Estee Lauder: Wide-Moat Beauty Leader at Compelling Discount; We Suggest Investors to Stock Up

We view the shares of wide-moat Estee Lauder EL as compelling, trading at a 29% discount to our $256 fair value estimate. The stock sold off 27% year to date due to a slow post-COVID-19 recovery in China, but we don’t view the challenges as structural and long term in nature. We expect the firm to return to its historical growth trajectory by leveraging strong brands, tight channel relations, and research and manufacturing initiatives in Asia to reinforce its positioning. Shares of this beauty leader rarely go on sale, and we recommend investors looking for exposure to beauty to stock up on the name.

We believe Estee has carved out a solid position in the $360 billion global beauty market. Its intangible asset-driven moat is premised on top-selling prestige brands and on agile and thoughtful channel strategies underpinning strength in brick-and-mortar retail and on digital platforms. The firm also benefits from a competitive cost structure thanks to scale efficiencies in procurement, manufacturing, and distribution. Its competitive edge is evident in returns on invested capital (including goodwill) that exceeded our 7.3% weighted average cost of capital estimate in the past 10 years, and we project excess investment returns to continue over the next 20 years.

In the coming decade, we expect premium beauty demand to expand at mid-single-digit rates each year, and that Estee will outpace the overall market given its focus on the structurally attractive premium skin care market. We have modeled its top line to expand at 6% rate annually. Excluding a challenging fiscal 2023 for which we have modeled an 11% sales contraction due to inventory issues in China, our top-line growth estimates would average 8%, close to its 9% average the past five years. On profitability, we expect operating margins to expand by 200 basis points to 22% by 2032 (versus 2022), driven by a better channel mix (away from heavy promotions in department stores) and manufacturing efficiency gains.