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Summary

  • Estee Lauder posted great fourth-quarter headline results, which came in above estimates.
  • This should be discounted to some extent, as accelerated orders are "borrowed" from the upcoming first quarter.
  • Despite the great track record and good growth prospects, a 25x earnings valuation leaves little appeal in my eyes.

Investors in Estee Lauder (NYSE:EL) hardly reacted to the very strong fourth quarter results which have been posted by the firm last week. Headline results have been impacted by one-time favorable items which are expected to reverse in the current first quarter.

Despite the steady growth, targeted future expansion and shareholder payouts notably in the form of share repurchases, I remain cautious with shares trading at a real premium valuation.

A Solid End To The Year

Estee Lauder posted fourth quarter revenues of $2.73 billion, a 13.2% increase compared to last year. Reported revenues came in comfortably ahead of consensus estimates at $2.66 billion.

Earnings jumped by an incredible 174% to $257.7 million. Earnings per share on a diluted basis advanced from $0.24 per share last year to $0.66 per share for the past quarter.

Reported earnings comfortably beat consensus estimates which stood at $0.56 per share.

Looking Into The Performance

While the headlines of double-digit sales growth for the final quarter appear very strong it is very important to realize that Estee Lauder is implementing its Strategic Modernization Initiatives. The company believes that this accelerated orders of retailers by some $178 million in advance into the final quarter, essentially weighing on the expected performance in the current first quarter of the fiscal 2015. This is had an expected positive impact of $0.21 per share, something expected to reverse in the first quarter.

Excluding this impact, and the remeasurement charge of the devaluation impact in Venezuela, sales would have been up by 5% for the final quarter.

The company continues to report sky high margins. Already very fat gross margins were up by 20 basis points to 80.4% of sales. Operating expenses fell to 66.4%, which marks a 780 basis points reduction in operating costs thanks to the sales leverage on accelerated orders and the lack of impairment charges compared to last year.

The company remains quite nicely diversified. Revenues in both the Americas as well as the EMEA region rose by 13% in constant currencies to $1.1 billion as sales in Asia-Pacific were up by 15% in constant currencies to levels just shy of half a billion. The company relies heavily on skin care and make-up articles, with sales growing at 12 and 14% respectively in constant currencies. Revenues for each of those sales categories came in comfortably above the billion mark.

Looking Into The New Year

For the first quarter of the new year, sales are seen down between 1 and 2% as reported. Foreign currency headwinds will have an anticipated 1 percent headwind while the accelerated retail orders impact will reduce sales by some 7%. Adjusting for this, the pace of organic growth remains very healthy.

GAAP earnings are foreseen between $0.51 and $0.55 per share which includes the $0.21 per share benefit recorded in the fourth quarter to show up as a negative in the upcoming quarter. Adjusted for this earnings are seen between $0.72 and $0.76 per share.

Full year sales for the upcoming year are seen up 3-4% in constant currencies, yet Estee Lauder already expects a two percent headwind from currencies for the upcoming year. Adjusted for the 3% estimated full year impact of the accelerated orders, sales are seen up 6-7% in constant currencies. Full year non-GAAP earnings are foreseen between $3.10 and $3.20 per share.

The full year guidance is largely in line with consensus estimates which call for revenues of $11.4 billion and earnings of $3.17 per share.

Valuation

Estee Lauder has a very solid financial position having some $1.63 billion in cash and equivalents. Total debt in the meantime stands around $1.33 billion, which results in a solid net cash position of about $300 million.

With some 390 million shares outstanding at the moment and those shares exchanging hands at $76 per share, equity in the business is valued at roughly $29.6 billion.

For the fiscal year which closed after the reporting of the quarterly results, revenues came in at $11.0 billion on which the company reported net earnings of $1.2 billion. This values operating assets of the firm at 2.7 times annual revenues and 24-25 times annual earnings.

Strong Player In A Growing Market

In a recent investor presentation Estee Lauder stressed the growing global market for beauty products aided by aging populations and growing disposable incomes. Yet the company is not alone in targeting to gain from the increased desire of the world for beauty products, as the growing market results in anticipated stiff competition of course.

For the upcoming years Estee Lauder has still set some challenging goals for itself. It aims to grow sales a percentage point quicker compared to the overall beauty segment per annum with acquisitions expected to add another percent to growth. The targeted 50 basis points in operating margin improvements should allow for double-digit earnings per share growth.

Optimistic Outlook, Based on Solid Fundamentals

The guidance for future growth is furthermore based on a solid performance in the company's history. Over the past decade the company has nearly doubled its sales from $5.7 billion to $11 billion by now. Earnings have grown even more as the company has expanded its after-tax net margins to levels over 10%.

Investors have seen even greater returns on a per-share basis as the company has repurchased about 15% of its outstanding share base in the meantime.

Takeaway For (Potential) Investors

Long term investors in the company have seen solid returns. After shares have been rather stagnant around $20 in the period of 2005 to 2008, shares fell to levels as low as $10 in 2009. Ever since, shares have seen a steady increase to current levels around all time highs.

Despite the solid operational performance, I think that a lot of the share price advancements being made over the past few years has been aided by lower interest rates and an increase in valuation multiples. Clearly the seven-fold in the share price over the past five years has outpaced operational achievements in the meantime.

Therefore I remain very cautious on the prospects for the shares, even as shares fro the company remain very rosy. Trading at roughly 25 times earnings a lot of good news, and some more has been priced into the valuation. This creates very little potential reward to the risks in my view.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Estée Lauder: Greater Operational Achievements, Yet Shares' Prospects Are Less Than Beautiful