Estee Lauder has been an Ugly Stock

Anyone with a diversified portfolio will tell you that a handful of stocks perform far better than your wildest dreams; a good chunk do better than the market; some underperform; and a select few have such awful performance that you’re afraid to look at the price each day.

Estee Lauder falls into the very latter bucket. This is a household name – they produce cosmetic products for skin care, makeup, and hair products.

We executed a block purchase of the stock for all suitable clients during November 2022. We purchased it thinking that China was on the cusp of an economic recovery. It was our view that the protests emerging would spark déjà vu of Arab Spring from 2011. We believed this movement (albeit over a decade old) would weigh heavily on the minds of China’s totalitarian regime, causing it to end the Zero-Covid lockdowns that had stifled economic growth for the prior three years.

Two years later, we simply got that call wrong. The investment return has been negative 30% after including dividends and a slight gain on currency.

China simply didn’t rebound by the pace we expected. It’s an important component of Estee Lauder’s business because almost 30% of its revenues are generated in the Asia-Pacific region. Last quarter, the company’s revenues declined by 5% compared to the year before in the Asia-Pacific region.

So, what do we do with the stock?

Every quarter, public companies report their financial results. This includes a snapshot of its assets and liabilities, as well as the revenues, expenses, and cash flow derived during the prior 3 months. We take a fresh perspective each time these numbers become available. Most important, in our view, is the conference call conducted with analysts where difficult questions are asked.

Based on last quarter’s earnings, which were released on February 5, and the accompanying conference call, we view the company at an inflection point and think the stock bottomed late last year at $102.22 (it’s up 44% since then).

The market welcomed the February 5 earnings report as the stock jumped 12% that same day. During their quarterly conference call, management articulated a plan to grow revenues and reduce expenses.

Management is guiding for a return to double-digit organic revenue growth over the next 6 months. It even sees China growing over the next six months.

Management introduced a “profit recovery plan” at the end of 2023. At first, it aimed to deliver incremental operating profit between $0.8 and $1 billion per year going forward. Now, it expects savings to be $1.1 to $1.4 billion with the lion’s share taking place after July 2024. For perspective, that constitutes 2.4% of Estee Lauder’s total market capitalization. While we don’t ever like to see a person lose their job, the plan unfortunately includes laying off 3-5% of Estee Lauder’s workforce.

Estee Lauder is a great company that has historically stood resilient during a recession. In fact, during the 2009 fiscal year, sales fell only 7.4% despite the economic backdrop that bankrupted many businesses. Furthermore, the company maintained its dividend during both the 2008-09 global recession and the 2020 pandemic.

Rather than sell the stock, we’re going to hold onto it through the summer to see if management succeeds in delivering on its promises, which include: (1) a return to organic revenue growth, and (2) progress on its profit recovery plan to reduce costs.

Should management fulfill these two promises, we see a clear pathway for the stock price to trade well over $200 per share, making it a strong contributor to future capital gains for our clientele.