Estée Lauder

Behind some of the world’s largest beauty brands, you will find a company with a robust business model that is based on low levels of tied-up capital, a solid level of demand and high profits. These attributes benefit us as co-owners. More than half of the billion dollar sales of the company’s most exclusive brand came from first-time buyers. So even though Estée Lauder Companies has proud traditions and strong historical roots, the company has a unique focus on the future consumers of beauty products.

In 1946, the fairy tale began when a woman called Estée Lauder launched her own skin care series consisting of four products. Estée promoted her products by giving out free samples and facial treatments in beauty salons on Manhattan – and that was how one of the world’s leading beauty companies was born.

Today – more than 70 years later – the skin care category remains an important part of The Estée Lauder Companies (hereafter Estée Lauder). Skincare represents around 40 percent of the company’s total sales and 65 percent of the earnings. At the same time, this category is the company’s most profitable with an operating margin of 27 percent. Combined, makeup and skincare products amount to more than 80 percent of Estée Lauder’s total sales, but the company’s categories also include perfumes and hair care products.

As the only large company in the beauty industry, Estée Lauder maintains an exclusive focus on the prestige beauty segment, and this makes the company particularly appealing to investors. The prestige category is the part of the beauty market with the highest growth rates. It is also the most profitable segment as the products are sold at higher prices without the costs being proportionately higher. Most women are willing to spend a lot of money for the feeling of luxury and quality when it comes to buying products that are applied to the face and body. Luxury cosmetics are often not the first area where cutbacks are made in economic downturns, as the prices for such are relatively manageable compared to other luxury items. This is one of the reasons why the business is quite stable and predictable.

Sales of Estée Lauder’s products are rapidly growing, particularly the skin care and makeup categories. In the last financial year, which ended in June 2018, the sales grew by 13 percent and thus almost twice as fast as the market for prestige beauty in the same period. Over the past 5 years, the company has grown sales by 7.5 percent annually, while the prestige beauty market has grown by 5-6 percent. The senior management team of Estée Lauder has a long-term objective of growing at least one percentage point faster than the market each year, and we certainly do not think that this target has become less likely for the company to achieve.

Increased global prosperity leads to higher sales

Estée Lauder is growing around the world, but sales are growing particularly strong in developing countries. The generally increasing prosperity has resulted in new lifestyles for many due to a larger disposable income. More and more people around the world find themselves being able to afford more than the bare necessities such as housing, food and drink, and this also leads to an increased focus on beauty ideals.

In Asia in particular, the growing middle class is very fond of Estée Lauder’s products. China was by far the largest source of growth last year. The company’s sales in China grew in all categories, sales channels, and brands, and for the first time, these sales passed one billion dollars. The high growth rates are continuing in the current financial year, and the fear of slowing growth due to a potential trade war is thus not reflected in the numbers so far.

Major department stores have been the largest sales channels for Estée Lauder’s products for many years and continue to remain so. However, other sales channels have seen strong growth in the last few years, including the online sales channel and sales from airport terminals and other tax-free stores that benefit from an increasing number of travellers. Chinese consumers are particularly keen on buying their makeup and skin care products online, and more than every fifth product sold in China is via online platforms. The sales of M·A·C products in China doubled last year after the brand was introduced on the Chinese’s preferred online department store, Tmall. M·A·C jumped straight to the top spot as the best-selling prestige makeup brand on the platform.

However, the company’s high growth in online sales is not limited to China. In fact, Estée Lauder’s total online sales have an average grown by a yearly average of more than 25 percent for the last five years and represent more than ten percent of the Group’s total revenue today – and over 20 percent of the sales on both the Chinese and the American market. Estée Lauder still has major plans for growing this sales channel. Its products are far from available in all the countries where the company operates. The cosmetics giant sees good opportunities for increasing this proportion and, at the same time, it continues to expand the range of products that can be bought online.

Four billion-dollar brands

Estée Lauder’s product portfolio consists of much more than M·A·C and the two flagship brands, Estée Lauder and Clinique. In fact, the company has just under 30 different brands. Four of these have sales in excess of one billion dollars per year – and the company is expecting that more of the small and medium-sized brands will become billion-dollar businesses in the coming years. The company
has been very successful in acquiring small up-and-coming companies. Via the group’s extensive global distribution network, Estée Lauder has managed to achieve better earnings than the previous owners of the acquired companies. The last two acquisitions, Too Faced and Becca (which joined the group in 2017), have contributed to the group’s high growth rates and are part of a strategy to remain relevant and innovative. These two trend-setting brands are targeting young consumers by, for example, marketing their products on social media. At the same time, the Estée Lauder brand is also focusing on providing new products.

The importance of constantly offering innovative products is highlighted by the fact that products developed in the last few years represent approximately a quarter of the company’s revenue.

Another brand under Estée Lauder’s exclusive umbrella is La Mer. This is the company’s most expensive and prestigious brand, and it was one of the main growth drivers in the skincare segment in the latest financial year – alongside Estée Lauder and Clinique. La Mer is the company’s fourth brand to hit the billion-dollar milestone in terms of net sales per year. When you can sell two ounces of La Mer moisturizer for 325 dollars, we do not find it hard to figure out how profitable the business is. Last year, more than half of the consumers who bought La Mer products were first-time buyers. If they develop a taste for the products, there are good opportunities for maintaining high growth levels here as well.

“Never underestimate any woman’s desire for beauty.” A quote by Estée Lauder that, in our view, is expressed in the willingness of consumers to pay such high prices for products from La Mer and Estée Lauder’s other brands. Whether it is about skincare or to wear great make-up, most women are happy to pay extra for the feeling of luxury and quality when it comes to beauty products that are used on the face, hair or body. This, combined with strong brand value, makes Estée Lauder’s customers willing to pay a great deal for the company’s products, and the group’s production costs account for a mere 20 percent of the sales.

Management targets operating margin improvements

The Lauder family is still very much involved in the company, and the second and third generation remain at the heart of it. William P. Lauder, the grandson of the founders Estée and Joseph Lauder, is Executive Chairman and Chairman of the Board. He assumed these roles in 2009 following his father, Leonard Lauder, after having been CEO since 2004. 2009 was the first year of the company’s history in which they hired a CEO who was not a member of the Lauder family, and Fabrizio Freda remains the CEO today. Since he assumed the position of CEO, he has – with the assistance of CFO Tracey Travis, who took on the role in 2012 – contributed to the earnings growing faster than sales. The company’s operating margin has thus risen from around ten percent before Freda took over to 15 percent in the latest financial year.

We continue to believe that there is potential for increasing the operating margin even more – and so does the management team. Their objective is for the operating margin to increase by half a percentage point annually in the coming years. In the last financial statements, management confirmed this potential by raising the expectations for the extent of savings that will be achieved through an ongoing cost-cutting initiative. The initiative, called Leading Beauty Forward, aims to optimize the use of resources inside the organization and at the same time ensure that it has the flexibility necessary to respond swiftly and correctly to market changes without impacting profitability. Furthermore, the programme aims to cut the time between design and sales so that inventory and warehousing costs can also be cut, thus accelerating already high growth in free cash flows.

Estée Lauder has low levels of debt, equivalent to around six months’ EBITDA. Due to the nature of the business not being capital intensive, the company manages to convert every dollar earned into free cash flows. This allows for large parts of the free cash flows to be distributed to the shareholders via dividends and share buybacks. For the last few years, these have amounted to between three and four percent of the market capitalization. The company’s return on invested capital is around 25 percent – and more than 30 percent when adjusted for goodwill from previous acquisitions. These returns should be improved as a result of increasing operating margins and even less tied-up capital moving ahead.

We are happy to be co-owners of a company with a profitable and robust business model, a highly competent management team and a wise approach to the allocation of shareholder capital. High returns on invested capital and a structurally rising demand should mean that our future will be a bit more beautiful.