Putting lipstick on a pig

Is it time to go long The Estée Lauder Companies after a 70% pullback

In 2020 and 2021 there was a stock that all compounder bros loved. A stock that never stopped going up and traded as high as 50x expected forward NTM earnings, even after running up more than 100% in 18 months. That stock? The Estée Lauder Companies (symbol: EL).

The hype for EL was unescapable and peaked in early 2022 just before Q4 2021 earnings. Those numbers came in well below expectations and its guidance was soft. The stock promptly crashed down almost 20% and started pullback that has continued until recently. Since that reversal the stock has fallen 70% off its highs and has given up a decade of gains. This has led to a historically low valuation for what use to be a fund favorite. In today’s post I’m going to lay out what I think are the bear and bull cases for Estee Lauder and if it’s worth trying to call a bottom on it or if there’s still major downside in this name.

---

First, what is Estee Lauder Companies. Broadly, they are a high-end makeup, skin care, hair, and beauty company that covers pretty much every premium segment for men and women’s needs. In their 10k they lay their brands out as such:

For those who don’t wear makeup, nor have a morning and nightly skin care routine, and wash their hair and body with the same singular bottle of liquid soap, these brands are all well known by enthusiasts. Even if you’ve never heard of them. Additionally, within the beauty consumers these brands are viewed solid/premium. This is important because when it comes to beauty maintenance people rarely if ever trade down. The lipstick effect* is a real thing. Estee’s ability to maintain their premium positioning matters as it helps them maintain share and historically outperform the beauty space during all parts of the market cycle. As once consumers trade up, they stay higher on the value chain. Obviously, this hasn’t been true for the last two years or the stock wouldn’t have collapsed, but more on that below.

---

Well, if they are able to defend their brand value proposition and the beauty segment is growing at 2 - 3% globally per year, why has the stock price collapsed? Answer: China.

Much like most high flying consumer brands like Nike, Lululemon, Hermes, LVMH, Apple, Starbucks and others China was Estee’s largest growth driver for the past decade plus. And similarly to those other brands as the Chinese consumer has entered- let’s call it borderline depression level spending on goods- they’ve seen a massive hit to their revenues, eps, and margins. Unlike those brands, Estee hasn’t recovered at all due to having some idiosyncratic issues that go beyond just China. But China is their largest issue by far.

Their other major issue stem from the massive overordering that was done in 2020 and 2021 to meet the spike in demand by consumers who were flushed with cash. This led to an oversupply of product on every level of their supply chain. This problem has mostly worked its way through the system and should be reversing during the back half of EL’s 2025 fiscal year (first half of 2025 calendar year) and into FY 26.

---

The China issue is no joke. This isn’t like Starbucks which can just struggle through an underperforming China segment and tolerate it until China figures their internal issues out. No matter if that timeline is next month, six months, 2 years, or 5 years. Nor is it like LVMH or Hermes which, while China is their growth stories, they have insane pricing power and can use that offset near-term weakness. No, Estee feels China demand not just in China, but in their Japan and EMEA segments. Really everywhere outside of Korea and Americas.

This is because the Chinese travelers tend to be huge buyer of higher end products abroad to bring home as gifts. In fact, its an open secret in the leather lux market (think handbags) that the majority of growth in the EU segment is Chinese buyers buying there and bringing them back home to sell and arb the (massive) price difference. The Chinese travel has been weak-ish they only now starting to look like the worst might be behind them. This should help EL with some of their lagging sectors that have felt the affect of the lack of Asian travel, but it won’t happen right away.

Mainland China continues to be weak though. That doesn’t look like its going to improve any time overnight. Though the commonly accepted excuse by Chinese watchers for why the CCP hasn’t don’t any consumption led stimulation is because they didn’t want to destroy their currency against the dollar and were waiting for the Fed to cut first. The Fed has cut, so if they’re going to do something it’ll likely happen in the next few weeks/months, or it won’t happen at all. We’re in the year of the Dragon, if the CCP are going do anything it’ll be before the next lunar new year. Otherwise, they’re just hopping for the economy to fix itself over time and that slowness needs to be realized by the market.

---

I’m going to pause right here before going further, there are other reasons to be bullish/bearish on EL outside of China, but China is going to play a critical role in their story. If you don’t want to be long another Chinese name, or trying to long as little of China as possible this name likely isn’t for you. I mean that. If you’re not comfortable with something that is levered to the Chinese consumer (while growing outside of China and has exposure all over the world) stay away. With that out of the way let’s talk some of the bull cases.

---

China is a huge part of the EL story, but as I said above its not the only part. The other major issue has been how stuffed the channels have been for Estee. In late 2021 every one of them was filled to the tippy top. This has led to an absolute collapse of margins as the supply works its way through the system. They’ve historically run at high teens op margins, just over 16%, and are guiding to a range of 11 - 11.5% for FY 2025. In order to fix both the margin issue and continue working off excess supply, they’re hoping that a cost cutting plan will help pull 1b~ of costs out that will be realized in FY25, FY26, and beyond.

On the Q4 call prepared remarks they noted that most of that cost cutting won’t really be felt until China stops being weak. Just wanted to note that.

Here is the rest of their FY 2025 guidance. We’re going to ignore their Q1 guidance because the quarter completes in 8 days. Those numbers aren’t worth thinking about.

Ignoring one time items their EPS mid point is $2.85 per share. At $85 its trading at just under 30x that number. At 11% margins. Historically it produced 16% - 18% op margins. 11% is very low for them. Let’s do some back of the napkin math. Say they can get their op margins up to 13 or 14% on flat (not down 1%) revenue. For easy math let say 15.6B of revenue. Suddenly their EPS would be in the high 4s, 4.6, .7, .8 level. Not 2.85. If you add in the idea that the new POTUS is going to attempt to drive the dollar lower, you suddenly get a stock that is at 20 - 23x NTM number, not 30. A market multiple for a premium brand that is in inning two or three of what should be a solid turnaround once it gets going seems cheap at $85.

---

I think they’re sandbagging. They have no real reason to be bullish on their numbers. They’re looking for external candidate for a new CEO as their current one is retiring at the end of FY25**. The new CEO announcement will likely happen early next year. That also matches up with expected inflection point of their channel clearing that will happen in early 2025. Maybe it even matches up a China consumer stimulus payment as well? The new CEO can step in and immediately looks great.

They have massive growth in Mexico and Brazil, and (current) management says trends of putting their product on Amazon.com should lead to top line growth in the US/CAN markets as well. So there is reason to be optimistic about their growth going back to above beauty trend (2 - 3% per year). Even if they are able just get back to trend instead of trend + 3+% you’re looking at a 4% top line swing. From -1% to +3%.

The South America growth looks to be for real, but one thing to be aware of is if China doesn’t come back and other brands are able to muscle out EL in these growth markets. Given their premium positioning I think that’s unlikely to happen, but it is a risk to consider.

---

Do I think EPS is going to come in at 2 dollars over their guidance in FY25? No. Do I think revenue will come in at +3% on the year vs the expected flat to -1%? Also no, but a slightly higher possibility than the EPS +2 dollar figure. For either or both of these to happen EL needs a flat or slightly down China.

Given the valuation of Estee, it doesn’t need China to be a double digit grower right now. It just needs China to stop plummeting in sales seemingly every quarter. The bull case for EL and China isn’t China returning to the 2010/early 2020s of growth, its just market performer. If that happens Op margins spike up the low teens quickly. Possibly higher than the historic 16% number I referenced above. Suddenly EL might be pointing at 6 - 7 dollars of EPS in FY 26 (or calendar year 26 depending on how long some of the China flatlining takes and what South America’s growth looks like over the next 18 months). If we see a 12 month forward EPS guide of $6.5 per share what does EL trade at? A market multiple puts it at 136.5, or a 60% premium to Friday’s close.

---

Why now? All of these bull cases have been laid out before for Estee. Again, this was a massively over owned name going into 2022. People have long memories when it comes to stocks that made them money, they’re able to forgive a lot. People have been trying to call a bottom for the last two years.

Well a couple things have happened since then. First from a technical point of view the downside is starting to get tight on longer time frames.

The 84.72 level was the 2015 and 2016 resistance/support line. 77.2 served as resistance all of 2014. and 70.32 served as support/resistance from 2012 - 2014. These are heavily traded areas, and are clearly defined levels as well. Going long here at 85, you can set your stop at either at a close below 77 or a close below 70. Depending on what you want to risk to the downside. If it gets below 70 we’re likely headed back to the GFC levels for Estee, and that likely means EPS is negative for a number of years or scientists have discovered a way for people to never need skin care products again.

I don’t think its ownable under 70 as it means whatever story its trying to tell, is broken and now you’re playing for a buyout/PE takeover.

Fundamentally it’s at 2x revenue, and we talked about the margin story above. It’s cheap on all levels if you assume that margins will revert somewhat back to historic numbers and revenue growth will at least get back to segment trend. It’s not pricing in anything above that right now, so there’s a lot of upsides if they can really get the turn around going.

But why late September specifically? Why not wait until earnings next month? Well you can do that, but here’s why I’m writing this now.

While its not a full on tender offer (needs to be more than 5% of float for that), a fund is attempting to call a bottom in EL and go long .64% of the outstanding shares, or 200mm in dollar terms. While this isn’t a huge bet compared to what you would like to see, this is showing that fund interest is here, or at least starting to arrive. This again gives us another downside level to consider.

The stock was quickly bought up when it got below that level. Barring a massive equity movement to the downside I think Estee’s bottom is starting to look constructive.

The real near term risks is Q1 earnings. Their guidance is going be critical, specifically their comments/focus on channel clearing. They need to be done with this story soon. The actual numbers for Q1 will be bad, this is known, and it wouldn’t surprise me if they’re bad EL sells off on them and then rebounds hard. You aren’t buying EL on near term numbers right now. We’re trying to front run the inflection to the upside that should happen in the next 18 months.

By this point I’ve been typing for awhile so I don’t want to go into great detail about the options chain, but this week, right after the tender offer was announced a few sizable put sales and call buys (not risk reversals) started hitting the tape. No *insanely huge* ones, but solid sized ones. Just want to note that.

---

So that my Estee pitch. I’m long 2027 calls and commons. I like the commons here because they have a 3% dividend yield and with a high investment grade credit rating, the dividend isn’t at risk of being cut any time soon (unless earnings collapse and the price follows but that will likely mean a downside break to one of the above stated levels so we’d be out).

The bullish take aways are that this is a China focused stock, but it doesn’t need Chian growth to come back, only for China to stop collapsing to see upside. That management is changing and should be bullish, and the they are likely sandbagging because of that change. Heading back to historic margin numbers could return 60% + dividends over the next 18 months to 2 years.

The bearish take aways is that China might not be coming back, they don’t get a solid new CEO, growth in SA slows and suddenly they’re losing share everywhere and this becomes a PE take under story. I don’t think it gets there, but that is a risk. In this case the stock would break below 77 maybe even 70 before we’re able to sell it and the realized loss would be about 20% minus the dividend payments.

So with 20% down, but likely to know it right away, vs huge upside if only some things go right for Estee Lauder I think its a solid long here over the next 2 years. Until we get confirmation of either (upside or downside) movement.

Let me know what you think of Estee Lauder in the comments below, and if you want to hear me talk about what I wrote above *and more* check out my video I put out on my YouTube channel below.

*The lipstick effect is when consumers still spend money on small indulgences during recessions, economic downturns, or when they personally have little cash. They do not have enough to spend on big-ticket luxury items; however, many still find the cash for purchases of small luxury items, such as premium lipstick. Put another way, beauty consumers will cut a lot out of their budget well before they cut beauty spend.

**The current CEO will likely leave within 8 weeks of whenever the new CEO gets announced. They don’t have a candidate yet otherwise the time line would be less vague than ‘12 months from now’. All else being equal if their current lasts until end of FY25 it leans bearish as it likely points to them struggling to convince a candidate to take the job.