The Estee Lauder Companies: Is it a wonderful company that can be bought at a fair price?
Opdateret: 12. nov. 2022
A famous Warren Buffett quote is: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price". In 2022 Estee Lauder Companies has dropped like the rest of the stock market. In this analysis I will investigate if Estee Lauder Companies is a wonderful company that can now be bought at a fair price.
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 also briefly go through why the company has meaning to me. 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 shares in Estee Lauder Companies. However, the company has been on my watch list for a while because of their high gross profit and operating margins. I don't own any of their competitors either but L'Oreal is on my watch list as well. If you want to see what stocks I own or want to copy my portfolio, you can read how to do so here.
Estee Lauder Companies is an American multinational manufacturer and marketer of skincare (56 % of net sales in fiscal 2022), makeup (26 % of net sales in fiscal 2022), fragrance (14 % of net sales in fiscal 2022) and hair care (4 % of net sales in fiscal 2022) products. The company sell their products all over the world and in fiscal 2022, the Americas contributed with 26 % of their net sales, Asia/Pacific contributed to 31 % of their net sales, and Europe, the Middle East & Africa contributed with 43 % of their net sales. Estee Lauder Companies was founded in New York in 1946 and is known for a broad range of brands such as Estee Lauder, Origins, Jo Malone London, Clinique, and Bobbi Brown, just to mention a few of their 27 brands. These brands are known all over the world and makes it very easy to determine that Estee Lauder Companies has a large brand moat.
Their CEO is Fabrizio Freda. He became CEO of Estee Lauder Companies in in 2009, after joining the company as COO and president in 2008. Prior to joining Estee Lauder Companies, he spent a couple of decades at Procter & Gamble, where he held various positions, among those 10 years in the health and beauty division. He graduated in economic & business administration from the University of Naples. He is known as a strategically focused, financially disciplined, and results-oriented leader that refuses to rest on his laurels and prefers to push forward to continue to make unique accomplishes in the business world. Under his leadership Estee Lauder Companies has shown multiple engines of growth and delivered record sales. Besides being the CEO and on the board of Estee Lauder Companies, he also serves at the Board of Directors of BlackRock Inc. He has previously been on Barron's list of the world's best CEOs but didn't make the cut in 2022 but he did make it to the 115th place in CEO World Magazine rankings of the best CEOs in the world in 2022. He receives an 86 CEO ranking at Comparably, which places him in the top 5 % among CEOs in similar size companies, while he gets a 90 % approval rating across the organization at Glassdoor. Hence, it seems that he is well-liked among the employees as well. I believe that Fabrizio Freda has the credentials and experience to move Estee Lauder Companies forward.
I believe that Estee Lauder Companies has a strong brand moat. I really do like the management as well. Now let us investigate the numbers to see if Estee Lauder Companies does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all benchmarks. Estee Lauder Companies has delivered some solid numbers in all ten years except for 2020, which was during the pandemic and lock downs. Once a company consistently delivers numbers above 10 %, it makes me interested. I would be happy to invest in a company that manages do deliver a ROIC like this. If you looked at ROE instead of ROIC the numbers would be even more impressing.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. While there are some years where the equity has decreased the numbers are still good. Usually, the decrease has had a reason such as a pandemic that has affected the growth. Thus, I find the numbers encouraging.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditure. It is not a surprise that free cash flow has been positive in all ten years. However, I do find it concerning that the free cash flow yield has been at the lowest numbers in the last two years. I would really like to see the free cash flow yield increase in fiscal 2023 and hopefully above the 2021 level.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by current earnings. Doing the calculation on Estee Lauder Companies, the debt can be paid off in 2,15 years. It is within the range of the 3 years and acceptable. Thus, I don't find that debt is any concern foor the time being.
Based on my findings so far, I believe that Estee Lauder Companies is a good company. However, no investments are without risk and Estee Lauder Companies has some risks as well. There are both some short-term and some long-term risks. One short-term risk is related to macroeconomics. Higher freight prices, higher prices on raw materials, and labor costs are all putting pressure on margins, which came on lower in fiscal 2022 than fiscal 2021. The gross profit margin decreased from 76,4 % to 75,7 %, while the operating margin decreased from 21,3 % to 17,9 %. Furthermore, the strong U.S. dollar is also impacting the results of Estee Lauder Companies, as more 74 % of their net sales are from outside of the U.S. Another short-term risk is the zero tolerance COVID-19 policy in China. Estee Lauder Companies have quite a lot of exposure to China. One example is that their largest individual customer is a company that sells products primarily in China travel retail, which accounted for 13 % of their consolidated net sales in fiscal 2022. If we see lock downs in China again, it will hurt the company short-term. Especially because management in their annual report in 2021 expected China to be huge growth driver that deliver double-digit growth year over year moving forward. A more long-term risk is competition. In their annual report from fiscal 2022, Estee Lauder Companies write that there is significant competition in each market where their products are sold. Estee Lauder companies lists competition as one of their largest risks moving forward, as the beauty business is highly competitive, and they mention that some of their competitors have greater resources than they do. Hence, in some cases they may be able to respond to changing business and economic conditions as quickly as their competitors.
There are also plenty of reasons to invest in Estee Lauder Companies, as there is great potential to grow their business. The beauty business will grow. The different markets that Estee Lauder Companies operate in are expected to grow. According to Globe Newswire the global skincare market is expected to grow by 5,52 % until 2028, the global makeup market is expected to grow by 5 % until 2028, the global fragrance market is expected to grow by 5 % until 2028, and the global hair care market is expected to grow by 6 % until 2028. These numbers may not impress you but so far Estee Lauder Companies has been able to grow their market share since 2015, and growth in their markets combined with growing their market share should lead to solid growth. China is slowly moving away from the zero tolerance COVID-19 policy. China's State Council has just released twenty points articulating a dynamic zero COVID-19 policy. While the easing of the COVID-19 policy won't happen overnight it is happening little by little. Travel restrictions have been eased slightly, which should be good for Estee Lauder Companies, as their largest individual customer is a company that sells products primarily in China travel retail. The easing of the COVID-19 policy could result in Estee Lauder Companies experiencing double-digits growth in China. The lipstick effect. The lipstick effect is a theory that when facing an economic crisis consumers are more willing to buy less costly luxury goods. Researchers from Texas Christian University published research in the Journal of Personality and Social Psychology that a downturn in the economy has been linked to an upswing in beauty sales since the Great Depression. Thus, we might see Estee Lauder Companies outperforming companies in other industries if we see a longer recession.
All right, we have gone through the numbers, potential and risk regarding Estee Lauder Companies, and now it is time for us to calculate a price for Estee Lauder Companies. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I have decided to use an EPS of 6,55, which is the one from fiscal 2022. Estimated future EPS growth rate of 11 (As management expects it to be between 9 and 12 %, and went with a higher option), Estimated future PE 22 (in this case we multiply our predicted growth rate with two, as this is lower than the historical highest P/E) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $101,14, and we want to have a margin of safety on 50 %, so we will divide it by 2 meaning that we want to buy Estee Lauder Companies at price of $50,57 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financials, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 3.040. The Capital Expenditures was 1.040. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 728 in our further calculations. The Tax Provision was 628. We have 257,056 outstanding shares. Hence, the calculation will be like this: (3.040 - 728 + 628) / 259,056 x 10 = $113,49 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 5,60 and a growth rate of 11 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $73,72.
I believe that Estee Lauder Companies is a great company. They have a strong moat, great margins and a good management. They are facing some short-term challenges, which resulted in some underwhelming numbers in fiscal 2022. Nonetheless, we see signs that China slowly reopening, while we may also see the dollar drop, which are good news for Estee Lauder Companies. I'm not too worried about competition because Estee Lauder Companies has a large moat that should protect them from competition. The market they are operating in is growing and they are winning market shares, which is good for future growth. You may not be able to get Estee Lauder Companies at a 50 % discount to intrinsic value at any time, but I would like to get it below intrinsic value on at least two out of three calculations. Meaning, Estee Lauder would get interesting at the intrinsic value of the PAYBACK TIME price at $147,44.
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