (P/E) ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $33,30. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy e.l.f. Beauty at a price of $16,65 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 95, and capital expenditures were 2. I attempted to review their annual report to determine the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 1,5 in our calculations. The tax provision was 5. We have 54,418 outstanding shares. Hence, the calculation will be as follows: (95 – 1,5 + 5) / 54,418 x 10 = $18,10 in Ten Cap price.

The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With e.l.f. Beauty's Free Cash Flow Per Share at $1,88 and a growth rate of 10%. If you want to recoup your investment in 8 years, the Payback Time price is $29,68.

You could argue that e.l.f. Beauty is a growth company. Thus, it would be better to value the company using a discounted cash flow model. Hence, I have done the same. To do so, I will need some numbers that you can see below. The numbers are the fiscal 2023 numbers, which I found on Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to choose the middle option. The chosen discount rate of 12% as it falls within the typical range of 9-12%. I decided to choose the highest option because of the current market conditions. Remember that all the numbers used in these calculations are in millions.

I also need to determine how much EBIT, Depreciation & Amortization, and Net Working Capital will change over the next couple of years. I decided to use a year-over-year growth rate of 40% for EBIT, which is in line with the analysts at Finbox. I believe that Depreciation & Amortization will grow by 10%, which is in line with analysts at Finbox. Finally, I have decided that Net Working Capital will grow by 20% per year. I haven't found a convenient method to share my entire spreadsheet here. However, after completing my calculations, I discovered the intrinsic value of e.l.f. Beauty is $121. The price with a 50% discount would be $61.

e.l.f Beauty is an interesting company with great management. The company has experienced tremendous growth over the past couple of years and continues to gain market share. I'm not overly concerned about customer concentration because I believe their customers want their products. The risk associated with China is real due to the current geopolitical environment, but e.l.f. Beauty is slowly starting to diversify away from China and has recently started operations in Thailand. Competition will always be a risk, and I believe that larger companies will catch up to e.l.f. Beauty marketing on Social Media Nonetheless, I believe the potential outweighs the risks. e.l.f. Beauty is gaining market share everywhere, and another thing that is growing is its loyalty program, which is growing by 25% year-over-year. Loyalty program customers have higher average order values, make more frequent purchases, exhibit stronger retention rates, and also buy directly from e.l.f. Beauty on a larger scale translates to higher profit margins. I have been very conservative in my calculations, and I believe that e.l.f. Beauty should be considered a growth company, meaning that discounted cash flow calculations give a better impression of its value compared to other calculations. Thus, if I will be able to buy e.l.f. Beauty shares at $61, I will buy them. I might even consider opening a position at a higher price.

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