e.l.f. Beauty is growing rapidly, emerging as the most popular beauty company among Generation Z. Their business model enables them to sell products at a lower price compared to their competitors. Despite the lower prices, e.l.f. Beauty delivers higher margins than competitors like Coty and is getting closer to the high margins of Estee Lauder and L'Oreal. Furthermore, the company is consistently gaining market share. Given these factors, it could be an opportune time to consider investing in e.l.f. Beauty.
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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.
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The Business
e.l.f. Beauty is an American cosmetics company founded in 2004, which conducted its IPO in September 2016. The company sells 100% cruelty-free products, meaning they do not conduct or tolerate any tests on animals, nor do they use ingredients that have been tested on animals in any of their products. Besides the e.l.f. brand, they also own Well People, Keys Soulcare, and Naturium. 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 offering them at a lower price point compared to the industry average. Today, the price point is a little over $6,50, compared to $9,50 for legacy mass cosmetics brands and over $20 for prestige brands. e.l.f. Beauty has established a brand moat by offering 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 its supply chain. By offering quality beauty products at affordable prices that are vegan, cruelty-free, and fair trade certified, e.l.f. Beauty has become the favorite beauty brand for Generation Z, while also growing in popularity among Generation Alpha and Millennials. The company runs a highly efficient operation, with income per employee significantly higher than that of its competitors—$295k per employee compared to $44k for Coty and $72k for L'Oreal.
Management
Their CEO is Tarang Amin, who joined e.l.f. Beauty and became the CEO in 2014. Prior to joining e.l.f. Beauty, he held various roles at 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. With over 25 years of experience in the consumer products industry, Tarang Amin 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, Tarang Amin mentioned his passion for brand building, a skill at which he excels. Not only has he delivered exceptional growth at e.l.f. Beauty, but he was also part of the team at Procter & Gamble that re-launched Pantene in the early '90s, growing the brand from $50 million to a $2 billion global market leader. He believes in engaging with customers, as it helps build relationships and fosters loyalty. e.l.f. Beauty improves by responding to every single review and taking feedback into account when developing new products and enhancing existing ones. Tarang Amin has done a remarkable job at e.l.f. Beauty, and his credentials and experience, combined with his strategy of engaging with customers, make him the right person to lead e.l.f. Beauty into the future.
The Numbers
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, and it increased again in 2024, making it two consecutive years with a ROIC above 10%, which is encouraging. e.l.f. Beauty is a growth company, so I'm not worried that e.l.f. Beauty didn't manage to deliver a ROIC above 10% before 2023. However, I do expect that e.l.f. Beauty will deliver a ROIC above 10% every year from now on. Overall, I'm not worried about the historic ROIC, and I'm encouraged about the current and future ROIC.
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 increased even further in 2024. It will be interesting to see if e.l.f. Beauty can sustain this momentum and propel that growth moving forward. Overall, I believe that e.l.f. Beauty has delivered some great numbers, and I'm encouraged that growth has picked up in the past two years.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected 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. Free cash flow decreased slightly in 2024, partly due to increased marketing expenses aimed at gaining market share, while fiscal 2024 has also been a challenging year due to macroeconomic factors. Thus, it is encouraging that e.l.f. Beauty managed to deliver its second-highest free cash flow in fiscal 2024. However, levered free cash flow significantly decreased in fiscal 2024 and is now at the third-lowest level since its IPO. Fiscal 2024 has been challenging, and while the numbers are underwhelming, this trend needs to be monitored moving forward, as I would like to see the levered free cash flow margin increasing in the future. The free cash flow yield is also lower than average, suggesting that the shares are trading at a high valuation. However, we will revisit this later in the analysis.
Debt
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 1,27 years. This is within the three-year requirement. Thus, debt is not an issue for me if I were to invest in e.l.f. Beauty.
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Risks
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 faces competition from companies worldwide, including large multinational consumer products companies with many beauty brands and independent beauty and skincare brands. Many of these companies have greater financial, technical, or marketing resources, longer operating histories, greater brand recognition, or larger customer bases than e.l.f. Beauty and may be able to respond more effectively to changing business and economic conditions. Many of these competitors’ products are sold in a wider selection or greater number of retail stores and possess a larger presence in these stores, typically having significantly more inline shelf space than e.l.f. Beauty does. Given the finite space allocated to beauty products by retail stores, e.l.f. Beauty's ability to grow the number of retail stores in which its products are sold and expand their space allocation once in these retail stores may require the removal or reduction of the shelf space of these competitors, which may be difficult to achieve. 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. However, competition may catch up as they can follow the blueprint that e.l.f. Beauty has established.
Another risk is that e.l.f. Beauty relies on third-party suppliers. e.l.f. Beauty uses multiple third-party suppliers and manufacturers to source and manufacture substantially all of their products. They engage with these third-party suppliers and manufacturers on a purchase order basis and are not party to long-term contracts with any of them. The ability of these third parties to supply and manufacture e.l.f. Beauty products may be affected by competing orders placed by other companies and the demands of those companies. Furthermore, almost 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. Additionally, 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 as the products will be more expensive for e.l.f. Beauty.
Another risk is customer concentration. Target, Walmart, and Ulta Beauty accounted for 25%, 17%, and 16% of e.l.f. Beauty's net sales in fiscal 2024. Management expects that these three retailers, along with a small number of other customers, will continue to account for a large portion of their net sales in the future. As is typical in the industry, e.l.f. Beauty's business with retailers is primarily based on discrete sales orders, without contracts requiring retailers to make firm purchases. This means retailers could reduce their purchasing levels or cease buying products from e.l.f. Beauty at any time and for any reason. If e.l.f. Beauty loses a significant retail customer or if sales to a significant retailer materially decrease, it could have a material adverse effect on the company's business, financial condition, and results of operations.
Reasons to invest
There are also many reasons to invest in e.l.f. Beauty. The company has identified three areas with significant potential for growth. The first one is the color cosmetics segment. Management has expressed confidence in e.l.f. Beauty's ability to significantly outpace category growth rates and gain market share, and so far, they have done a great job. In color cosmetics, e.l.f. Beauty ended fiscal 2024 with about a 10.5% market share, more than double the level it had four years ago. e.l.f. Beauty continues to gain market share, having done so for 21 consecutive quarters. Management believes they can double their market share again over the next few years. The strategy to gain market share includes earning additional space at retail partners. They are off to a good start in fiscal 2025, as e.l.f. Beauty has announced that they will be expanding space for their products in fall 2024 with CVS, in addition to previously announced space gains in spring 2024 with CVS and in summer 2024 with Walmart.
The second area of growth is the skincare segment. e.l.f. Beauty is rapidly expanding its presence in this segment. In the last quarter of fiscal 2024, the skincare segment grew by 38%, significantly outpacing the category growth of 2%, indicating that e.l.f. Beauty is gaining market share. Management believes there is still plenty of runway ahead in the skincare segment, as e.l.f. Beauty currently holds only a 1.6% market share. In October 2023, e.l.f. Beauty acquired Naturium, a clinically effective biocompatible skincare brand. This acquisition means that e.l.f. Beauty now owns two of the fastest-growing skincare brands. When e.l.f. Beauty acquired Naturium, it was only available on its website, Target, and Amazon. However, starting in the summer of 2024, Naturium will also be available at Ulta Beauty, expanding its availability to more customers. Management has expressed strong confidence in Naturium and its future prospects.
The third growth area is expanding internationally. e.l.f. Beauty first expanded to the United Kingdom and Canada and has performed remarkably well, becoming the fastest-growing among the top 10 cosmetics brands in both countries, driving significant share gains in each market. Despite this success, there is still ample runway for e.l.f. Beauty internationally. In fiscal 2024, international sales accounted for 15% of e.l.f. Beauty's revenue, compared to its global peers, which average over 70%. e.l.f. Beauty is now expanding to other countries. They launched their products at Douglas (a retailer) in Italy in the fall of 2023 and have become the number one brand at Douglas across both mass and prestige categories. In April 2024, e.l.f. Beauty launched its products in the Netherlands with Etos (a retailer), quickly becoming their number one brand. Additionally, e.l.f. Beauty will launch its products in Sephora in Mexico in 2024. The company expects to continue launching its products in more countries, as their marketing across social media has already generated significant popularity in markets where they have not yet launched. International expansion could be highly profitable for e.l.f. Beauty, as management has mentioned that international sales have larger profit margins, partly because they do not incur the same tariffs as in the United States.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
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 2,21, which is from the fiscal year 2024. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 29,1% in the next five years, but 15% is the highest I use. Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on e.l.f. Beauty's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $66,30. 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 $33,15 (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 71, and capital expenditures were 9. 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 6 in our calculations. The tax provision was 13. We have 55,507 outstanding shares. Hence, the calculation will be as follows: (71 – 6 + 13) / 55,507x 10 = $14,05 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 $1,13 and a growth rate of 15%. If you want to recoup your investment in 8 years, the Payback Time price is $17,84.
Conclusion
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. ROIC has been underwhelming in most years but has topped 10% in the past two years, which is encouraging. Free cash flow decreased last year, but it is more concerning that the levered free cash flow margin is currently at a low level. Thus, I believe that the levered free cash flow margin is something to monitor. e.l.f. Beauty operates in a competitive industry and doesn't have the financial strength that its larger competitors possess. So far, this hasn't adversely affected e.l.f. Beauty, but its growth depends on winning shelf space, which may be difficult if it comes at the expense of its larger competitors. e.l.f. Beauty is dependent on its third-party suppliers and has no long-term contracts with any of them. While this hasn't been an issue so far, it could become one as e.l.f. Beauty grows larger. Additionally, most of its suppliers are Chinese, which may pose a risk in the future. e.l.f. Beauty is also reliant on a few large customers who prioritize their own interests, meaning that if these customers reduce their orders of e.l.f. Beauty products, it would significantly impact the company. e.l.f. Beauty has shown tremendous growth in color cosmetics, and management believes they can double their market share in a few years. They seem to be on the right track, as they are increasing shelf space at both CVS and Walmart during fiscal year 2025. e.l.f. Beauty holds a small market share in skincare, indicating plenty of runway to gain market share, and the acquisition of Naturium should accelerate this growth. Internationally, e.l.f. Beauty has done exceptionally well, as their products are very popular even before entering new markets. This has allowed e.l.f. Beauty to quickly become the top brand in the retailers they have launched in. The company plans to launch in more countries, with management talking about entering a new country every quarter. This could be very profitable for e.l.f. Beauty, as international sales have higher profit margins. I really like e.l.f. Beauty, and I will buy a small position if the stock reaches $66, which is the intrinsic value of the Margin of Safety price.
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