Weekend Special (2)- Estee Lauder, US

Confidence in sustainable top tier sales growth remains high On the topic of sales the focus of discussion was concentrated on key areas of uncertainty:

On China, while EL’s non-China EM growth has been impressive at roughly 30% in aggregate last quarter, management acknowledges that dynamics within this important market have been more challenging. Growth slowed late last-year, but reaccelerated in 2Q15 (retail sales climbed to +15%). While growth may remain choppy from one quarter to the next, management believes it has made adjustments that will enable sustained improvement. Management said its flagship Estee Lauder brand has begun to more aggressively pivot to the on-line channel as department stores lag and toward the make-up segment as they believe Chinese consumers are rapidly gaining interest in make-up – a segment where EL has an advantage as the global leader. It has also recently implemented a new loyalty program for its flagship Lauder brand which, according to them, is proving to be a more responsive promotional tactic. At the same time it has embraced the K-pop cultural phenomenon with its MAC brand and related marketing and innovation efforts. Ongoing distribution expansion was the third lever of growth highlighted as it pushes
further into tier three and four cities. The promotional environment was described as still challenging in the market and management expects it will have to continue making ongoing price adjustments to remain competitive and avoid cross-channel and crossmarket dislocations. Momentum from strong Korean-based competitors was also acknowledged. All-in, we heard no reason to believe historical 20%+ growth rates for EL would resume in China anytime soon, but it appears to have initiatives in place that can enable it to continue outperforming the category’s 7-8% growth rate.



On Estee Lauder’s global acceleration plans, the aforementioned China initiatives, including greater push into make-up, is an important component in our view, but initiatives extend well beyond China. Its greater focus on make-up appears to be a global initiative, an important enabler being to reach a younger consumer cohort in the US; an objective it hopes to achieve through both product mix and marketing (e.g., its digital initiative with Kendell Jenner). Focus on make-up does not mean de-emphasis of skin care, according to the company. In fact, management is excited about what it described as a truly breakthrough new skin care product it expects to launch in the next 8-9 months (management was unwilling to share details this early). Lastly, it conceded that it needs to continue to shift the brands’ sales beyond department stores, with particular emphasis on specialty multi-brand stores and on-line platforms.

On the Clinique turnaround in North America, management acknowledges that this has been an area of most concern. Prior rejuvenation efforts (e.g., DDML+) failed to generate the expected response and management is now heavily focused on turning the business around in its core US market. It has plans to market the brand in a more selective fashion and to utilize more digital vehicles. It is also increasing initiatives behind more opening price point level products, including re-entry into foundation, re-launch of its lipstick portfolio and launches of new oil and face mask extensions. From our perspective, its efforts at point of purchase may prove most beneficial. It continues to look for ways to expand distribution, focus efforts behind higher growth markets and outlets and has plans
to modernize in-store counters to sell more products.

On travel retail, management expects growth to remain relatively slow in the near term as Chinese tourism remains subdued (we model mid-single-digit growth into the foreseeable future). The company believes Chinese consumers are shifting where they travel and shop (e.g., more to Japan given currency factors) and EL is trying to shift with them. It also has aggressive plans to increase its distribution, both in terms of number of airports with branded stores and range of brands featured within the airports.

Glam Glow may prove another upside surprise enabler. While investor attention remained centered on key markets and brands, management repeatedly mentioned the opportunity it sees in its recently acquired Glam Glow brand. They mentioned that the brand holds the rank of number one selling SKU in Sephora, and management sees it as the “next coolest mask globally.” It has plans to rapidly expand the brand around the globe.

Management highlighted its working capital opportunity early in the meeting with noted
benefits in accounts receivable and accounts payable since SMI implementation. EL’s inventory balance remains relatively bloated, though progress has been made recently and management believes a 130-140 days-sales-outstanding should be achievable over time for the firm. Timing of achievement, however, remains uncertain with an update they believe is likely to come with FY16 guidance.