Has Estée Lauder Stock Flown Too Far, Too Fast?

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In this final segment of a recent podcast show devoted entirely to prestige beauty stalwart Estée Lauder (NYSE: EL), our hosts break down risks of owning shares, and discuss the company's current valuation. Should you buy this high-flying stock now, or wait for a pullback? Click below to find out.

A full transcript follows the video.

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This video was recorded on April 10, 2018.

Vincent Shen: We have a few more minutes here. I want to make sure we leave enough time to talk about these last couple of topics. One thing to keep in mind is, that growth in Asia, for example, very strong, other developing markets, very strong. But the U.S. home market is somewhere where they're seeing mixed results still, and that's something to keep in mind, in terms of how they're going to approach that. Traditionally, Estée Lauder has been very reliant on department stores. And obviously, there's a lot of changes. There's struggles going on in terms of department stores, brick and mortar operations. Given some of those challenges, the company is going to have to rethink how it can access consumers and meet their needs basically where consumers now choose to shop and how that's changing. For example, that might mean increasing offerings with certain specialty retailers like Ulta and Sephora.

Also, they're work with department stores to improve that in-store experience and support their efforts to grow their online and digital businesses, too, because that's often an area of strength for these companies that have otherwise experienced a lot of weakness. Something else, again, the company mentioned, I think they said they're 20% into their efforts of taking advantage of some of the data and analytics they're getting from their consumers, in that they've managed to gather it from a lot of their online sites, in terms of, in partnership with some of these other retailers that they sell through. But, the remaining 80% is in terms of how they can use that data to optimize the way they sell, how they gauge the demand and what consumers are looking for. But, they are testing that and using that.

An interesting tidbit is how they're noticing how, for example, differences between the Boston and California markets might actually end up being bigger than the differences between the California and Japan markets. So, being able to fine-tune their offerings for each region is going to be really important for the company going forward.

I think, something else bigger picture in terms of risk for this company, of course, when you are a prestige brand, you're operating at luxury levels, and the risk of an economic downturn is always there. What do you think about that?

Asit Sharma: Certainly. One of the things that we've seen is, during recessions, discretionary companies get hit, and this is one of those. Very interesting phenomenon going on. Retail traffic in the United States, Vince, as you mentioned, something that the company discloses in its annual report is its largest customer, which is Macy's. Macy's accounted for 8% of fiscal 2017 sales. So, you can trace that decline in physical foot traffic and the way Macy's and its peer companies have been hit with the fact that U.S. sales only grew at a 5% rate in this most recent quarter. We were talking about Europe and the Middle East growing double digits, and of course Asia-Pacific growing over 33%.

So, the company has to find ways to offset that slowing foot traffic. Data and analytics could obviously be a key to doing that. If this experience of investing in data and analytics is going to be anything like the company's investments in technology and personalization have been for them, I think they can probably offset more foot traffic losses. It's good that at least this North American traffic hasn't caused revenue losses yet. They're still creeping along at a positive rate. So, I think that the company will be able to, if the economy stays where it is at this slow growth rate, offset declines.

Now, if we go into a slower phase of economic growth, obviously, then the company could get hit. Which leads us into this next, last topic, Vince, valuation. The stock has gotten a little pricey over the past 12 months.

Shen: Yeah. With a lot of the strength that we've spoken to with this business -- again, the shares being up about 80% in the past year, it's definitely approaching a point where that growth that it's seeing on the top line, the double-digit growth that it's seen in its earnings, it's very enviable, obviously, for this company, and it seems like a lot of investors are jumping in and trying to get a piece of that growth. I believe, in terms of its forward price-to-earnings, for example, it's at very high levels compared to its historical averages. So, there's definitely a premium going on there. What do you think?

Sharma: This company is trading at about 35X forward earnings. That's 10% higher than its average over the last 10 years, which is about 25X forward earnings. Just to compare it to some of the companies that Estée Lauder lists as competitors: LVMH, that's Louis Vuitton Moët Hennessy, the famous luxury brand, trades at a forward P/E ratio of 25X. Coty trades also at a forward P/E ratio of 25X. Then, two companies which are broader consumer conglomerates, which nonetheless, each has divisions which provide a lot of competition to Estée Lauder, Procter & Gamble trades at a forward P/E ratio of 19X and Unilever trades at a forward P/E ratio of 20X.

So, you see all four of these great companies are cheaper right now relative to Estée Lauder. And that's the one thing which cools my enthusiasm a bit. I looked at the balance sheet, a very solid, clean balance sheet. Obviously, the company has the revenue side of the equation figured out. But, if you look at the actual trailing 12-month P/E ratio of this company, it's past 50X. And on the chart, it looks like a Michael Jordan vertical leap, a standing vertical leap. Just, you pull it back a year and you just see it take off, where, as Vince mentioned, the stock moved this 80% over the last 12 months.

My personal opinion, if you're interested in investing in Estée Lauder, maybe wait for a pullback. I rarely say that with a great company. I always feel that over time, it truly doesn't matter. But here, this may be a case of, it's gotten a little bit ahead of itself. And I'm curious, Vince, what are your thoughts? Do you think it might have gotten just a little bit ahead of where its normalized price should be?

Shen: I think, in doing research for this, I wasn't previously very familiar with the company. I've been really won over, I think, by the story. In reading multiple calls and looking at their presentations with management, I think the way they're approaching this, the industry, their growth, their vision for how things will continue is really strong and compelling. And I generally do favor these companies that focus on these higher price points, this prestige level, as being stronger and a little more robust, in terms of the consumer demand and how they resonate with customers.

So, I'm with you in that. But, keeping in mind, long-term, this story is really important. I'd say, because the stock is trading at a premium right now, it's at a more expensive level, if you're interested in getting in, take a small position and then over time get into your position that way. That's always something we recommend with any stock that you invest in, not to dump everything you're planning to put into the stock at one time. You can ride out any major jumps over a period of six months or a year, for example, that way.

Sharma: Agreed. My last point, if you're interested in investing, read the conference call transcripts. There's so much going on and so many strategies that Estée Lauder is employing. I really couldn't do it justice in this brief podcast. But if you like the company, it's quite interesting, take a read through those, I think you'll be rewarded.

Shen: Alright. Thank you very much, Asit! That's all the time we have for today. We will definitely follow up on this company, probably later this year, see how they're going in terms of their bullish rally, and then how some of those various growth initiatives are panning out.

Asit Sharma has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool recommends Ulta Beauty. The Motley Fool has a disclosure policy.